Born This Way: Acceptance Grows For New Speculative-Grade Companies Through 30 Years of LBOs, Bank Loans, and

Falling Interest Rates

Global Fixed Income Research

Diane Vazza, Managing Director New York (1) 212-438-2760 Evan Gunter, Associate New York (1) 212-438-6412

January 2012

Diane Vazza Managing Director +1 212 438 2760 diane_vazza@standardandpoors.com

Evan Gunter Associate +1 212 438 6412 evan_gunter@standardandpoors.com

Born This Way: Acceptance Grows For New SpeculativeGrade Companies Through 30 Years of LBOs, Bank Loans, and Falling Interest Rates
1. NEW YORK (Standard & Poor's) Jan. 12, 2012Since 1981, the number of U.S.based 'AAA'-rated nonfinancial companies has dropped from 61 to four, while the number of speculative-grade companies (those rated 'BB+' and lower) has risen to more than half the 2902 U.S.-rated companies. Currently, 64%, or 1,421, of nonfinancial ratings in the U.S. are classified as speculative grade. 2. This explosion of lower rated debt has helped fuel growth in many industries. At the same time, some blame the vast leverage that resulted from the growth in speculativegrade debt as one of the key factors in the credit crisis that erupted in 2008, and from which the world economy is still suffering. 3. Several factors contributed to the diminished creditworthiness of U.S. companies over the past three decades, but two stand out: a search for yield on the part of investors as interest rates declined, and increasing comfort on the part of company management in taking on debt to increase shareholder value through dividends, acquisitions, and leveraged buyouts (LBOs). As Standard & Poors Ratings Services started rating bank loans and as LBOs gained prominence, acceptance grew for speculative-grade bonds as an asset class and Standard & Poor's assigned speculative-grade ratings ('BB+' and lower) to an increasing proportion of companies. Many industries, including telecommunications, transportation, and media and entertainment have become predominantly speculative grade. Technological advancements, regulatory changes, consolidation, and privatization transformed many industries. Fallen angels downgraded to speculative grade from investment grade ('BBB-' and higher) have contributed somewhat to this change in U.S. corporate ratings, but a greater shift has come from the steady influx of newly-rated speculative-grade companies. As more newly-rated companies have been "born" into the speculative-grade-category, investment-grade companies have declined as a share of ratings in the U.S.

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Table 1. Speculative Grade Share of U.S. Ratings by Sector, 1981-2011

Sector U.S Corporates (total) All Financials Financial Institutions Insurance All Nonfinancials Auto/capital goods/aero/metals Consumer & service Energy/natural resources Forestry, homebuilders Health care/chemicals High technology/office equipment Media and entertainment Real estate Telecommunications Transportation Utility 1981 24 13 10 23 25 34 30 34 26 24 48 43 42 3 28 4 1986 35 19 18 19 39 46 49 42 46 46 59 73 19 4 19 9 1991 28 15 21 7 33 45 41 32 42 36 68 66 13 3 29 4 1996 34 6 9 3 44 57 55 46 57 47 46 73 17 44 31 9 2001 39 8 13 5 49 68 55 46 66 59 61 74 17 63 43 9 2006 50 13 16 11 62 74 70 62 71 71 75 83 29 73 58 18 2011* 53 16 21 12 64 69 70 65 74 74 73 88 33 84 67 10

