Wall Street Steward Blog

Hey S&P - Downgrade 'Em All!

I have been asked multiple times to give my opinion on the S&P downgrade of US debt from a “AAA” rating to a “AA” rating.  Ask and ye shall receive my faithful readers!

First of all, it is my belief that most ratings agencies have many hidden agendas – under the table arrangements.  Other than rumors of such deals, there is not any concrete proof, but how else can one explain how one entity is rated above another despite having much more risk on their respective balance sheet?

I digress…it is not my intention to write about how I feel about the rating agencies….

The downgrade.  It is a big deal.  The United States has had NEVER been downgraded before, which makes this occurrence unique in a very real way.

What does it all mean?  Let’s look…

Ratings Defined
Here are the definitions that Standard and Poors uses to define each credit rating (taken from their own website).

‘AAA’   Extremely strong capacity to meet financial commitments. Highest Rating.
‘AA’      Very strong capacity to meet financial commitments.
‘A’          Strong capacity to meet financial commitments, but somewhat susceptible to adverse
               economic conditions.
‘BBB’     Adequate capacity to meet financial commitments, but more subject to adverse economic
‘BBB-‘   Considered lowest investment grade by market participants.
‘BB+’    Considered highest speculative grade by market participants.
‘BB’       Less vulnerable in the near-term but faces major ongoing uncertainties to adverse
               business conditions.
‘B’          More vulnerable to adverse business, financial and economic conditions.
‘CCC’    Currently vulnerable & dependent on favorable business, financial & economic conditions.
‘CC’       Currently highly vulnerable.
‘C’          Currently highly vulnerable obligations & other defined circumstances.
‘D’          Payment default on financial commitments.

Rating is Relative
If a corporation is rated “A,” then that means it has “strong capacity to meet financial commitments, but is somewhat susceptible to adverse economic conditions” according to the above definition.

In real world terms, it means “hey, that company is strong, but it is not quite the US Government.”  Treasury Bonds have always been the standard by which all others are measured.  They are were the crème de la crème…the best…the eliteThe Navy Seal Team 6 of the bond world.  Yes, that good.

If a country is rated “BBB,” it means to me that “they are adequate, and probably will not default, but if things really hit the fan, they could struggle.  Which, essentially, means they are not the US Government.”

So, since they downgraded the US…everyone else needs to drop down a notch as well.  At least in my book.

I think there is no safer place than the US, despite our debt load, etc…

Who is Better?
There are currently four corporations that still sport a AAA rating.  They are Automatic Data Processing (ADP), Exxon Mobil (XOM), Johnson and Johnson (JNJ), and Microsoft (MSFT).

That’s right.  Those 4 companies have higher credit ratings than their own country.  So, in the event that their country were to default, they would be in even better financial shape and be able to pay their debts?  Please.

These 4 companies are very stout, no doubt, but lest I remind you that AIG was also at one time a AAA rated company.  How did that turn out?  Without a bailout in 2008, they would likely have been put out of business.  I say that only to illustrate that credit ratings can be meaningful, but they can also mislead. 

Honest question:  if I asked you, the reader, to bet on the debt paying ability of one of the following entities, which one would you choose?

(A)   ADP
(B)   XOM
©   JNJ
(D)   MSFT
(E)    US Government

I choose the Stars and Stripes.  That being the case, I believe that the other 4 are riskier investments, which means that they need to be downgraded in my opinion.  I don’t believe that ANY company is as secure as our government.  

What if we broke this down to the country level?  The following countries still have a AAA rating according to S&P:  Australia, Austria, Canada, Denmark, Finland, France, Germany, Guernsey, Hong Kong, Isle of Man, Liechtenstein, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland, and the United Kingdom.

Ok, I am about to be very honest….I didn’t know that Guernsey, Isle of Man and Liechtenstein were even countries…nevermind that they have a AAA rating.  Of course, I was educated in the South so maybe I am just….what is that?  Upon further review, they are not countries but territories/provinces of other countries. 

Whew….scared myself there. 

The ratings are only as good as the TOP DOG, and in my book, that TOP DOG is still the United States of America.