Commentaries

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Investors ignore ratings at their peril

    Rexam is delivering a nasty surprise to its shareholders, but the logic of its proposed rights issue is hard to fault.
    If trading turns out to be as bad as the board expects, then the penalty payments for refinancing its existing debt will far outweigh the cost and dilution of the issue.
    Broker Oriel Securities reckons the cost to Rexam if it loses its investment grade rating will be an extra 8 to 12 million pounds a year in interest payments.
    Businesses everywhere are rediscovering the joys of equity, as the way to stave off the dreaded downgrade. So far this year, shareholders have put up $119 billion, according to Thomson Reuters data, with $28 billion more due.
    Even cash-rich carmaker Volkswagen is reported to be considering issuing shares to bolster cash reserves and pre-empt any ratings downgrade relating to its merger with Porsche. Spanish utility Iberdrola and French construction groups Lafarge and Saint Gobain all took similar steps to bolster their ratings.
    Unfortunately, credit ratings agencies are so jumpy about regulators and the risks of legal action by investors that companies can’t always bank on such moves working.
    Saint Gobain launched a rights issue, but still S&P cut it to BBB from BBB+. Lafarge did worse. Fitch not only cut its rating to BBB-, it added a “negative outlook”.
    One reason ratings have increased in importance is that as banks have turned off the taps, companies have turned to the bond markets, allowing the agencies like Moody’s Corp and McGraw-Hill’s S&P to cash in.
    Experience has taught them caution, however, and the number of issues downgraded from investment grade to junk is on the rise. The threat of this — with the higher cost of borrowing and reduced market access it brings — is a powerful incentive to go to the shareholders. S&P has identified 75 issuers — with $255 billion of debt — in danger of losing their coveted investment grade.
    The unhappy experience of Rexam shareholders is likely to repeated many times as the debt crisis unwinds, but at least it’s better than losing control of the business to its lenders.

Credit conditions good, credit quality not so much

In line with the grim mood taking hold of financial markets, S&P’s Dianne Vazza just emailed around a report that drives home the point. U.S. companies are still struggling even if access to credit markets has improved.

Thanks to a nice boost from government intervention in short-term markets, the risk premium on the S&P index for investment-grade corporate bonds fell more than 270 basis points from a peak of 578BPs in mid-Dec. Yet in the last 12 months, S&P axed corporate credit ratings 229 times, the highest number in a one-year period since March 1990 to March 1991. And there’s likely more to come, with 27.5% of all investment-grade issuers on watch for a downgrade or with a negative outlook that signals a company is heading in the wrong direction.

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