As of 9-30-11, Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

4. We consider a rating investment-grade when it is 'BBB-' or higher, and we consider a rating of 'BB+' or lower as having significant speculative characteristics. In this report, we refer to these issuers as speculative-grade. Transition studies have repeatedly confirmed that higher ratings tend to be more stable and that speculativegrade debt is generally more volatile and has a higher rate of default. 5. Since 1981, the overall distribution of ratings has become more speculative grade, though this growth is much less pronounced in the financial sector. Currently, 64% of nonfinancial ratings are speculative grade, compared with only 16% of financial ratings. Investor demand for speculative-grade debt as an asset class increased as insurance companies and mutual funds amended their investment policy guidelines to include acceptance of high-yield bonds as an asset class. As investors learned how to value and analyze high-yield bonds, the appeal of these bonds as an asset class grew. In 1995, Standard & Poors introduced ratings on leveraged loans. As the loan market grew, demand for ratings increased along with it, attracting many companies that would have otherwise gone unrated. Also during this time, corporate managers attempted to please equityholders through shareholder-friendly actions such as onetime dividends, mergers, divestitures, and LBOs. The growing acceptance of the Modigliani-Miller theorem partially explains this shifting preference among corporate managers. Franco Modigliani and Merton Millers theory states that a firm may be able to maximize its valuation by replacing equity with debt, given that the firm is taxed and that interest payments are deductible. While corporate managers preference for debt in the capital structure over equity may have helped to improve short-term stock returns, this boost frequently came at the expense of lower credit ratings.

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6. Pinnacle Foods Group LLC is a consumer services company with a history that shows examples of several of the credit trends that have led to the growth of highyield issuance. In 2001, Standard & Poor's Ratings Services assigned speculativegrade ratings on Pinnacle Foods as the group tapped into the bank loan and bond markets for the first time. Pinnacle accessed the speculative-grade market again six years later to undergo an LBO, and again in 2009 when it acquired Birds Eye Foods Inc., which led to further industry consolidation. Within the eight years since receiving the rating, Pinnacle has issued bank loans, undergone a leveraged buyout, and pursued an acquisition. Many other companies have adopted similar strategies, contributing to the growth of the speculative-grade share of ratings.

A Rise In LBOs Spurs An Increase In Speculative-Grade Companies

7. As high-yield debt has gained acceptance, LBOs have become more prominent since the early 1980s. Bryan Burrough and John Helyar, in their book "Barbarians At the Gate," immortalized this kind of debt-fueled, private takeover of a public company. The book recounts the $31 billion takeover battle for RJR Nabisco that closed in 1989. As the "leveraged" in LBO implies, these deals include high levels of debt and credit risk that seldom fit an investment-grade credit profile. Since the 1980s, LBOs have gone through cycles of popularity, with buyouts growing in size and scope each cycle. The Nabisco takeover remained the largest LBO for nearly two decades until the resurgence of large takeovers in 2006-2007 when LBOs such as HCA Inc. and TXU Corp. surpassed Nabisco in size. The prevalence of LBOs increases the pool of speculative-grade companies in several ways. First, if an investment-grade company goes through an LBO, Standard & Poor's has often downgraded it to speculative grade, sometimes overnight. For example, the takeover of RJR Nabisco resulted in Standard & Poors lowering its rating on Nabisco by six notches, to 'BB' from 'A'. Secondly, an LBO of an unrated company will often result in new ratings for the reorganized company as it taps into the credit market to replace equity with debt. Third, as the scope of private equity companies has expanded to include LBO targets of ever- larger companies and broadening industry preferences, many large companies have adopted more aggressive and shareholder-friendly financial policies to help prevent themselves from becoming the next takeover target. 8. As the 1990s progressed and as technology firms attracted more investor dollars, private equity companies began to pursue LBOs of technology companies, beginning with some of the more stable and predictable business models--from software to semiconductors. By 2006, Freescale Semiconductors became the largest LBO of a technology company to date, in a transaction valued at $17.5 billion. This led to Freescale becoming a fallen angel, as Standard & Poor's lowered its 'BBB-' rating on the company to 'BB+' once the sale was announced, and then lowered it further to 'BB-' when the transaction closed.
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9. Two gaming companies in the media and entertainment sector offer a good illustration of industry consolidation and LBOs. Caesars Entertainment Corp. and Harrahs were each rated 'A' in 1981. These two companies become one rated entity in 2005 when Harrahs Entertainment acquired Caesars. The corporate credit rating remained just within the investment grade category at 'BBB-'. Just over a year later, Harrahs was downgraded to speculative-grade as it announced that Apollo Management and Texas Pacific Group had proposed an LBO. Harrahs Entertainment changed its name back to Caesars Entertainment Corp. in 2010.

The Ratings Landscape In 2011 Bears Little Resemblance To That Of 1981

10. When we look at the rise of speculative-grade companies among U.S. nonfinancials over time, we note that each period has a different pool of companies. The pool of rated companies in 1981 has only a small overlap with rated companies in 2011. While Standard & Poors rated 1,398 U.S. issuers in 1981, we currently rate more than double that amount, 2,902, as of third-quarter 2011. Only 24% of the companies rated in 1981 are still rated. Of those companies, 20% are currently rated investment grade, while 4% are speculative grade (see table 2). The majority of companies from 1981 is no longer rated--16% of the initial pool defaulted, while 60% are no longer rated because of reasons such as consolidation, takeovers, or reorganization. As expected, the companies from the speculative-grade category had the highest rates of default--36% of nonfinancial issuers and 47% of financials rated speculative grade in 1981 defaulted over the subsequent 30 years.
Table 2. Ratings Transition Between Investment Grade and Speculative-Grade For Companies Rated in 1981
(as of 12/31/1981) Total Investment Grade Speculative Grade Financials Investment Grade Speculative Grade Nonfinancials Investment Grade Speculative Grade (as of 9/30/2011) Investment Speculative Count Grade (%) Grade (%) 1060 26 4 338 3 3 110 17 950 321 15 0 27 3 2 0 4 3 Defaulted (%) 9 36 10 47 9 36 Not Rated (%) 61 58 73 53 59 58

* As of 9-30-11, Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

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M&A, Consolidation, And Divestments Transform The Health Care, Telecommunications, And Transportation Sectors
11. Mergers and acquisitions can transform a sector by reducing the number of companies (for instance when two investment-grade companies become one). In the health care and chemicals sector, for example, many large players have consolidated to gain scale. Through the late 1990s and early 2000s, Pfizer Inc. acquired several other U.S. investment-grade companies, including Warner-Lambert Co. ('AA', 2000), Pharmacia Corp. ('AA-', 2003), and Wyeth ('A+', 2009). During this period, the corporate credit rating on Pfizer remained investment grade, though Standard & Poor's lowered it to 'AA' from 'AAA'. Pfizers consolidation of these companies has lowered the count of investment-grade companies within the sector by three. 12. Change in the telecommunications sector has been pronounced, as the speculativegrade share of the industry grew from 3% to 84%. First, the sector deconsolidated. This was followed by a period of rapid growth, and then the consolidation of many new firms due to technological change. AT&T was broken-up into the baby bells in 1984. This was followed by the technological changes of the Internet and cellular phone networks, and, eventually, industry consolidation. The Telecommunications Act of 1996 encouraged competition in the telecommunications industry, and allowed for a surge of upstart small, competitive local exchange carriers (CLECs) that aimed to compete against the larger, more established, regional bell operating companies. This period saw a sharp rise in the number of rated new speculative-grade CLEC and cellular companies. One of the survivors, independent cellular tower operator Crown Castle International Corp., received its initial 'B+' rating in 1997. The company is currently rated 'B+'. 13. Telecommunications saw successive increases in the speculative-grade share of new issuers from 1985 to 1990 and from 1990 to 1995. This sudden influx of lower-rated entities followed the break-up of AT&T in 1984 and subsequent industry deregulation. The new ratings of small companies with short track records flooded the previously investment-grade sector. Investor demand for telecommunications-related debt grew so strong that this sector comprised 13% of the high-yield issuance market by the second half of the 1990s. 14. The transportation sector is another example of an industry that experienced a pronounced shift in corporate ratings. Its investment-grade portion fell to 33% from 72%. The transformation of the rating profile of this sector is partially a result of the consolidation of the U.S. railroads. Four of the railroads that Standard & Poors rated investment-grade in 1981, Chicago Burlington & Quincy Railroad Co. ('A'), Atchison Topeka & Santa Fe Railway Co. ('AA-'), Great Northern Railway Co. ('A'), and Northern Pacific Railway Co. ('A'), have consolidated into one rated entity, Burlington Northern Santa Fe LLC ('BBB+'). In turn, Berkshire Hathaway
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acquired Burlington Northern in 2010. Burlington retains its standalone corporate credit rating, as this rating does not incorporate an explicit guarantee from Berkshire Hathaway. 15. In the forestry and homebuilders sector, a favorable financing environment in the mid-1990s led to many new ratings for speculative-grade issuers, as companies refinanced existing debt for longer term financing. In 1993-1994, we assigned new speculative-grade ratings to ten homebuilders. Several of these companies are still rated today, including Toll Corp. and Beazer Homes USA Inc. 16. Although the speculative-grade percentage of ratings has increased since the early 1980s, the absolute number of investment-grade companies continued to increase through the mid-1990s. While the investment-grade ranks were growing, speculativegrade companies were growing more quickly. The overall number of investmentgrade companies reached its peak in 1998 at 1,851. During this period, the number of investment-grade financial entities increased at a higher rate than nonfinancials, and financials reached their peak in 1997 with 724. The influx of newly rated speculativegrade companies outpaced the number of newly rated investment-grade companies.

