By Jonathan Schwarzberg
NEW YORK (LPC) - Oil producer Continental Resources is one of several US companies that have been able to cut borrowing costs after their credit ratings were upgraded to investment-grade on the back of rising commodity prices and a robust economy.
The number of companies poised to cross the threshold to high-grade from speculative-grade or "junk" ratings rose to 18 in the first quarter from 15 in the fourth quarter of 2017. The number of potential "fallen angels" that could move in the other direction dropped to 35 from 40 in the first quarter, which is the 10th consecutive quarter to see a reduction, according to Moody’s Investors Service.
The proportion of potential fallen angels to "rising stars" also dropped to 1.9 times on March 31 from 2.7 times on December 31, according to Moody’s. It was as high as 5.7 times in the fourth quarter of 2015 after oil prices collapsed, which was the highest level since 8.0 times in June 2009, after the financial crisis.
“Economic strength, along with improved commodity prices, is a factor in the ratio of fallen angels to rising stars remaining below historical averages,” said Michael Corelli, a senior credit officer at Moody’s.
Companies typically need at least two investment-grade ratings to move into high-grade territory with ratings of BBB-/Baa3 or higher, from high-yield, which starts at BB+/Ba1.
Fitch gave Continental Resources its second ratings upgrade on April 30, which allowed it to reach investment-grade status after S&P upgraded the company to BBB- from BB+ in February. Moody’s rated it Ba2, two notches below investment-grade, in March.
Moving up to investment-grade can reduce borrowing costs significantly if interest margins are linked to ratings grids. High-grade ratings also help companies to refinance more cheaply.
Continental Resources was upgraded shortly after the company lined up a US$1.5bn revolving credit facility with pricing linked to a ratings grid, which saw pricing fall to 150bp from 175bp over Libor.
The company has traditionally used its revolving credit, and had US$188m of outstanding borrowings under its revolver at the end of 2017 which it repaid in the first quarter of 2018, according to filings with the Securities Exchange Commission.
Continental Resources will also save money on the commitment fee, which dropped to 20bp from 25bp, if the revolving credit facility is undrawn.
PRO RATA SAVINGS
An investment-grade credit rating for loan issuers means that companies can easily switch from syndicated term loans to less expensive pro-rata facilities, which can save up to 300bp. Discount retailer Dollar Tree (NASDAQ:DLTR) did just that in April, after Moody’s upgraded its debt to Baa3 in March from Ba2.
Dollar Tree lined up a US$1.25bn revolving credit facility and a US$782m term loan shortly after the upgrade to replace 5.75% senior notes due in 2023 and existing term loans, including a US$650m term loan B-2 due in July 2022.
Dollar Tree’s new term loan, which matures in April 2020, is priced at 100bp over Libor, compared to a fixed interest rate of 425bp on its existing term loan B.
Other rising stars this year have included building products manufacturer Masco Corp (NYSE:MAS) in March and chipmaker Western Digital Corp (NASDAQ:WDC) in January, which were both upgraded to investment-grade at Baa3 from Ba1, according to Moody’s.
The pattern of rising stars and upgrades could be threatened by increased M&A activity in the robust US economy as companies making acquisitions load up with debt to buy rivals, which can drag their credit rating lower, according to Corelli.
Changes in technology could also hit high-grade credit ratings and produce more fallen angels in the near future, according to Michael Terwilliger, a portfolio manager at investment firm Resource America.
“Unquestionably the biggest threat facing all businesses—whether they are high-yield issuers or not—is technology,” Terwilliger said. “The Uber/Facebook/Amazons of the world are quickening the pace of change in our economy, threatening the core of countless businesses. Given the pace of technological change, the trend will inevitably result in more fallen angels versus rising stars over time.”