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Financial Times: Triple-A loses some of its allure


By Charles Batchelor

Published: April 27 2004 20:14 | Last Updated: April 27 2004 20:14  


Posted 28 April 04


The loss by Royal Dutch/Shell of its triple-A rating has reduced to just two the number of European non- financial companies to enjoy the highest accolade of the credit rating agencies.


Nestlé, the Swiss foods group, retains its triple A status, as does Novartis, the pharmaceuticals group. Elsewhere, just seven US companies and three in Asia have a triple A rating from Standard & Poor's, the largest of the big three rating agencies, while similar numbers achieve this distinction from rival agencies, Moody's Investors Service and Fitch Ratings.


In 1990, 11 per cent of telecoms companies rated by S&P were triple A but by 2001, privatisation, deregulation and heavy investment in new technology had taken their toll and none remained in the sector.


Ratings are intended to measure the probability of default - a vital tool for investors assessing risk in the bond and loan markets. They look at an issuer's ability to meet interest payments from cashflows but take in factors including management expertise.


The decline in the number of top-notch ratings is seen by the pessimists as a sign that corporate finances are in terminal decline. Each downturn produces a notching down of the average credit rating and, while companies rebuild their balance sheets in the subsequent recovery, they do not get back to the previous level of rating.


The loss of a triple A status is also a blow to a company's prestige. "In most cases [triple A] issuers are 'born', that is, rated [triple A] at first rating as opposed to reaching this elite status through an upgrade," wrote Diane Vazza, head of global fixed income research, in an S&P report.


But a fundamental change is taking place in the way companies, investors and creditors view ratings. Maintaining a top rating may mean a company can shave its cost of borrowings but there are other significant, countervailing costs.


"From a shareholder point of view it can be pretty expensive to maintain," said Mirco Bianchi, global head of ratings advice at UBS. "Some companies have to maintain it for strategic reasons - because they deal a lot with governments - but many companies are not defending their triple A rating."


Maintaining an unleveraged balance sheet pushes up the weighted average cost of capital a company has to bear. It can also impinge on a strategy that involves acquisitions. A single A rating - five notches below triple A - is regarded by some as the most efficient spot on the ratings graph.


Shell's loss of triple A status last week was involuntary but some companies take a deliberate decision to jettison it for more profitable alternatives. Unilever sacrificed its triple A rating to acquire Bestfoods, a US group. Previous acquisitions had already pushed Unilever to the limits of its triple A rating. When the company issued further debt to fund the $20.3bn acquisition of Bestfoods in June 2000 its ratio of earnings (ebitda) to interest fell to 5.6 times, triggering a ratings downgrade to single A-plus.


Companies would not have found it so easy to relinquish their triple A rating unless investors had proved willing to accept a greater degree of risk. Not only are investors ready to provide funds for companies that drop down the ratings scale; they are more willing to back companies that start out with a lowly rating; hence the rapid growth of the European market for "junk" or non-investment grade bonds.


A top rating has also seen its appeal eroded by the compression of credit spreads in recent years. As interest rates have fallen, the differential between the different rating categories has narrowed, so that slipping down a notch or two has less of an impact on the coupon demanded by investors.


There is still a cost, however. "Once you get down to triple B you get a much thinner market," said Barbara Ridpath, chief credit officer for Europe at S&P.


And it would be a mistake to think that the triple A rating is dead. It is still widespread among banks and financial institutions - though less frequently among banks than previously - and among sovereign issuers and structured bond products.


Sovereign issuers do not have to worry about shareholders seeking to maximise their returns but they do value the ability instantly to tap markets for funds at a fine rate of interest.


Structured bond issues - including securitised packages of mortgages and collateralised debt obligations - are created with credit insurance from a specialist or "monoline" insurer specifically to obtain the triple A rating.


In the struggle between bondholders and shareholders for position in the capital structure of companies, the past five years have seen a growth of bondholder power. The move down the ratings scale, by contrast, demonstrates shareholders reasserting their influence.

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