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Chart 1. Number of Investment Grade Financial and Nonfinancial U.S. Companies, 1981-2011
#

1400

Number of Investment Grade Financials (left) Speculative Grade Percentage of U.S. Ratings (right axis)

Number of Investment Grade Nonfinancials (left)

% 100

90

1200
80

1000

70

60

800
50

600
40

400

30

20

200
10

0 1981 1986 1991 1996 2001 2006 2011*

* As of 9-30-11, Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

17. In many sectors, Standard & Poor's rated significant numbers of new companies in the speculative-grade category. In the consumer and service sector, for example, in 2005 and 2006, Standard & Poor's rated several fast-food (or quick-service) restaurants, Burger King Corp. ('B+'), Arby's Restaurant Group Inc. ('B+'), and Dunkin' Brands Inc.. ('B-'), in the 'B' category as they accessed the bank loan market. Illustrating the frequent consolidation and LBOs within this industry, within three years of its initial rating, Arbys had merged with Wendys International, which was rated 'BB-' prior to the merger. Meanwhile, within five years of receiving an initial rating, 3G Capital took Burger King was through an LBO in 2010.

The Business Cycle's Effects On Trends In New Ratings

18. The entry of so many new speculative-grade issuers contributed substantially to the expansion of the overall pool of rated companies in the U.S. (see chart 2). The growth of speculative grade as a share of all ratings reflects the high proportion of new issuers that were assigned ratings of 'BB+' or lower (see chart 3). In 1981, less than half (47%) of newly rated issuers fell into the speculative-grade category, but this climbed to a peak of 91% in 2010. During the recessionary periods of 1991, 2001, and 2008, we saw stark decreases in speculative-grade ratings as a share of all new ratings as business activity slowed. Fewer companies come to market to issue debt as the market for bank loans tightens, M&A activity slows, and companies reduce inventories as well as lower capital expenditures on expectations for declines in
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demand. These recession periods coincide with declines in the number of new issuers overall. More than half of new issuers have been rated speculative grade every year since 1992, with the exception of 2001. As a result, its not surprising that weve seen investment-grade ratings decline as a proportion of overall ratings.
Chart 2. Number of U.S. Rated Companies and the Percentage that are Speculative-Grade
(count) 3500 3000 2500 40 2000 30 1500 1000 500 0
20 09 20 11 * 19 89 19 95 19 87 19 93 19 81 19 83 19 85 19 91 19 97 19 99 20 01 20 03 20 05 20 07

Total Ratings (left)

Speculative Grade % of Ratings (right)

