Immelt Fights to Keep GE’s AAA as Cost of Cut Surges

Dec. 30 (Bloomberg) -- General Electric Co. Chief Executive Officer Jeffrey Immelt has good reason to fight for GE’s AAA credit rating. It’s never been more expensive for a company to lose the top ranking. The gap between bonds rated AAA and those three steps lower, at AA-, averaged a record 112 basis points in December as the credit crunch deepened, according to Merrill Lynch & Co. data. Before credit markets began unraveling 16 months ago, the difference averaged about 6 basis points. A basis point is 0.01 percentage point. GE and Toyota Motor Corp. had the outlook for their bonds lowered to negative by Standard & Poor’s this month. The number of non-financial AAA companies in the U.S. dwindled to 6 from more than 60 in the early 1980s, according to S&P. The loss of the highest ranking mattered less when the interest penalty was lower. In the current crisis, a downgrade may result in tens of millions of dollars in extra annual borrowing costs. “People look to Aaa companies as one level removed from the safety of the U.S. government,” said Benjamin Garber, an economist at Moody’s Analytics in New York. “There is a very high premium on the best-rated issuers.” In Europe, the spread between bonds rated AAA and AA- is 127 basis points, compared with 17 basis points in June 2007, before the onset of the credit crunch, Merrill Lynch data show. Seeking Safety The cost of a downgrade jumped because investors have fled stocks, mortgage securities and high-yield, high-risk corporate bonds after more than $1 trillion in bank writedowns and credit losses since January 2007 and the failure of Lehman Brothers Holdings Inc. in September. The highest-ranked company debt and Treasury securities have benefited most because they are considered the least risky. Fairfield, Connecticut-based GE has held S&P’s top rating since 1956, longer than any other company. An extra percentage point in interest would have cost $233 million more in annual payments on the $23.3 billion GE Capital Corp. raised in the U.S. bond market in this year’s first half, according to data compiled by Bloomberg. A downgrade is already factored into the prices of GE’s bonds and derivatives, according to Moody’s Market Implied Ratings service. GE’s bonds are trading as if the company were ranked five levels lower at A2, according to Moody’s. S&P gives an AAA stamp to Automatic Data Processing Inc., Exxon Mobil Corp., GE, Johnson & Johnson, Microsoft Corp. and Pfizer Inc. The McGraw-Hill Cos. unit considers Berkshire Hathaway Inc. a financial company and also rates it AAA. Moody’s Investors Service confers its equivalent Aaa on all those companies except Pfizer, which lost the designation in December 2006 following the failure of its cholesterol pill, torcetrapib. Best Returns Toyota is the only non-financial, non-government borrower outside the U.S. with an AAA ranking from either Moody’s or S&P, according to the ratings companies. Moody’s, S&P and Fitch Ratings also issued top marks to $3.2 trillion in subprime mortgage-backed securities at the root of the financial crisis, more than three-quarters of which were later downgraded. The only corporate rating category to give bondholders a profit this year was top-ranked debt, Merrill data show. AAA corporate bonds in the U.S. returned 4.8 percent, compared with losses of 6.7 percent for all investment-grade debt. Treasuries gained 14 percent, while the S&P 500 Index declined 41 percent. ‘Very, Very Few’ Investors may have fewer opportunities to invest in top- rated bonds as the number of qualified issuers dwindles, according to Craig Hutson, a Chicago-based senior analyst at bond research firm Gimme Credit LLC. “Longer term, there are going to be very, very few companies that will have a triple-A,” he said. About 0.2 percent of bonds worldwide with an Aaa rating default within 10 years, based on a Moody’s analysis of securities from 1983 to 2007. That compares with 0.5 percent of those ranked Aa2 and 1.7 percent of all investment-grade debt. Almost 32 percent of high-yield bonds defaulted within a decade, the analysis showed. Moody’s founder John Moody defined Aaa bonds in part as debt “of the highest class, both as regards security and general convertibility,” according to Moody’s Analyses of Railroad Investments in April 1909. The ratings company’s current official definition of Aaa is debt “judged to be of the highest quality, with minimal credit risk.” Falling Numbers The number of AAA issuers represents less than 0.3 percent of all 2,276 rated non-financial companies, down from 5 percent in the early 1980s, S&P analysts Diane Vazza and Jacinto Torres said in a Dec. 23 report. “The overarching reasons for the shrinking of this elite group over the years have been investors’ increased tolerance for risk and the shift of companies from adopting historically conservative financial policies to placing greater emphasis on shareholder returns,” they wrote. United Parcel Service Inc. was the last U.S. borrower to lose its AAA. Moody’s downgraded UPS two levels to Aa2 in December 2007, citing additional debt the world’s largest package-delivery company took on to exit a pension fund. S&P reduced UPS three levels to AA- the following month because of a share repurchase plan. “It has made very little difference,” said Norman Black, a spokesman for Atlanta-based UPS. “We changed the financial structure of the company precisely because it had become clear to us the AAA standard was not going to result in a big decrease in borrowing costs.” Coca-Cola Former Coca-Cola Co. CEO Roberto Goizueta gave up an AAA classification to finance hundreds of millions of dollars of investments in bottlers. The Atlanta-based company’s long-term debt-to-capital ratio surged from 5.48 percent at the end of 1981 to 26 percent in 1986, when ratings companies downgraded the soft-drink maker. It’s now labeled A+ by S&P and Aa3 by Moody’s. The loss of an AAA may be more costly for GE, whose financing arm relies on access to public markets. GE Capital would be rated A+, or four grades lower than its current AAA, without the support of its parent company, S&P said. As part of GE’s plan to maintain its AAA, Immelt is shrinking GE Capital to less than 40 percent of total profit next year, from about half in 2007. On Dec. 2, the company said it plans to issue about $45 billion in long-term debt in 2009, less than the $66 billion it has maturing, and to reduce commercial paper to $50 billion, below the $75 billion it said previously. AAA ‘Philosophy’ “I want to make it clear: The AAA is a philosophy of how you run the company,” Immelt said at an investor meeting on Dec. 16. “I think the AAA’s important.” S&P cut the outlooks for GE and the financing unit to negative on Dec. 18 as the recession deepened. GE has a 1-in-3 chance of losing its top grade within two years, S&P said. Since the reduction, GE’s 5.25 percent notes due in 2017 rose 1.3 cents to 101.3 cents on the dollar to yield 5.06 percent, according to Trace, the Financial Industry Regulatory Authority’s bond-pricing service. The spread over Treasuries has narrowed 22 basis points. The average AAA bond difference declined 24 basis points in the same period, Merrill data show. GE, the world’s biggest maker of turbines for power plants and jet engines, has raised about $12.5 billion globally in sales of bonds guaranteed by the Federal Deposit Insurance Corp. That’s allowed the company to “prefund” some of the $45 billion of GE Capital debt it plans to refinance next year at some of the lowest rates it has paid since 2002. Toyota’s Outlook Toyota, Japan’s biggest automaker, had its credit rating outlook lowered to negative from stable by both S&P and Moody’s this month as the recession cripples demand for cars worldwide. Toyota lost its AAA at Fitch on Nov. 26, when the New York- based ratings company cut the carmaker two levels to AA, citing the “ongoing turmoil in the global automotive sector.” The Toyota City, Japan-based automaker “will make efforts to have our outlook raised to stable again even under this external environment,” said Hideaki Homma, a company spokesman. “They’re going to suffer like every other automaker in the world,” said Hutson, who expects Toyota to eventually lose its top rating at Moody’s and S&P as well. To contact the reporter on this story: Bryan Keogh in New York at bkeogh4@bloomberg.net