Flight To Quality Underscores Credit Rating Importance

July 23, 2008

Last Friday, Zuffa LLC. received word of a credit rating revision on its debt to stable from negative. The revision was good news for many reasons, chief among them that it signaled the end of a year-long financial slump that was pushing the organization’s debt further into “speculative-grade” territory.

Zuffa’s current credit rating sits at BB-/Stable and because it is below Standard & Poor’s BBB, it’s considered to be “junk” or “speculative-grade” debt.

Speculative-grade bonds present difficulties for corporations because they require a higher yield to be paid to creditors in return for accepting greater levels of risk. Not only is the interest larger on these “junk” bonds, but they also come with an increased number of debt covenants; provisions that can restrict a corporation’s financial freedom.

A recent press release from Standard & Poor’s Rating Service, put the importance of credit ratings into the context of today’s tight market. The release noted increasing hardships for companies with “junk-rated” debt:

Granted that corporate defaults are creeping higher as the days of cheap and easy money have disappeared – at least for now – and speculative-grade borrowers face a tough row to hoe. At best, these companies can expect to pay interest rates significantly higher than a year ago, and with stricter covenants imposed by lenders. At worst, they face a stonewalling from an investor base too risk-averse to loosen its purse-strings.

On the other hand, “investment-grade” bonds – those rated AAA, AA, A, or BBB – have benefited from a flight to quality; investors, risk-averse and still shy of the capital markets, flock to the safety of reliable yields.

Through June, investors had snapped up almost $477 billion in investment-grade corporate bonds in the U.S. And while that’s less than the $550 billion in the first half of 2007, the decline isn’t nearly as stark as we’ve seen in the speculative-grade market, where issuance has been only about a third of the $100 billion in the first half of last year.

While Zuffa currently has nearly $325 million in outstanding debt, its on-going expansion plans may require further leverage. If and when that happens, their “speculative-grade” rating could become more of an issue.

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