AAA Rating Is a Rarity in Business
Hanging over the debt ceiling negotiations in Washington has been the threat that the United States could lose its triple-A credit rating, a coveted measure of the federal government’s financial strength. But in corporate America, the top rating long ago became an anachronism.
Scores of big corporations have lost their triple-A status in recent years—only four non-financial companies continue to hold the rating—as it became seen in board rooms as more of a straitjacket than a path to riches. Just as many consumers relied on their credit cards to finance a higher standard of living, companies took on more debt to reap bigger returns.
The choice did not appear to hurt them. The borrowing costs of companies with triple-A ratings and those one level below are not that far apart. Investors, in other words, do not see much difference in quality.
“It’s like you are going from a Rolls-Royce to a Mercedes—not from a Rolls-Royce to a Yugo,” said Chris Orndorff, a senior portfolio manager for the bond giant Western Asset Management. “That’s nothing to be ashamed of.”
More and more, in fact, companies have found that a triple-A credit rating is not something worth aspiring to if a more conservative approach means lower profits.
Today, markets often render credit judgments before the rating agencies can take out their pens, so a downgrade has a less noticeable effect. By that time, many of the traditional benefits of being deemed triple-A, like lower borrowing costs and reputational glow, have evaporated.
In the early 1980s, around 60 companies had AAA credit. By 2000, the number of AAA companies was about 15. Today just four corporations—Automatic Data Processing , Exxon Mobil , Johnson & Johnson and Microsoft —can claim those once-coveted three initials. (Five big insurers and several government affiliated organizations can too.)
Analysts say corporate buyouts and acquisitions accelerated the trend. Many triple-A companies lost their ratings when they were taken over and their new owners loaded them with cheap debt to help pay for the deal. Other strategic decisions also triggered downgrades.
UPS , for example, struck a long-term agreement with its union workers in fall 2007 that raised pay and benefits but froze certain pension obligations. Soon after, the ratings agencies started knocking down the company’s credit rating to double-A because of the new pension arrangement.
“Maintaining a triple-A rating is not a financial goal of this company,” a UPS spokesman said at the time. Investors barely reacted. In the three months after the downgrade, yields on UPS bonds responded by increasing about 0.4 percentage point from 5.32 percent. Today, with borrowers enjoying ultra-low interest rates, the bond yields are back to their levels in late 2007.
Meanwhile, the financial crisis and deep recession laid into several of the sturdiest pillars of American capitalism. Berkshire Hathaway, General Electric and Pfizer all lost their triple-A ratings.
Still, a funny thing happened when these companies were sent down to double-A. Investors shrugged off the change; the markets had already rendered their verdict. Borrowing costs for General Electric and Berkshire actually fell in the weeks after they were downgraded in spring 2009, amid a broader market rally.
“The rating agencies were late to the party,” said Mr. Orndorff, the bond investor.
Ratings for companies and countries are viewed differently, even if they are evaluated in much the same way.
Unthinkable May Be Inevitable
For most Americans, the prospect that the government could lose its triple-A credit rating is almost unthinkable—a blow to national pride and consumer confidence that could turn out to be more damaging than any increase in borrowing costs.
That is why even after President Obama signed a law on Tuesday that lifted the debt ceiling, some in Washington were worried that the plan’s spending cuts were not deep enough to appease all the major rating agencies.
For now, all three major rating firms continue to give the United States a triple-A rating. But on Tuesday, Moody’s said its outlook was negative after putting the government on notice last month that it could be downgraded. Fitch said on Tuesday that it planned to complete another review of the government’s finances by the end of this month, and Standard & Poor’s has warned that the United States might lose its rating if it did not sharply rein in the deficit.
It helps, of course, that the dollar remains the world’s leading currency, ensuring that demand for United States debt is strong in spite of the nation’s myriad financial challenges.
But the truth is, even as the government maintained its triple-A grade, the markets suggested long ago that the United States was no longer deserving of such a high rating.
The credit-default swap market provided one clue. During the financial crisis in early 2009, the price of insurance that would pay off if the United States government defaulted on its debt was similar to that offered for companies ranked just above junk. Even today, the price of insurance on a government default has been higher than that for Colgate Palmolive, the global toothpaste giant, which has a rating two notches below triple-A.
The economic data also suggests that the United States has higher debt levels than most AAA corporate borrowers. Today, the United States debt as a percentage of the nation’s economic output is 75 percent and could top 84 percent by 2013, according to Standard & Poor’s research. The typical triple-A-rated country has a ratio of about 11.4 percent.
By contrast, Exxon Mobil and Microsoft each had debt-to-income ratios exceeding 20 percent, while Automatic Data Processing had a ratio of 1.8 percent, according to Capital IQ, a business owned by Standard & Poor’s. Johnson & Johnson had a ratio of 92 percent.
But unlike Washington, there is no threat to the triple-A credit rating of Johnson & Johnson. That Johnson, the 125-year-old maker of Tylenol and Listerine, could have a better rating than the country in which it resides would be unusual but not a first
Toyota retained its triple-A rating for several years after a sluggish economy led the rating agencies to start downgrading Japanese government debt in 1998.
Today, a handful of European corporations, like Portugal Telecom or Helecom of Greece, have received higher ratings than their fiscally troubled homelands. That is because a big portion of their revenue comes from foreign customers. In the last few weeks, the ratings agencies have made it clear that lowering the triple-A rating of the United States government was unlikely to cause any triple-A-rated American company to lose its rating—at least in the coming months.
But longer-term, top-flight ratings for American companies could be jeopardized if the government’s effort to get its own finances under control caused a slowdown in economic growth.
“What agreement there is on the deficit, and what spending is going to be or not be, will have an impact,” said John J. Bilardello, the head of corporate ratings at Standard & Poor’s.
A downgrade of a country rating can ripple through other entities that rely on the government for support, potentially raising borrowing costs across the economy. These include mortgage bonds issued by Fannie Mae and Freddie Mac, as well as debt sold by dozens of states and counties whose local economies have strong ties to Washington. It also could affect about a dozen insurance companies and too-big-to-fail banks, whose ratings benefit from the perception that the government would bail them out if they ran into trouble again.
But could an American company’s credit really be more solid than the full faith and credit of the United States? The ratings agencies may say so one day, but lawmakers and citizens might have a reaction like that of Warren E. Buffett, after his Berkshire Hathaway lost its prized triple-A status in 2009.
“We’re still triple-A in my mind,” he said.