U.S. credit quality continued to deteriorate sharply in the first quarter, as downgrades outnumbered upgrades by a margin of 4.7-to-1 according to a report from Moody’s Investors Service.

That marked the steepest decline in corporate credit worth since the fourth quarter of 1990, when downgrades exceeded upgrades by a 6.3-to-1 margin. However, an analysis of Moody’s outlook changes in the first quarter suggests that “credit deterioration will slow and corporate credit worth may soon bottom.”

Moody’s economist John Puchalla said, “Improved operating cash flow, lower debt relative to EBITDA, lower interest expense, and debt reduction contributed to the stable to positive outlook changes for many corporations.” Also factoring into new positive rating outlooks were divestitures, common equity offerings, reductions in high coupon/dividend-paying securities and utilizing the proceeds of note sales to pay down short-term debt and lower refinancing risk.

“A rebound in corporate profits and capacity utilization should help to narrow the gap between upgrades and downgrades,” said Moody’s chief economist, John Lonski. “However, debt service will need to lag behind cash flow for several years before upgrades can surpass downgrades again.”

“Assuming a containment of hostilities in the Middle East, including the absence of destabilizing terror attacks elsewhere, by the final quarter of 2002, cash flows might recover by enough to help lift credit rating upgrades from their latest 9.5 year low,” said Lonski. “A healthier stock market could facilitate mergers and acquisitions and a larger volume of equity offerings that would also help to improve credit worth.”