Over Rated?

The subprime fiasco has put corporate credit-ratings on thin ice.

Some of the SEC proposals address that very issue, but it remains to be seen how much will really change. The status quo persists at least in part because the Big Three have done their job in many or even most respects. But when you’re selling credibility, any mistake can be a killer. If other companies follow Brunswick’s lead and shrug off a downgrade, reform may become a moot point.

Alix Stuart is a senior writer at CFO.

Lessons in Self-Reliance

Many issuers sidestep credit ratings altogether by tapping the unrated private-placement market, where companies with good credit pay no premium versus rated debt. Aqua America, one of the largest private water utilities in the United States, routinely goes the private route to furnish $1.2 billion in long-term debt. CFO David Smeltzer applauds the cost-effectiveness. Besides avoiding hefty fees to Standard &Poor’s and Moody’s (as much as 4.25 basis points on a transaction’s face value), private placements impose no interest-rate premiums and carry lower closing and legal costs. “Heretofore, there has been very little differential in what we could get as a rated entity and without a rating,” according to the company’s investment bankers’ assessment of the market, says Smeltzer. To play it safe, Aqua America maintains an A+ rating at its largest subsidiary but often issues debt out of the corporate holding company or other subsidiaries.

Large institutional investors already stress self-reliance. A staff of 220 people scrutinizes potential fixed-income investments for the California Public Employees’ Retirement System, the country’s largest public pension fund. Insurance giant MetLife Inc., with $560 billion in assets under management, employs 100 analysts to assess creditworthiness. “The credit-rating agencies are here to stay, but there still needs to be an independent evaluation of credit,” adds MetLife CFO William Wheeler.

Corporate issuers without armies of credit analysts also look beyond rating agencies to evaluate debt owed them. Applied Materials, a $9.7 billion supplier to the semiconductor industry, uses “ratings as a reference point, but we have always looked through to the collateral” in choosing investments for its $3 billion–plus cash portfolio, says CFO George Davis.

As credit-rating agencies lose cachet, corporate finance executives should prepare to step up internal due diligence, say experts, or take cover. Cautious, recession-minded corporate treasurers are moving their cash into money-market funds that do not require credit ratings. A recent Association for Financial Professionals survey found that nearly 40 percent of corporate cash is in money-market mutual funds, up from 31 percent last year. Meanwhile, James Kaitz, the AFP’s president and CEO, has noticed more use of outside firms to validate credit quality. It adds another layer of cost to credit decisions, he concedes, but still may furnish the soundest alternative to a flawed system. — A.S.


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