Triple-A Ratings Are So Yesterday
UNIDENTIFIED PERSON, BYLINE: NPR.
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STACEY VANEK SMITH, HOST:
So this is the season when going to the gym is hard. And, you know, everybody's a little soft from the holiday calorie extravaganza, so, you know, a lot of people slide a little bit. You know, like, you want to make sure you can get into your pants. But it's not like the summer, when you got to wear dresses and tank tops and swimsuits and, there's just all this pressure to look good.
CARDIFF GARCIA, HOST:
Yeah, it's like we all have this kind of deal in the winter...
VANEK SMITH: Yeah.
GARCIA: ...Where it's like, we're a little out of shape. But also, we're wearing clothes that hides the fact that we're out of shape, so it's fine.
VANEK SMITH: Exactly, it's fine.
GARCIA: You know?
VANEK SMITH: And, in fact, this is exactly what is going on in the bond market right now.
GARCIA: It's getting love handles, or...
VANEK SMITH: Bond market is getting love handles.
VANEK SMITH: Yes. And, in fact, it is best illustrated, I think, by today's indicator, which is two.
VANEK SMITH: Two - that is the number of companies in the U.S. that have a triple-A credit rating. So triple-A is basically the bond market's version of swimsuit ready; you know, like the guy who's always ripping off his shirt. Basically, there are only two companies that are in a position to do that - Microsoft and Johnson & Johnson. Those two companies have a triple-A rating. Nobody else does.
GARCIA: John Lonski is the chief capital markets economist with Moody's Analytics, which is owned by Moody's Corporation, one of the firms that gives out these ratings.
VANEK SMITH: That's so few companies.
JOHN LONSKI: The days have long since passed where companies strove to have the highest - the triple-A rating.
GARCIA: John says that the number of triple As has been sliding for years, and the reason has everything to do with interest rates.
This is THE INDICATOR FROM PLANET MONEY. I'm Cardiff Garcia.
VANEK SMITH: And I'm Stacey Vanek Smith. Today on the show, hold on to your doughnuts. We look at why the bond market is letting itself go; why everyone's gotten soft and what it means.
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GARCIA: OK. So first, we should explain how the whole bond rating system works. A company's credit rating is a lot like a person's credit score. So, like, if you have a super-high credit score, the bank will lend you a bunch of money really easily. It'll let you take your time paying it back, and it'll charge you a really low interest rate on the loan. They know you're good for the money. They'll get paid back.
VANEK SMITH: But if you have a low credit score, it's a very different story, right? I mean, the bank might not lend you money at all. And if it does, it will probably charge a really high interest rate and, you know, want you to pay the money back ASAP because you are seen as riskier - less likely to pay back the money.
GARCIA: And it works in a similar way with companies. When companies borrow money, they issue bonds, and those bonds have a rating. Those ratings are generally determined by three ratings agencies - S&P, Fitch and Moody's. And the highest grade is a triple A, then down to double A and single A. And then goes all the way down to single D. You don't want that one.
VANEK SMITH: Single - that's - no, you don't want to be a single-D company. But there is this really important indicator in the bond market, and that is between triple B and double B. And if you cross that line, it is a big deal. They actually call companies that cross this line fallen angels.
GARCIA: Yeah. Triple B and above, you are investment grade. Double B and below, your bonds are called junk bonds or, to be more polite and scrupulous, high-yield bonds.
VANEK SMITH: Sounds way better.
GARCIA: Yeah, it sounds way better than junk bonds. But also calling it high-yield makes sense because a company typically has to pay a really high yield or a high interest rate on its bonds. They have to pay investors a premium to lend them money because that low rating means your company is seen as risky.
VANEK SMITH: And if you're below triple B, in junk territory, a lot of investors cannot buy your bonds. So, like, pension funds and investors that are supposed to be really safe will not lend you money if you cross that line from triple B to double B. It can make it really hard to get a loan.
GARCIA: Now, if you're a company - seems like you would want to be triple A, right? The best of the best, the highest credit rating - you're as safe as can be. And then that means that you can borrow money for super cheap because you're top of the class. You're Lisa Simpson.
VANEK SMITH: You're Lisa Simpson.
GARCIA: John says that used to be true. Back in the 1980s, when he started his job at Moody's, there were dozens of triple-A-rated companies in the U.S.
VANEK SMITH: Wow.
LONSKI: OK, so that's quite a...
VANEK SMITH: Yeah.
LONSKI: So the world has changed.
VANEK SMITH: OK. What are some of the companies that had triple A?
LONSKI: Ford, GM, DuPont, IBM, General Electric, Merck - a lot of pharmaceuticals; Warner-Lambert - Exxon - oil companies; Exxon, Gulf Oil, Mobil Oil, Texaco.
