Some major US firms feel edge of lower credit ratings
| New York
The bond-rating services are beginning to lower the boom on some major American companies.
Investors are now discovering that Standard & Poor's Corporation and Moody's Investors Services, the two major debt-ratings services, are cutting credit ratings for a large slice of US industry.
For affected corporations, these cuts translate quickly into higher borrowing costs at a time when interest rates are dear.
For investors, it is a sign they may face increased risks. The rating systems are designed to differentiate between the various financial risks involved in buying the debt of a company or municipality.
Investors might normally expect to see some downgradings because of the impact of the recession on the corporate balance sheet. But, both ratings services say they try to ignore the impact of a recession -- and a boom -- in making their judgments. Instead, they look at the longer-term business and financial prospects for a company. And those prospects for a whole host of companies, both rating services note, have turned less bright.
According to the ratings services, there are fundamental -- even structural -- changes that are altering the long-term outlook for many corporations. These changes are now being reflected in the lower ratings.
Standard & Poor's last year lowered the credit rating on 104 companies. Since then, it has dropped the rating for 49 more. Moody's, says Kenneth Pinkes, director of industrial research, has downgraded ''more companies than you normally would expect.''
The principal industries hit by the ratings blitz have been the hard-core ''smokestack'' companies which produce such goods as steel, automobiles, and chemicals. However, the downgrading has spilled over into the airline, mining and metals, utility, finance, forest products, and building materials companies. It has also hit savings-and-loan organizations.
Both credit-rating agencies agree the principal villain has been inflation. ''A lot of companies decided to finance their acquisitions or expansions with debt, much of it short term,'' notes Mr. Pinkes. This ''was fine when business was booming and you could make up the increased interest expense with strong sales. You could pass on the increased cost to the customer.. . . But now, interest costs have stayed high, and sales have declined.'' Corporations have little or no chance of passing on their high borrowing expenses.
This has taken its toll on the financial position of many companies. Leo O'Neill, group vice-president at Standard & Poor's, says, ''The relative return on investment is not where it used to be, nor is it expected to improve.'' Mr. O'Neill says the financial problems are more serious than that of short-term cash flow difficulties. ''The return on invested capital for a portion of US industry has declined below the cost of money. Given that situation, there is little incentive to reinvest in new plant and equipment since the profit is less than the cost to make it.''
For many of the companies the ratings reflect long-term problems they may have meeting foreign competition - particularly from Japan. Mr. Pinkes says many of the ratings take into account ''deteriorating productivity gains over an extended period of time.''
Companies are also downgraded when their financial flexibility is diminished due to an acquisition. Recently, S&P downgraded Standard Oil of Ohio from AA to AA-, noting that it had spent $1.8 billion to buy Kennecott Corporation and $600 million to buy some coal properties from US Steel. S&P also noted that Sohio is ''moving into cyclical, low return industries . . . that it has an undemonstrated track record.''
Another example of a recent downgrading is AMAX Inc., a mining concern based in Greenwich, Conn. S&P recently dropped AMAX's rating on its long-term debt from A+ to BBB+ and on its commercial paper from A-1 to A-2. According to Jay Lassner, a bond trader at Salomon Brothers, this cost AMAX about 75 basis points on its commercial paper. With $175 million in commercial paper outstanding, it added approximately $1.3 million in interest cost to the company. And, since AMAX is close to issuing $160 million in long-term debt, it will also add to this cost.
Fortunately for AMAX, the rating downgrading still kept its debt in the ''investment grade category.'' This ensures the company that institutions that have established guidelines mandating that they buy only such debt, will continue to be lenders. However, as O'Neill notes, many of the money market mutual funds will buy only the top-rated commercial paper. Money market funds buy 30 percent of the commercial paper issued.
According to Gail Silberman, the S&P analyst who did much of the work on the AMAX case, the decision to lower the rating came from both a deterioration in its financial position and from the long-term outlook for the company's products. The financial position clouded over, she says, because the company had borrowed more money in relation to equity than it should have.
On a more fundamental basis, it was decided the outlook for molybdenum, which is used in making stainless steel and other alloys, had diminished. Molybdenum generates half of the company's operating earnings. With greater supplies of molybdenum on the market and lower demand, she decided AMAX would have trouble returning to previous cash flow and earnings levels.
For its part, AMAX's chairman issued a statement saying it disagreed with S&P and thought its prospects were excellent because of its long-term reserves. The company sees more growth once the economy picks up.
According to Mr. O'Neill, virtually all companies appeal a ratings downgrading. About one-third are successful since they often present new information that the analyst had not seen before. And not all companies felt the downgrade boom -- S&P last year upgraded 85 and this year has upgraded 49.
The stock market tried to stabilize last week as some investors started shopping for bargains. The Dow Jones industrial average managed a gain/loss of 9 .99 points, closing at 797.37. High-technology stocks were hard hit after Honeywell said its first quarter earnings would be below expectations. The weakness in computers spilled over to such companies as Teledyne, GCA Corporation, and Digital Equipment.
What the bond ratings mean Ratings Description AAA Extremely strong AA Very strong A Strong BBB Adequate BB, B, CCC, CC increasing degrees C and D ratings are for bonds that are no longer paying interest; they are already in default. Standard & Poor's Corporation