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A limit to Kraft’s sweet tooth

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Cadbury’s swift rejection of Kraft’s $16.7 billion offer has set off widespread speculation that Kraft will bump up its bid to ensure that it becomes king of candy land.

There is a limit, however, to how much Kraft can pay if it is committed to its investment-grade ratings. The company’s ratings sit two to four notches above speculative, or junk, territory, and every dollop of extra debt to pay for the acquisition would pressure the company’s ratings, making this and future financing much more expensive.

During the last merger and acquisition boom, ratings often became secondary for many firms, since the difference in the cost of financing for investment-grade companies and junk-rated companies had narrowed.

The credit crisis and the re-pricing of risk, however, mean the consequences of losing a sterling credit rating is much greater.

Breaking the credit ratings habit

How many times do investors need to rail against rating firms’ credibility before things really change? Standard & Poor’s set off the most recent round of vitriol on Tuesday after it raised the ratings on bonds backed by commercial mortgages back to sterling AAA just a week after it cut them. It tweaked its assumptions after investors complained about the downgrades.

There’s good reason to be upset. Ratings changes still have real world consequences, even though the credit crisis has gone a long way to discredit them.

Fitch comes out swinging on California

Fitch Ratings is at it again. The credit rating firm cut California’s general obligation bonds by two notches to BBB, leaving the rating just two notches above junk. Fitch had already cut the state’s full faith and credit bonds one notch on June 25.

The junk threshold is an important one to keep in mind. If it’s breached, fund managers who can only invest in investment-grade credits would be forced to sell, causing valuations to tumble further. It would also turn up the pressure on legislators to sort out their differences and close the $26.3 billion budget gap.

California stares at possible ratings downgrade

It was only a matter of time before another ratings agency weighed in to warn that California could see its rating slashed if it doesn’t get its fiscal house in order soon. Moody’s Investors Service said that the state’s rating could be put on the chopping block for multiple downgrades.

It’s unlikely that California, among the biggest issuers of municipal debt, would be shut out of credit markets should its ratings slide further, but it would face steeper financing costs at a time when it’s running out of precious cash.

Really, a new type of rating will make a difference?

The Obama Administration’s expected to require rating agencies to differentiate the ratings it applies to corporate bonds and more complicated securities to give investors a heads up that some debt is not the same as others.  Wall Street, unsurprisingly is opposed to the idea, since it could sap demand out of the already lackluster securitization business. But, this all seems a bit silly. If investors need a different rating to let them know what they are investing in, they’ve hardly learned much from the debacle of the last two years.

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