UK: Debt that loses its gilt edge.

UK: Debt that loses its gilt edge. - A drop in credit rating may not be the disaster it seems.

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Last Updated: 31 Aug 2010

A drop in credit rating may not be the disaster it seems.

Is your business an impressive AAA or a C, a one or a 10, prime or not prime? The codes, of course, refer to the way in which a company's credit is rated. The very best firms can boast that they have ratings rather higher than the countries in which they operate. But when a company's rating slips, how concerned should its managers be?

Being downrated, explains Christian Wenk, director of corporate credit at Standard & Poor's, is bad, but not that bad. 'I recently downgraded ICI (after the acquisition of Unilever's specialist chemicals division) from A+ to A-but we still kept them in the A band. Their finance costs will go up, but as they're now in a riskier sector anyway, they'll still be happy.' Really bad, warns Wenk, is if the ratings are downgraded below 'investment grade' - the level below which certain investors will not countenance putting their funds into the company.

Of course, the faster the ratings fall, the harder the company lands. Midland Bank ranks companies from one (the very best) to 10 (a complete write-off) but merely slipping down a notch or two, explains spokesman Adrian Russell, is not too significant. 'A slip may well be an indicator of financial stress, but in cyclical sectors like retail, this is entirely normal.' But costlier credit worries Duong Vuong, European banking analyst at Merill Lynch, mainly because of the huge sums involved: 'If (a company's rating) goes from AAA to A its borrowing costs (ie interest) might go from £100 million to £110 million.'

Merli Baroudi, director of the Economist Intelligence Unit's (EIU) risk service, agrees with Wenk - particularly in the US, she says, many investors are not able to invest below a certain grade. And neither, she adds, should a company's peer group be ignored when assessing ratings. 'If all the banks are AAA, then even if you're as high as AA, that's pretty bad news, too.' Harold Rose, emeritus professor of finance at London Business School, stresses that: 'Although a fall will affect the terms on which companies can issue bonds, it's not as important for, say, industrials as it is for financial institutions. There are some things they cannot do unless they get AA.'

It's not all bad news for the downrated company. For while AAA debt carries very little risk, individual investment houses have their own strategies and, for many, buying gilt-edged debt may be a case of little ventured, little gained. Thus while a downrated company may find its debt costlier to issue, it may also find no shortage of investors queuing up to buy it.

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