I spend a significant part of my working life teaching about financial markets around the world, often to participants that are about to start a career working in the financial markets.
When teaching about credit, one of the questions I often pose to the course participants how many companies in the world are rated triple-AAA by one of the main rating agencies -- Standard & Poor's. (NB: at the end of April Standard & Poor's changed their name to S&P Global Ratings, but for this article I have continued to use the more familiar "old" name). Most of the time my classes are surprised that (as of last week) the number was only three -- out of several thousand publicly traded companies in the US.
Sometimes investors forget that the rating assigned by the rating agencies is just a proxy, or easy-to-use reference for how "safe" or credit worthy the company is. It does not give a definitive answer or a numerical figure for how likely an investor is to see a default on his bond holdings. So it is worthwhile remembering that AAA, in the words of Standard & Poor's means "Extremely strong capacity to meet financial commitments", while a double-AA rating means "very strong capacity to meet financial commitments" (i.e., very as opposed to extremely).
I often ask my classes to try and guess which companies are in the AAA-list by telling them that there is a good chance every student had used products from all three companies by about one hour after they woke up each morning. (Guess yourself if you don't know before reading on).
The companies that held this proud record until last week were Johnson & Johnson (NYSE: JNJ), Microsoft (NASDAQ: MSFT), and oil & gas major Exxon Mobil (NYSE: XOM). Not so long ago back in 2014, there were four companies in the list until Automatic Data Processing (NASDAQ:ADP) was downgraded. Well it seems that the list is getting smaller, and I may have to change the question I pose in my courses. With the downgrade of Exxon Mobil last Tuesday, by not just one notch but two, the list of AAA-rated companies is dwindling quickly and now stands at a paltry two.
The reasons given by Standard & Poor's were: "We believe Exxon Mobil's credit measures will be weak for our expectations for a 'AAA' rating due, in part, to low commodity prices, high reinvestment requirements, and large dividend payments." It was not a total surprise to the market as it followed on from a "CreditWatch" that had been placed on the company back in February. But given that the company have been AAA-rated since 1949, the downgrade of the rating is going to be a nasty shock for some investors who woke up each day for the last 67 years holding on to triple-AAA rated stocks or bonds.
Other oil companies have also been downgraded during the recent turmoil in the oil markets, but none of them were holding on to the top rating of AAA.
The shortening list is yet another sign of how tricky it is for investors looking to navigate current financial markets in the search for "safe" investments. Given that (the increasingly small number of) AAA-rated bonds are trading at only approximately 50 basis points over the equivalent maturity US Treasuries, and the problem for investors seeking yield and safety becomes clearer.
The decreasing pool of AAA-rated companies is one that has been trending in the same direction for many years. Back in 1980, the number stood at around sixty AAA companies and it was perfectly feasible to select investments using a criteria limited to just the top ranked companies. But by 2008 and the depths of the financial crisis, the number had been slashed and stood at six, including General Electric (NYSE:GE), Pfizer (NYSE:PFE) and the companies mentioned above.
The downtrend in the ratings of AAA-rated companies is also a trend that is seen in the ratings given to countries. The ratings are not strictly comparable as the methodology and criteria used by the agencies are different for countries and for companies. But even so, the list of countries given a triple-AAA "clean sweep" by all three rating agencies is shrinking fast and currently stands at just ten -- Australia, Canada, Denmark, Germany, Luxembourg, Netherlands, Norway, Singapore, Sweden, Switzerland. Two of the most notable and obvious missing members from the list are the United States and the United Kingdom, who both are ranked AAA by only two out of the three leading rating agencies.
The situation of deteriorating credit ratings is not just an interesting topic of note for an observer of financial markets, but one that carries great significance for investors across the world. The investment guidelines of almost any asset manager, whether it be a Central Bank, a pension fund or even companies themselves, will contain rules about the allocation of investments that can be held in different credit categories. As someone who previously worked investing the multi-billion dollar Reserves of a Central Bank, guidelines that would have once specified that all investments had to be only countries ranked AAA by all three agencies, were no longer feasible.
But the story is the same for any investor who invests or allocates based on credit rankings. They are faced with an increasingly stark choice -- either having to deal with the reality of a decreasing pool of investments that fit their original guidelines or alternatively a need to rewrite guidelines in a way that will allow for investing in assets with a lower credit quality.
Neither of them is particularly appetizing choices to the investor who likes security, but then again, welcome to the world of "and then there were only two."
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.