10/22/19, 9(43 AMBond Ratings Firms Go Easy on Some Heavily Indebted Companies - WSJ

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In August, bond-ratings firms Moody’s Corp. and S&P Global Inc. predicted that Newell Brands Inc. would soon reduce its heavy debt load, allowingit to keep its coveted investment-grade bond rating.

They made the same prediction in 2018. And in 2017. And in 2016. And in 2015, when thecompany announced a big merger that quadrupled its debt. Yet bond ratings for the maker ofRubbermaid containers and Sharpie markers haven’t budged.

When S&P and Moody’s made their upbeat projections in 2018, they made an error thatunderstated Newell’s indebtedness, according to a Wall Street Journal review of the ratingfirms’ calculations. They have since fixed their numbers, but still rate Newell investment-grade.Investors have been less forgiving, selling off the bonds and driving up their yield.

Moody’s and S&P didn’t dispute revising their calculations, but said the changes didn’t affecttheir ratings.

Amid an epic corporate borrowing spree, ratings firms have given leeway to other bigborrowers like Kraft Heinz Co. and Campbell Soup Co. , allowing their balance sheets to swell.

“It’s pretty eye-popping if you’ve been doing this for 20-plus years, to see how much moreleverage a number of these companies can incur with the same credit rating,” said GregHaendel, a portfolio manager at Tortoise in Los Angeles overseeing about $1 billion in corporatebonds. “There’s definitely some ratings inflation.”

Years of rock-bottom interest rates have fueled a boom in borrowing, driving debt owed by U.S.

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https://www.wsj.com/articles/bond-ratings-firms-go-easy-on-some-heavily-indebted-companies-11571563801

MARKETS | CREDIT MARKETS

Bond Ratings Firms Go Easy on SomeHeavily Indebted CompaniesKraft Heinz, Newell Brands among big consumer companies given time to get their leverage down

Oct. 20, 2019 5:30 am ET

By Gunjan Banerji and Cezary Podkul

MCO +0.06%▲ SPGI 0.53%▲

NWL -1.20% ▲

Bonds of Newell Brands, makers of Elmer’s Glue, have risen in yield, while keeping their investment-grade rating. PHOTO:RICHARD B. LEVINE/ZUMA PRESS

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companies excluding banks and other financial institutions to nearly $10 trillion—up about 60%from precrisis levels. Leverage—how much debt a company owes relative to its earnings—hit ahigh in the second quarter of this year, according to JPMorgan Chase & Co. data on investment-grade bonds going back to 2004, which also excludes financial companies.

The buildup has fueled one of the most divisive debates on Wall Street: Will higher debtloads cause big losses when the economy turns? Or have low interest rates made the borrowingmore manageable?

Moody’s and S&P say their ratings are accurate because companies like Newell have solid,global brands and generate sufficient cash flow to pay off the bonds. “We take rating actionswhere appropriate in line with our methodologies,” said Tom Mowat, analytical manager atS&P Global Ratings. The ratings firms also say their grades have accurately predicted defaults,which is their main purpose.

S&P and Moody’s rate Newell, Kraft and Campbell Soup in their triple-B category, which isthe lowest for bonds considered investment-grade. These bonds are popular with investors

because they are considered unlikely to lose money. A downgrade below the lowest of the threenotches in the category, triple-B-minus, would drop the companies into the junk-bond category,which could raise their borrowing costs.

The triple-B rating has exploded in the last decade, with debt outstanding more than tripling to$3.7 trillion, Intercontinental Exchange data show. These days, about 50% of all investment-grade bonds are rated triple-B, up from 38% in September 2009.

Investors are skeptical of some of the ratings. More than $100 billion worth of bonds trade withyields like junk despite their triple-B-minus ratings, pricing info from Advantage Data Inc.shows. That is despite a flood of cash into investment-grade debt. The Bloomberg Barclays U.S.Corporate Investment-Grade Index has returned 13% this year, on track for its bestperformance since 2009, according to FactSet.

Investors and analysts have told the Securities and Exchange Commission that they areconcerned about the buildup of triple-B debt.

Last October, Adam Richmond, Morgan Stanley’s then head of U.S. credit strategy, testified atan SEC hearing that if leverage were the sole criteria for ratings, many triple-B rated companieswouldn’t qualify for such high grades. He warned that “downgrade activity could be heavy”once the economy inevitably weakens. The firm’s analysts wrote in a September report thatinvestment-grade companies “have not de-levered significantly and are still getting credit forassumed earnings growth, integration of acquisitions, and other ‘plans’ to delever.”

JPMorgan raised similar concerns in a report it submitted to a bond-investor advisorycommittee at the SEC. In February, the committee created a new group to examine creditratings and potentially recommend new regulations to boost oversight of the industry,according to people familiar with the group.

Kraft Heinz, makers of boxed macaroni and cheese, was given two years to meet a leverage target by S&P. PHOTO: ALEXWONG/GETTY IMAGES

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Moody’s and S&P both say other factors they consider show less risk among triple-B ratedcompanies. Cash flow relative to debt has improved even as leverage has increased, S&P says.Moody’s analysts wrote in a January report that these borrowers are “substantially larger,more profitable and less burdened by interest expense than in 2007.”

Kristalina Georgieva, the new head of the International Monetary Fund, was more cautious in aspeech earlier this month. In a major downturn, she said, $19 trillion of corporate debt would beat risk of default, nearly 40% of total debt in eight major economies. “This is above the levelsseen during the financial crisis,” she said.

