From Junk to Investment Grade
We at Standard & Poor's Ratings Services update monthly the list of credit issuers that become what we call rising stars—those whose credit ratings are raised to investment grade (BBB- and above), from speculative grade (BB+ and below). We also tally those companies poised to make the leap in the future.
Why is an investment-grade rating so important? Ratings play a critical role in determining how much companies and other entities that issue debt have to pay to tap credit markets—i.e., the amount of interest they pay on their issued debt. The threshold between investment-grade and speculative-grade ratings has important market implications for issuers' borrowing costs. Indeed, the cost of capital decreases sharply when an issuer crosses the rising-star threshold.
An issuer's status as a potential rising star—defined as an entity rated BB+ with either a positive outlook or with ratings on CreditWatch with positive implications—is a good leading indicator of an actual upgrade.
A long-term study published by Standard & Poor's Global Fixed Income Research corroborates this unequivocally. CreditWatch status and outlooks are strong predictors of ratings behavior, both in the aggregate as well as when broken out by rating category, region, or sector.
For example, of all BB ratings (BB+, BB, and BB-) on CreditWatch with positive implications, 74% are raised. Of all the BB ratings with positive outlooks, 45% are raised.
The bottom line: Keeping track of entities with rising-star potential is important for investors, especially bond holders, who would experience a capital gain on the debt securities they own if their holdings were upgraded.
As of July 13, 2006, there were 29 globally rated entities best poised to acquire rising-star status, five more than the number reported in June, but two fewer than the count a year ago. Together, these 29 entities constitute $51.1 billion (€64.8 billion) in rated debt.
Globally, sectors displaying the highest count of potential rising stars included utilities with four entities; and banks, capital goods, insurance, and oil and gas exploration and production. with three entities each. In terms of rated debt outstanding, the utility sector was the most prominently placed for the highest amount of debt affected by potential upgrades, followed by integrated oil and gas, oil and gas exploration and production, transportation, and high technology.
Of the 29 issuers most likely to benefit from potential upgrades, 17 belonged to the broadly defined industrial sector, four to utilities, and one was a sovereign issuer. Financials accounted for seven entities, of which four were in banking and three in nonbanking financial institutions.
STARS TO FOLLOW.
Within the industrial sector, oil and gas exploration and production and capital goods had the greatest number of entities (three each) likely to attain rising-star status. Of the three issuers in the oil and gas exploration and production sector, two were U.S.-based and one came from Canada. All three in the capital goods sector were from Europe, where relatively strong conditions overall are expected to continue throughout 2006.
U.S.-based issuers showed geographic preponderance among the current list of potential rising stars, constituting 17 of the 29 issuers.
Here is our list of potential rising stars as of July 13, 2006: