Low Credit Ratings Don’t Faze Companies: S&P

Standard and Poor's traces the decline of corporate ratings to the growing appetite for risk, which has gained much wider appeal since the risk-ave...
Alan RappeportOctober 9, 2007

Aggressive risk-taking has diminished company credit ratings, Standard and Poor’s said this week. To be sure, the summer’s credit squeeze may have tamed corporate tactics a tad. But the crunch is unlikely to keep them mild for long.

The ratings agency’s new report found that the median credit rating for non-financial corporations in the United States was ‘BB-‘, down from ‘BBB-‘ in 1997 and ‘A’ in 1980.

If history is a reliable guide, the latest turmoil in the credit markets may cause a lull in the allure of debt, but not a full retreat. Companies returned to high-risk strategies soon after credit market problems in 1997 and 2000. “Capital markets will force a pullback from more extreme leverage and a rebalancing of financial priorities — until the next cycle begins,” Standard and Poor’s said.

Ratings have shown a steady decline during the last decade, according to the report. “Several factors have fueled this trend: an influx of mostly speculative-grade first-time issuers, the LBOs (leveraged buyouts) of some companies, and a move toward more aggressive financial policy,” it said.

Standard and Poor’s traces the decline of corporate ratings to the growing appetite for risk, which has gained much wider appeal since the risk-averse days after the Great Depression. Meanwhile, financial innovation has changed the perception of debt, which companies now use liberally to increase returns on equity. “What was once an admission of financial weakness or an unfortunate necessity became just another form of long-term capital, and a tax-deductible one at that,” the report said.

Many market forces are responsible for companies’ more liberal use of leverage. Low interest rates, narrow bond spreads, the leveraged loan market, the advent of the credit default swaps market, and ties between executive pay and share prices are among the factors that have encouraged firms to use more debt, according to Standard and Poor’s.

Along with the appeal of debt has come diminished concern about low credit ratings. Companies once strove for the highest ratings, but now, said Standard and Poor’s, “a higher rating is not necessarily a ‘better’ rating.” In fact, just 30 percent of industrial companies are considered investment grade.