More Pain: Top-Rated Borrowers Increasingly Denied Credit

In this space last week, I covered several indicators in the markets to track the development or contraction of the credit cycle (see my April 16 blog). My reasoning is that despite an impressive rally in stocks since March 10th, credit markets have not improved to the extent that this rally can be justified. In fact, several credit indicators have deteriorated over the last six weeks with a marked slowdown in lending joining my list of bearish developments.

Lending to some of America’s top rated investment-grade companies has slowed as banks increasingly refrain from lending to even quality credits. As banks’ capital ratios continue to bleed this year amid a deluge of credit write downs, traditional forms of lending have contracted – affecting the ability of companies to finance or rollover existing loans. What is alarming is that credit is now harder to secure for prime borrowers.

U.S. investment-grade loan issuance declined 26% in the first quarter compared to 12 months earlier, according to Reuters Loan Pricing Corporation and The Wall Street Journal. That is definitely bad news for the economy, businesses and overall corporate liquidity, as companies struggle to refinance or seek new funding. In 2006 and 2007, companies borrowed more than $1 trillion dollars; the first three months of this year tallied just $68.6 billion in loan growth – a significant plunge compared to 2006 and 2007 levels measured on an annualized basis.

Investment-grade borrowers are companies with BBB credit ratings or better.

As I also noted last week, the current default rate among junk bond borrowers or companies rated below BBB, is still historically low at 2%. Previous recessions have resulted in an average 5% default rate, suggesting more pain lies ahead for those troubled companies that missed easy access to credit before July 2007, when subprime halted the “easy-money” train.

This story gets worse…

Moody’s reported last Thursday that an increasing number of American companies are now in their weakest financial position since 2001, as they struggle to pay bills and other operating expenses. Moody’s reports that 47 companies are in the midst of liquidity troubles, more than double the rate compared to June 2007.

The above data, combined with my Credit Check-List last week, shows that most credit indicators are actually deteriorating, not improving. This strongly suggests that the stock market is mustering a bear market rally, and eventually will head to new lows as the economy continues to contract this year.

The Federal government’s spending bill, which will hit American consumers this summer, will only temporarily boost the economy. The big picture for this economy is dominated by the contraction of credit, and that story still has a long way to play out before it is safe to aggressively buy stocks again. Remember, the smart money is in credit, not stocks. That is where I am looking for clues this bear market is bottoming.