By Nicole Bullock in New York
The creditworthiness of US corporate borrowers has fallen sharply in the past three decades as companies have taken on more debt to boost returns to shareholders, according to a report from Standard & Poor?s.
The number of triple A-rated non-financial US companies has dropped to four from 61 in 1981, while groups with ?junk? ratings now account for more than half the companies S&P rates in the US, up from 24 per cent 30 years ago.
?Fallen angels?, or investment-grade companies that have been downgraded to junk, have contributed only a small part to the shift in US corporate ratings. The main reason for the change has been a surge in newly rated junk companies. More than half first-time debt issuers have had junk ratings every year since 1992, with 2001 being the only exception, S&P said.
The decline in US interest rates over the past 30 years has contributed to this, too, prompting investors to buy lower-rated but higher-yielding debt to increase their returns.
Corporate managers have embraced a philosophy that a company can maximise its valuation by replacing equity with debt because interest payments are tax deductible. ?While corporate managers? preference for debt in the capital structure over equity may have helped to improve short-term stock returns, this boost frequently came at the expense of lower credit ratings,? said Diane Vazza, head of global fixed income research at S&P.
The growing prominence of leveraged buy-outs, which require debt that typically results in downgrades to junk ratings, or newly rated junk companies, illustrates the trend. Broad syndication of bank loans, largely used to fund LBOs, to institutional investors has also resulted in a new crop of junk-rated companies.
Technology, regulatory changes, consolidation and privatisation have transformed some industries, too. Telecoms, transport and media and entertainment are among the sectors that have become predominantly junk-rated.
Deregulation in the telecommunications sector led to big rise in new small companies financed with junk bonds in the 1990s, while recent expansion and consolidation in gaming and media has driven an influx of new junk-rated debt.
The migration to junk ratings ?will drive greater volatility in specific sectors such as telecoms, where the share of [junk] ratings went from 3 per cent to 84 per cent, and lead to pops in the overall default rate in times of recession,? Ms Vazza said.
The US default rate rose to 11.5 per cent of speculative grade-rated debt issuers in 2009, 10.9 per cent in 2002 and 12.5 per cent in 1992. The average default rate since 1981 has been 4 to 6 per cent. Although investment-grade companies are now the minority in the US, they issue the majority of debt. Most investment-grade companies are larger institutions; financial groups, which are still mostly rated investment grade, account for much of the total US debt issuance because their business models rely on large amounts of debt funding.
? The Financial Times Limited 2012