By Camille Drummond - Analysis
NEW YORK (Reuters) - The AAA credit rating, once a point of pride for leading industrial companies, has lost its luster as confidence in ratings agencies has fallen and the number of companies in its ranks has dwindled -- sometimes by choice.
But other companies, most recently Pfizer Inc (PFE.N), have sacrificed top ratings for a more aggressive growth stance, often funded by debt.
While companies pay a price for reduced ratings in higher borrowing costs, analysts say the loss of a top-tier rating is not as dire a fate as in the past.
“Having pristine credit quality is not the most important factor for determining whether or not management has been a good steward of a corporation’s well-being anymore,” said Sean Egan, managing director at ratings firm Egan-Jones Group.
The allure of the AAA has been dimmed by the loss of confidence in ratings agencies, which have come under fire for assigning top ratings to risky mortgage securities that later defaulted -- moves that exacerbated in the ongoing financial crisis.
The three main agencies, Standard & Poor‘s, Moody’s Investors Service and Fitch Ratings, are paid by debt issuers to rate their creditworthiness on a scale that directly impacts the cost of selling debt. The top rating, AAA, was once a cherished grade, reflecting the solid financial position of the issuer.
“I don’t think there’s any real value in ratings today,” said Peter Schiff, president of investment firm Euro Pacific Capital. “That’s obvious, from the way they rated a lot of the structured products as investment grade.”
The agencies have “undermined their brand,” Schiff said, creating a “caveat emptor” reputation rather than one of trustworthiness.
The use of debt to fund business growth or reward shareholders has also increased in recent years, outweighing any perceived benefits from holding onto the top ratings rank.
Pfizer’s $67 billion acquisition of Wyeth cost the company the top ranking from Standard & Poor’s it held for 13 years. Pfizer will take on $22.5 billion in debt as part of the deal.
GE had less control when it lost its top rankings earlier this year, hit by losses at its financial arm.
The U.S. conglomerate had enjoyed a top credit rating since 1956, making it the oldest member of the AAA club. Exxon Mobil was created from a deal involving top-rated Standard Oil Trust, which earned that rating prior to GE.
GE is a “poster child” of the waning worth of the top-tier rating, said Egan. Shares of the blue chip company rallied about 10 percent after the news it was downgraded only one notch, which came after weeks of speculation it would be cut further.
Amid a growing embrace of all investment grade-rated companies in what Egan deems “a wholesale dilution of the AAA brand,” investors must find a different route to judge whether a company is sound or not, he said.
Egan said a shift in corporate culture that emphasizes shareholder returns over conservative financial policy -- a change S&P also cites -- is also aiding in the departure from traditional AAA value.
The Obama administration has proposed repealing legal rules on debt that encourage the use of ratings, as a way of reducing reliance on them.
The Securities and Exchange Commission is considering reforms and Representative Paul Kanjorski, House capital markets subcommittee chairman, has proposed legislation that would let the SEC dictate how agencies determine ratings.
Investors should “do their own due diligence” by hiring companies unaffiliated with underwriters and issuers to evaluate a company’s credit quality, said Schiff. “Obviously, these entities are not unbiased.”
Reporting by Camille Drummond; Editing by Andrea Ricci