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Royal Dutch Shell Plc lost AAA and Aaa ratings earlier this decade

Bloomberg: Walking Away From AAA, UPS Indicator, Level 3 Meaning: Timshel

Commentary by David Wilson

April 10 (Bloomberg) — AAA bond ratings are increasingly scarce among publicly traded companies, and it’s hard to blame them for shunning the designation.

Only half a dozen companies worldwide have the highest possible rating from Standard & Poor’s and Moody’s Investors Service, whose scale peaks at Aaa. Toyota Motor Corp., Japan’s largest auto manufacturer, is the sole non-U.S. company to have this distinction.

The number has fallen by a third since August, when Nestle SA, the world’s largest foodmaker, lost the top ranking because it plans to buy back 14 percent of its shares by 2010. United Parcel Service Inc., the biggest package-delivery company, surrendered them for a similar reason in December.

Novartis SA, Switzerland’s second-largest drugmaker, joined them this week after agreeing to a two-step purchase of Nestle’s 77 percent stake in Alcon Inc. for $39 billion. Novartis showed a “lack of commitment” to a AAA rating by planning to finance the takeover with borrowed money, S&P wrote in a report.

The common denominator for Nestle, UPS and Novartis is that each company was downgraded because of financing choices, rather than business setbacks. The opposite was the case when companies such as American International Group Inc., Merck & Co. and Royal Dutch Shell Plc lost AAA and Aaa ratings earlier this decade.

Yield Differentials

It’s understandable that the companies’ executives would make these decisions. Dropping into the AA range may have little effect on borrowing costs for non-financial companies. Yields on AA-rated notes and bonds denominated in dollars are within five basis points, or 0.05 percentage point, of those for the AAA category, according to data compiled by Bloomberg.

The difference in yield, or spread, is far more substantial for financial-services companies. Ten-year bonds with AA ratings yield 71 basis points more than comparable securities that are rated AAA, Bloomberg’s data shows.

Berkshire Hathaway Inc., Warren Buffett’s insurance and investment company, and General Electric Co., whose GE Capital finance unit handles much of its business, are among companies able to benefit from the spread. Both have AAA and Aaa ratings.

The other three companies at that level are Automatic Data Processing Inc., the world’s largest manager of payrolls; Exxon Mobil Corp., the biggest U.S.-based oil producer, and Johnson & Johnson, the world’s largest maker of consumer health products.

Municipal Demands

Regardless of yield spreads, AAA ratings — or Aaa ratings, for that matter — have lost much of their cachet. Last year’s subprime-mortgage market collapse and the subsequent credit crunch sent all kinds of bonds tumbling from these levels.

Just yesterday, for instance, S&P cut ratings on a dozen series of AAA-rated collateralized debt obligations that were tied to home loans. The hardest-hit CDOs sank eight levels to BBB, the second-lowest investment grade.

Only U.S. state and local governments, it seems, are really interested in reaching the highest level these days. California State Treasurer Bill Lockyer and others argue they would be AAA and/or Aaa already if rating criteria didn’t exaggerate the potential for default.

Assuming they eventually move up, the municipalities may find it’s increasingly lonely at the top. Corporate borrowers are giving stock repurchases and takeovers greater weight, as Nestle, UPS and Novartis show.

* * *

UPS’s reduction in its first-quarter profit estimate indicates the U.S. economy contracted during the period, if history is any guide.

Yesterday’s cut was only the third for any quarter since the Atlanta-based company went public in November 1999.

The first one brought down figures for the third quarter of 2001, when the Sept. 11 terrorist attacks took place. U.S. gross domestic product slumped by 2.6 percentage points in that period from the second quarter, as measured by annual growth rates, and ended up at minus 1.4 percent.

The second affected the fourth quarter of 2004. During that three-month stretch, the pace of U.S. economic expansion slowed by 1.1 points. That’s almost twice the rate of increase in last year’s fourth quarter, which amounted to 0.6 percent.

UPS trimmed its estimate for the first quarter by as much as 12 cents a share because U.S. shipments are slowing and fuel costs are surging. The company now expects earnings per share of 86 cents to 87 cents.

* * *

Level 3 Communications Inc., a money-losing provider of telephone service, is due for a name change. Accounting rules have saddled the Broomfield, Colorado-based company’s name with unintended meaning.

U.S. financial companies have to report their assets on three levels, separated by the relative difficulty of finding market prices. The hardest to value, including securities and loans hurt most by the current credit crunch, go in Level 3.

Goldman Sachs Group Inc., the most profitable securities firm, yesterday reported that Level 3 assets climbed 39 percent during the first quarter ended Feb. 29 to $96.4 billion. Morgan Stanley, the second-largest U.S. brokerage, and Lehman Brothers Holdings Inc., the fourth-biggest, had sub-10 percent growth.

There’s a big difference between Level 3 assets and Level 3’s assets — totaling $10.2 billion as of March 31, according to data compiled by Bloomberg. Even so, this distinction may be lost in the same way that the 1980s outbreak of acquired immune deficiency syndrome doomed Ayds, an appetite-suppressant candy.

(David Wilson is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: David Wilson in New York at [email protected]

Last Updated: April 10, 2008 00:01 EDT and its also non-profit sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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