Rather, it speaks volumes about the
impact of an adaptive approach to weighing costs and benefits in a mutating global economy.
Such a rating comes with costs required to maintain it. But in this financial and operational environment, the returns provided by that rating may no longer justify the effort and price of doing so. We live in an age in which it is possible to analyze our options to a degree not previously conceivable. A rating of any kind is a means to an end rather than a destination in itself. The judgments inferred may be less important to the long term prospects of the organization than the flexibility that less stringent standards provide.
Every outside assessment signifies something of value. What has changed is their relative worth to the institution. JL
Vipal Monga and MikeCherney report in the Wall Street Journal:
Once coveted and brandished by more than 60 companies and subsidiaries in 1980, the gold-plated triple-A credit rating has almost vanished from corporate America.
Who cares?
Only three companies — Microsoft Corp., Johnson & Johnson and Exxon Mobil Corp. — hold that distinction today, the lowest on record.
Not Jan Siegmund, chief financial officer of Automatic Data Processing Inc. The payroll processor lost the top credit rating on April 10 because it announced plans to spin off its dealer services business, which is focused on marketing for auto dealers and manufacturers.
ADP’s shareholders don’t appear to care either. Since then, the company’s stock is up 0.6%. ADP has no outstanding bonds.
“There was no fallout,” Mr. Siegmund said. “We feel that double-A is a perfectly fine rating.”
The decline in triple-A ratings reflects a shift in attitude among corporations and investors about the value, cost and risk of bonds. Historically low interest rates and economic growth have scattered investors in search of higher yields and dulled their fear of default. That has led to a steady, downward drift in credit ratings. In fact, 81% of newly rated companies in 2013 got a rating in the single-B category from Standard & Poor’s Ratings Services, which investors call “junk.”
Against that backdrop, investors see a negligible difference between the top two rungs of the ratings ladder, and trade them as if they had almost equal risk. So now more analysts and investors say shareholders of companies with the triple-A rating are actually paying for a privilege that offers little reward.
“It’s a very good question that any responsible CEO and CFO should consider: is having a triple-A rating worth it?” said Mark Puccia, a managing director at S&P, one of the rating services that downgraded ADP.
Credit ratings are the corporate version of an individual’s FICO score. S&P, Moody’s Investors Service and Fitch Ratings grade corporations on their ability to repay their debts. Unlike consumer credit scorers, however, the firms charge companies for the ratings.
The highest-rated companies have some distinct qualities, such as little debt, high cash flow and profit margins, strong brands and leadership positions in their industries, said Daniel Gates, a managing director at Moody’s.
In theory, that should make borrowing much cheaper for the triple-A companies. But the market isn’t treating the companies that way.
Microsoft, for example, sold $450 million of five-year bonds last April with a yield that was 0.32 percentage point over Treasury notes. Less than a week later, double-A-plus rated Apple Inc. sold $4 billion of five-year bonds with only a slightly higher yield premium of 0.40 percentage point. Both were among the lowest premiums ever paid by corporate borrowers.
As of April 22, bonds issued by double-A rated companies were trading with yield premiums only 0.05 percentage point higher than the highest-rated bonds, according to BarclaysBARC.LN -4.14%.
To be sure, the increase in overall risk could become a problem in another financial meltdown. Investors, in particular, found they liked holding triple-A long-term bonds in the wake of Lehman Brothers’ collapse. At the peak of the recent financial crisis, in April 2009, the yield spread between the top-tier bonds widened to 1.93 percentage points, the largest since 1998.
Jesse Fogarty, a portfolio manager at Cutwater Asset Management, said triple-A corporate debt is among the few things that can be sold during times of financial stress, making it useful if an investor needs to raise cash quickly.
“If you did need to raise liquidity, a triple-A Johnson & JohnsonJNJ +0.69% would be one of the best things you’d have to be able to do that,” said Mr. Fogarty, whose firm manages $25 billion, mainly for pension funds and insurance companies. “Many times in periods of stress, you don’t sell what you want, you sell what you can. These assets are kind of what you turn to.”
A Johnson & Johnson spokesman said the company likes the highest credit rating, because it gives the company “greater flexibility in managing our business, virtually unlimited access to the capital markets and the most favorable interest rates to finance our business.”
The pharmaceutical company sold $900 million of 10-year bonds in June 2008, as financial markets teetered, and was able to get them priced at a premium of 1.03 percentage points to comparable Treasurys. By contrast, PepsiCo Inc., which was rated Aa2 by Moody’s, sold $1.75 billion of bonds only a month earlier with a premium of 1.25 percentage points.
Maintaining the highest rating is a potentially expensive proposition for the companies themselves, said Joe Mayo, head of corporate credit research for Conning Inc., which manages more than $85 billion in assets, primarily for insurance companies.
“The benefit to them in terms of lower borrowing costs really is not that significant,” he said.
Many analysts argue that companies with pristine balance sheets are penalizing their shareholders by not borrowing enough money.
The highest-rated companies could increase shareholder returns by adding a bit more debt to their balance sheets and giving that money back to shareholders, said Martin Fridson, the chief investment officer at investment adviser Lehmann, Livian, Fridson Advisors LLC.
Microsoft, for example, could boost its per-share earnings by 10% if it borrowed $50 billion more to expand its buyback program, said Chris Hickey, analyst with Atlantic Equities. The software company reported per-share earnings of $2.58 last year.
“I don’t think triple-A as opposed to a double-A is meaningful to equity investors,” Mr. Hickey said.
A Microsoft spokesman declined to speak about the credit rating, but said the company has borrowed almost $25 billion in the bond market since 2009 and returned $189 billion to shareholders through dividends and buybacks over the past decade.
Mr. Siegmund, ADP’s finance chief, recalls the triple-A rating used to carry some weight. In fact, his sales force used it as a “prestigious element” when they approached new clients.
But now that the company has dropped to a double-A rating and clients and investors haven’t blinked, it is content to let that pitch-point go.
“We’re certainly not lobbying for” a return to triple-A, said Mr. Siegmund. “We’re very happy and content with our rating today.”
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