March 1, 2021

AAA Rating Is a Rarity in Business

Scores of big corporations have lost their AAA 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 AAA 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 AAA 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 AAA, 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 AAA 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 AA because of the new pension arrangement.

“Maintaining a AAA 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 AAA ratings.

Still, a funny thing happened when these companies were sent down to AA. 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.

For most Americans, the prospect that the government could lose its AAA 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 AAA 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 AAA grade, the markets suggested long ago that the United States was no longer deserving of such a high rating.

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