(%) 60 50

20 10 0

* As of 9-30-11, Includes both financial and nonfinancial rated companies. Shaded areas are periods of recession as defined by the National Bureau of Economic Research. Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

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Chart 3. Number of New Issuers and Share Of These That Are Speculative-Grade
Count of New Issuers (left) Speculative Grade % of New Issuer Ratings (right)
(Count) (%)

600 500 400 300 200 100 0

19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 20 0 20 9 11 *

100 90 80 70 60 50 40 30 20 10 0

* As of 9-30-11, Includes both financial and nonfinancial rated companies. Shaded areas are periods of recession as defined by the National Bureau of Economic Research. Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

Chart 4. Speculative-Grade Share of New Ratings and the Default Rate

Speculative Grade % of New Ratings % 100 90 80 70 60 50 40 30 20 10 0
20 11 * 20 01 19 99 19 87 19 97 20 03 20 05 20 07 19 83 19 85 19 89 19 91 19 81 19 93 19 95 20 09

U.S. 12 Month Trailing Speculative-grade Default Rate (actual), as of December

Shaded areas are periods of recession as defined by the National Bureau of Economic Research. Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

19. The percentage of new issuers rated speculative grade tends to dip when the default rate spikes. The default rate was at its highest--near 10%--in 1991, 2001, and 2009.
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During these years, the speculative-grade share of new issuers hit its troughs (see chart 4). Rising default rates provide a reminder to investors of the increased credit risk that accompanies high-yield debt. In periods of stress, investors risk aversion lowers the demand for high-yield debt. Without this investor demand for high-yield debt, corporate managers have less access to credit markets for funding, and, in turn, they are less likely to pursue new ratings.

A High-Yield Alternative To Declining Interest Rates

20. Part of the reason for the growing acceptance of speculative-grade debt is the decline of interest rates over the past 30 years. Treasury yields have subsided from their highs of near 15% in the early 1980s to near 1% currently. During this time, investors have sought to generate higher yields with their savings. As investors appetite for yield has grown, so have their tolerance for credit risk and their demand for speculativegrade bonds. The speculative-grade portion of new ratings has increased over this time period. In 1981, less than half of new ratings (47%) were speculative grade, compared with 83% in 2011. This reflects the opening up of a market for high-yield bonds and investors growing acceptance of companies with initial ratings of 'B' to 'BB'. The yields offered by speculative-grade issuers have attracted a growing segment of the investor base. In the early 1980s, pension and mutual funds held only a handful of fallen angels in their portfolios, but by the 1990s, dedicated high-yield funds grew, and this investor demand supported newly rated speculative-grade companies as they entered the credit markets.
Chart 5. Speculative-Grade Percentage of Newly-Rated Issuers Compared to Treasury Yields
(%) 16 14 12 70 10 8 6 4 2 0 60 50 40 30 20 10 0 5-Year Treas Yield Speculative Grade % of New Issuer Ratings (right) (%) 100 90 80

19 81

19 93

19 87

19 99

20 07

19 83

19 95

19 91

19 89

20 01

20 03

19 85

19 97

20 05

20 09

Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro; and Federal Reserve Board Born This Way: Acceptance Grows For New Speculative-Grade Companies Through 30 Years of LBOs, Bank Loans, and Falling Interest Rates Page 10

20 11

Chart 6. Speculative-Grade Portion of Total U.S. Ratings versus percentage of Total Issuance That Is High Yield
High Yield 60 Spec Grade % of Ratings (TOTAL)

50

40 TREND 30

20 TREND 10

0
19 85 19 91 19 93 19 95 19 89 19 97 19 81 20 01 20 05 20 07 20 09 20 03 20 11 19 83 19 87 19 99

Source: Standard & Poors Global Fixed Income Research and Thomson Reuters

21. Although the proportion of speculative-grade ratings has doubled in the U.S. since 1981, the volume of high-yield issuance has remained fairly steady between 10% and 30% of total U.S. issuance volume (see chart 6). Although the number of speculativegrade-rated companies is rising, the amount of debt that these companies issue tends to be small relative to that of investment-grade entities. Financial companies account for much of the total issuance volume because their business models require large amounts of debt funding. Although investment-grade companies are now the minority in the U.S., they still issue the majority of debt.