Last year, S&P upgraded Kraft, one of the biggest corporate borrowers, saying cost savingswould help push leverage below four times annual earnings by late 2019. In June, S&Pdowngraded Kraft as the company restated past earnings but kept Kraft at the lowest rung ofinvestment-grade, giving it another two years to meet the target. In September, S&P estimatedleverage was in the “high-4x area.”

“How long do you give management the benefit of the doubt?” said Lon Erickson, a portfoliomanager at Thornburg Investment Management, who oversees $7 billion in corporate debt,including some Kraft bonds.

A spokesman for the company said that “KraftHeinz remains committed to our investment-grade status.” S&P raised questions about thebonds in an August report, but said it is waitingto see how a new strategy expected at thecompany next year will impact them.

Moody’s downgraded Campbell Soup as it boughtsnack company Snyder’s-Lance last year for $6.1billion, including debt. About seven months afterthe downgrade, Moody’s estimated Campbell’s

leverage had topped five times earnings and said it was “too high at current ratings.” Moody’sgave the company until July 2020 to get it below four times earnings.

A Campbell spokesman said the company is “well on our way” to meeting that target. After thecompany announced it would sell some businesses in August, Moody’s analysts said theproceeds “should be sufficient to reduce Campbell’s leverage closer to sustainable levels” forthe rating.

When Keurig Green Mountain merged with Dr Pepper Snapple Group in 2018, Moody’s said itcould downgrade the combined company if leverage didn’t fall to about four times earnings byJanuary 2020. This year, Moody’s said four times annual earnings by the end of 2020 was fine.

“If it’sastrike,it’s astrike.If it’sa ball,it’s aball,”saidJoe

Pimbley, a former Moody’s analyst and principal of Maxwell Consulting. “Call it as you see it.”

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Moody’s recently gave Campbell until July 2020 to get its leverage down. PHOTO: JUSTIN SULLIVAN/GETTY IMAGES

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A spokeswoman for Keurig Dr Pepper said that S&P’s and Moody’s ratings “appropriatelyreflect the strength and creditworthiness of our company.”

The ratings firms say they question companies’ debt reduction plans. “By nature we are a prettyskeptical bunch. We like to poke holes in stories,” said Peter Abdill, who oversees Moody’sratings for consumer products companies.

One company that has been given significant leeway by ratings firms is consumer goods giantNewell Brands, which makes everything from Elmer’s glue to Yankee Candles. While foodcompanies like Kraft and Campbell produce steady earnings in good and bad economies, Newellis more cyclical, meaning it is more likely to run into trouble during a downturn.

When Newell said it would acquire rival Jarden Corp. for about $20 billion in December 2015,S&P and Moody’s analysts said Newell could keep its low investment-grade rating because debtwould fall from more than five times projected earnings to under four times by December 2017.

Newell had tens of millions of dollars riding on that decision. A provision tucked into an $8billion acquisition bond sale in March 2016 said Newell would owe its investors as much as $160million more in annual interest costs if it got downgraded into junk territory.

The provision highlights the conflict faced by the ratings firms. Investors use rating firms’research, but companies that issue bonds pay for the ratings. Moody’s and S&P say they don’tallow the conflict, or bond provisions like these, to influence their rating decisions.

In 2018, under pressure from activist investors,Newell announced plans to sell about a third of itsbusinesses and buy back more than 40% of itsshares, moves that could slow downdeleveraging. Moody’s and S&P confirmed thecompany’s rating and predicted its leveragewould fall to less than four times earnings by theend of 2018.

This past February, Newell announced that itsdebt was 3.5 times earnings at the end of 2018.But Newell failed to account for lost earningsfrom businesses it sold when it calculated thefigure.

Investors were skeptical, said James Dunn of CreditSights, an independent credit research firm.He estimated Newell’s actual debt load to be 5.3 times projected earnings.

Moody’s and S&P’s leverage estimates mirrored Newell’s approach, according to a Journalreview of their calculations. Moody’s estimated Newell’s year-end leverage at 3.8 times in aNov. 2018 report. S&P put it at 3.9 times in a July 2018 note.

Moody’s also overstated Newell’s earnings by double-counting amortization when calculatingearnings before interest, tax, depreciation and amortization—the denominator of the leverageratio.

Adjusting for the errors, Moody’s estimate of Newell’s leverage should have been closer to sixtimes earnings, the Journal found.

Earlier this month, Moody’s updated its calculation of Newell’s year-end 2018 leverage to sixtimes earnings, versus a revised estimate of 5.5 times it published in August that took variousasset sales into account. S&P raised its number to 5.4 times earnings, citing “normalized”figures that also took into account Newell’s asset sales.

An S&P spokesman said in an email that “our analysis speaks for itself.”

Moody’s confirmed its 2018 calculation included earnings from businesses Newell had sold.

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Moody’s said the calculation was just a different way of measuring leverage, though it agreedthat double-counting amortization was an error, and said it corrected it in October.

Kraft and Newell long-term bonds trade in junk territory. S&P and Moody’s predict Newell willreduce its debt to about four times earnings within the next year or so.

Write to Gunjan Banerji at Gunjan.Banerji@wsj.com and Cezary Podkul atcezary.podkul@wsj.com

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