Downgraded bonds junk up market
With profits down everywhere, many once investment-grade corporate bonds are quickly getting downgraded to junk. Jeremy Hobson explores where this can hurt the economy and why it's bad for the companies involved.
Traders work on the floor of the New York Stock Exchange during morning trading in New York City. (Mario Tama/Getty Images)
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Steve Chiotakis: Today, we're gonna hear from the Treasury Department and the size of its latest bond sale. It could reach almost $100 billion worth of T-notes. But finding buyers won't be as hard as you might think. One reason is because many corporate bonds are literally turning into junk. And that's hurting the economy and doing damage to a lot of portfolios. Here's Marketplace's Jeremy Hobson.
Jeremy Hobson: Corporate bonds are essentially IOU's that companies issue in exchange for cash. The borrowers are businesses of all kinds, from Macy's to Dr. Pepper to Rubbermaid.
Marilyn Cohen of Envision Capital Management wrote a book called "The Bond Bible:"
Marilyn Cohen: The bond market is so much larger than the equity market. It is the lubricant of the world.
Right now, you won't be surprised to hear that lubricant isn't working as well as it used to.
Diane Vazza is head of global fixed income research at Standard and Poors, which rates bonds so investors know what they're buying. Vazza says in the first quarter, S&P downgraded 93 percent of the bonds it rates.
Diane Vazza: In my 30-year career, this is, you know, the worst really that we have seen in terms of, you know, corporate credit risk.
It's easy to figure out the reason, says Marilyn Cohen:
Cohen: Many corporations are getting downgraded in their credit quality because business is terrible. Their earnings are down, their profits are down, their revenues are down and their ability to make these timely interest payments is deteriorating faster than a speeding bullet.
That doesn't necessarily mean that all those downgraded companies will default on their debt or go out of business. Just that many of them won't have the money to expand operations any time soon.
In fact, this wave of downgrading could trigger another round of layoffs, because borrowing becomes much more expensive the lower the ratings go, says S&P's Diane Vazza.
Vazza: You know, once they're downgraded, companies have been, over the past year, have paid an average of 12.5 percent more.
The companies that fall from an investment-grade rating to a junk rating are called fallen angels. In March alone, 17 borrowers joined that list -- that's three times more than a typical month.
Marilyn Cohen says for most of those companies, a re-ascent is unlikely.
Cohen: If you happen to remember that commercial, "I've fallen but I can't get up," when a company goes from investment-grade to junk, they rarely crawl back to investment-grade.
That's not just bad news for the company involved. It's also bad for many investors, who are required to sell -- and probably take a loss -- when a bond is downgraded to junk.
In New York, I'm Jeremy Hobson for Marketplace.
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05/05/2009
I still don't trust any of the rating systems for commercial paper. I pulled all of my savings out of that type of stuff in August of 2007 and the only bonds I have these days are government bonds.
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