Whileshare repurchase programs are typically considered risky to bondholders, theydon’t always lead to immediate rating downgrades. Moody’s Investors Service studied 100 share repurchase agreements over the past 19months and said that in 56 percent of the cases, the agency didn’t take anyrating action. Critical to whether a stock buyback program led to a creditrating downgrade was its size, source of funding, and time horizon, the creditratings agency wrote in a report released yesterday.
“Negativerating actions are more likely when share repurchase programs reflect asignificant shift in prior financial policies,” said Moody’s Senior VicePresident Michael Levesque. “All the negative rating actions in our studyresulted from repurchases that increased debt enough to move the needle onleverage ratios, debt-service ratios or other metrics to a lower rating.”
Severalfactors can help offset the potential for negative rating actions.”Funding repurchases with excess cash on the balance sheet, operating cashflow, or asset sales, can alleviate the need for incremental debt, easingdownward rating pressure,” said Mell Matlow, Moody’s associate analyst andlead author of the report.
Moody’scited IBM’s $15 billion buyback plan announced in April as an example; itdidn’t result in a downgrade, even though it was funded with $10 billion worthof debt.
All 44negative rating actions in Moody’s study resulted from buybacks that “increaseddebt enough to move the needle on leveraged ratios, debt-service ratios andother metrics,” the agency said.
Additionally,of the 100 transactions studied, eight cases involved an asset sale to fund ashare buyback. Of those eight cases, one transaction led to an outlook changeto negative and two led to rating downgrades. Moody’s said that when assetsales are used to fund share buybacks, rating actions would depend in part onwhether the assets sold were profitable, as well as on their size insofar asthey served as collateral for the company’s debt.
Overall,downgrades linked to share buybacks often occur when Moody’s believes a programresults in a significant shift in financial policy, an erosion of creditmetrics that may take several years to restore or a significant loss ofcollateral value or future cash flow. Moody’s also noted that buyback programsstructured over several years are less likely to lead to a rating action.