Doing a Buyback? Here’s How to Avoid a Debt Downgrade

Moody's study finds that excess cash, careful funding that uses future cash flow are among the reasons that 56 percent of repurchases result in no ...
Roy HarrisOctober 25, 2007

Stock-repurchase announcements don’t spark credit-rating downgrades in 56 percent of cases, according to a Moody’s Investors Services study of 100 recent stock buyback programs. The ratings service noted that the result is surprising because of the buyback’s “reputation as running counter to the interests of bond holders.”

The study, examining repurchases announced over the past 19 months, showed that only 44 percent of the time “a change in rating outlook or a downgrade of one or more notches did occur.” Moody’s explained that the buyback’s size, its source of funding, and its timing seemed critical in determining whether a rating downgrade resulted.

“Negative rating actions are more likely when share repurchase programs reflect a significant shift in prior financial policies,” said report co-author Michael Levesque, a Moody’s senior vice president. “All the negative rating actions in our study resulted from repurchases that increased debt enough to move the needle on leverage ratios, debt-service ratios or other metrics to a lower rating.”

According to the study, the potential for negative rating actions was reduced by factors that included an excess of cash on the balance sheet, operating cash flow, or asset sales. Those conditions “alleviate
the need for incremental debt, easing downward rating pressure,” said lead author Mell Matlow, a Moody’s associate analyst.

Matlow noted that ratings also are more likely to be retained if a repurchase is funded with future operating cash flow, rather than incremental debt, or if the rating service is confident about the predictability of this cash flow.

A stock buyback that is small enough to avoid being material to credit quality also generally staves off negative rating. Likewise, Moody’s is likely to take no negative rating action if the company is seen as using the buyback only temporarily, placing “only a temporary strain on credit metrics, potentially up to one or two years.”

The rating service said that financing with asset sales is another factor in helping a company avoid a downgrade, especially if there isn’t an impact on collateral value or future earnings.