VANEK SMITH: So what happened? For one thing, says John, triple A is hard to achieve. A company basically has to have a lot of cash on hand relative to its debt because triple A means that, basically, there is no way you're going to default on your loans. You've got the money right there - money at the ready. And in return, you can borrow money for super cheap.
GARCIA: And that's where we get to the why. Why are so few companies aiming for triple A? The answer is low interest rates.
VANEK SMITH: So you know what? The Federal Reserve has kept interest rates low for years. It does that to stimulate the economy because low interest rates make loans cheaper. That is supposed to encourage businesses to take out more loans, to expand, hire more people, build more buildings - generally get bigger. And interest rates have been really low for a really long time - for more than a decade.
GARCIA: And because interest rates are so low and have been super-low for so long, even if you are a company with a not-awesome credit rating, you can still get loans for super cheap. Loans are super cheap for pretty much everybody, for all companies. So there's, basically, no reason to go to all the trouble of getting a good credit score and jumping through all those hoops and having cash sitting around.
VANEK SMITH: What is the meaning of a triple A then if - is there one now? Bragging rights. Claire Boston is a credit reporter at Bloomberg News. She says if you weigh bragging rights against the ability to spend with abandon sans consequences, companies are like, bring on the cheap loans.
CLAIRE BOSTON: Basically, they're looking at how expensive it is to borrow. And they're saying, well, you know, we used to have to work really hard to maintain this A rating. But now we can borrow so cheaply, even if we're rated, say, triple B, which is the sort of tier that is just above junk.
VANEK SMITH: Like, why am I killing myself for an A...
VANEK SMITH: ...When it doesn't really matter?
BOSTON: When I can get a triple B and it's, basically, the same price - so one of the things we've seen is the universe of companies that are one tier above junk - that triple-B tier and specifically the triple-B-minus tier, so one grade...
VANEK SMITH: But people are, like, doing the minimum. It's like...
VANEK SMITH: ...Figuring out the lowest possible grade you can get to pass a class...
VANEK SMITH: ...Like, on your final and then just aiming for that.
BOSTON: So that has absolutely ballooned.
GARCIA: Along with corporate debt, by the way - it's at an all-time high - record levels. U.S. companies owe nearly $10 trillion.
VANEK SMITH: That is huge. That's, like, a giant chunk of our economy.
GARCIA: Yes, it is.
VANEK SMITH: Meanwhile, more and more companies are sliding by with their barely passing triple-B grade - big, wealthy companies like McDonald's, Fox, Verizon, AT&T, Western Union, Kraft Heinz. They are all issuing bonds that are just above the junk rating. And why not? So you get a little belly. No one will see it under your sweater. Have a cookie. Have two cookies. Have the box.
GARCIA: Now the metaphor comes into focus.
VANEK SMITH: (Laughter).
GARCIA: I love it.
VANEK SMITH: Yes.
GARCIA: Yeah, it's totally fine until it's time to jam yourself back into a swimsuit. That's what John Lonski of Moody's Analytics says.
VANEK SMITH: I mean, when you look at the situation right now, does it concern you?
LONSKI: Oh, yeah. Let me put it this way. With a higher level of debt to income, the economy will have more difficulty handling an unforeseen drop in business activity. Basically, the public and private sectors have, if you like, surrendered financial flexibility that could be sorely needed in the time of an economic slump.
VANEK SMITH: So if the economy turns south, things could change fast in a bad way, says John. Companies will have a ton of debt. Suddenly, they're making less money. They might not be able to pay back that debt, and they're all already teetering just above a junk rating. It could be easy to slide into junk status, become a fallen angel and, you know, maybe get stuck in a kind of spiral.
GARCIA: A bunch of really high-profile companies are already in junk territory. One ratings agency just downgraded Ford's debt to junk status. Also junk - the bonds of Twitter, Netflix, Xerox, Tesla, J.C. Penney. Claire Boston with Bloomberg says investors have gotten worried about this.
BOSTON: Last year, as a result of the worry, the companies came out and said, OK. We're going to cool it. And so now those companies are working really hard to try to pay down their debts. We've seen CEOs even have their compensation tied to maintaining certain ratings.
VANEK SMITH: Why - because people are starting to get nervous, like they're, like, walking so close to the edge?
BOSTON: Exactly. And so companies have basically said, OK, we're going to go on a debt diet. Like, we're going to make our priority paying down this debt.
GARCIA: Yeah, I guess spring is not that far away.
VANEK SMITH: No, it never is.
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VANEK SMITH: This episode of THE INDICATOR was produced by Darius Rafieyan. Our intern and fact-checker is Brittany Cronin. And THE INDICATOR is a production of NPR.
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