Moody’s: Share Buybacks Don’t Always Lead to Debt Downgrades

While share repurchase programs are typically considered risky to bondholders, they don’t always lead to immediate rating downgrades. Moody’s Investors Service studied 100 share repurchase agreements over the past 19 months and said that in 56 percent of the cases, the agency didn’t take any rating action. Critical to whether a stock buyback program led to a credit rating downgrade was its size, source of funding, and time horizon, the credit ratings agency wrote in a report released yesterday.

"Negative rating actions are more likely when share repurchase programs reflect a significant shift in prior financial policies," said Moody's Senior Vice President Michael Levesque. "All the negative rating actions in our study resulted from repurchases that increased debt enough to move the needle on leverage ratios, debt-service ratios or other metrics to a lower rating.”

Several factors can help offset the potential for negative rating actions. "Funding repurchases with excess cash on the balance sheet, operating cash flow, or asset sales, can alleviate the need for incremental debt, easing downward rating pressure," said Mell Matlow, Moody's associate analyst and lead author of the report.

Moody’s cited IBM’s $15 billion buyback plan announced in April as an example; it didn’t result in a downgrade, even though it was funded with $10 billion worth of debt.

All 44 negative rating actions in Moody’s study resulted from buybacks that “increased debt enough to move the needle on leveraged ratios, debt-service ratios and other metrics,” the agency said.

Additionally, of the 100 transactions studied, eight cases involved an asset sale to fund a share buyback. Of those eight cases, one transaction led to an outlook change to negative and two led to rating downgrades. Moody’s said that when asset sales are used to fund share buybacks, rating actions would depend in part on whether the assets sold were profitable, as well as on their size insofar as they served as collateral for the company’s debt.

Overall, downgrades linked to share buybacks often occur when Moody’s believes a program results in a significant shift in financial policy, an erosion of credit metrics that may take several years to restore or a significant loss of collateral value or future cash flow. Moody’s also noted that buyback programs structured over several years are less likely to lead to a rating action.