Across Sectors, New Issuers Are Increasingly Speculative Grade

22. Nonfinancial issuers are a much larger proportion of new speculative-grade issuers than financials (see chart 7). Since 1981, the share of speculative-grade ratings has risen in both sectors. Nonfinancials have seen a relatively steady rise, while financials have experienced a significant pick-up since 2001. However, the total number of new financial ratings has been declining since 2006. The proportion of new financial ratings that were speculative grade peaked in 2010 at 66%, or 19 issuers.

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Chart 7. Speculative-Grade Portion of New Issuers, Financial vs. Nonfinancial

% 100 90 80 70 60 50 40 30 20 10 0
20 09 20 11 * 19 81 19 87 19 85 19 93 19 83 19 95 19 91 20 01 19 89 19 99 19 97 20 07 20 05 20 03

Nonfinancials

Financials

Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

23. Newly rated companies tend not to be born into investment grade. Since 1981, speculative-grade ratings as a share of all new ratings has risen in every sector (see chart 8). Across all nonfinancial sectors, only two sectors, high technology/office equipment and media and entertainment, had new ratings that were more than 60% speculative grade between 1981-1985, while in the recent period, each nonfinancial sector has a share of new speculative-grade ratings above 60%, with the exception of utilities. Utilities, financial institutions, and insurance are the only sectors in which less than half of newly rated companies are speculative grade. These sectors are particularly sensitive to both regulations and investor confidence, and the credit market has been considerably less accommodative of newly rated speculative-grade companies in these sectors than in others. However, even in these predominantly investment-grade sectors, the speculative-grade share of new issuers has increased over the past 30 years. 24. The media and entertainment sector is a good example of the effect an influx of newly rated speculative-grade companies can have on a sectors ratings mix. Expansion and consolidation of gaming companies and the birth of many new media companies characterize activity in this sector. The number of rated media and entertainment companies increased more than five-fold since 1981, outpacing the 1.75x growth of the nonfinancial sector overall.

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25. The proportion of new issuers in this sector rated speculative grade since 1981 is 91%, compared with 77% for nonfinancials overall. The higher number of newly rated companies provides us with a few examples of entities that are born into speculative grade, thrive, and are upgraded to investment grade. For example, Turner Broadcasting System Inc. was initially rated 'B+' by Standard & Poors in 1984. Twelve years later, the company was upgraded to 'BBB-' when Time Warner Inc. acquired it. Another notable media company, News Corp. was initially rated 'B' in 1986, upgraded to investment grade in 1993, and is currently rated 'BBB+'. Meanwhile, Standard & Poor's assigned speculative-grade ratings on several gaming companies, including Las Vegas Sands LLC (rated 'B' in 1997) and Wynn Las Vegas LLC (rated 'B' in 2002).
Chart 8. Speculative-Grade Share of New Ratings by Sector
1981-85
%

1986-90

1991-95

1996-2000

2001-05

2006-10

100 90 80 70 60 50 40 30 20 10 0
na nc ia lI ns t it ut io ns Re al es Tr ta an te sp or ta tio Te In n le su co ra m nc m e un ic En at er io gy ns /n at Ut ur Fo ilit al re y re st so ry ,h ur Au ce om Co to s eb /c ns ap ui um ld it a er er lg s & oo se Hi rv He d s/a gh ice er al te th o/ ch m ca no et re lo al /c gy s he /o M m ffi ed ica ce ia ls eq an ui d pm en en te t rta in m en t

Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

Born This Way: Acceptance Grows For New Speculative-Grade Companies Through 30 Years of LBOs, Bank Loans, and Falling Interest Rates Page 13

Fi

26. Industries that show the most dramatic changes in the make-up of new issuers are real estate, telecommunications, and transportation. Through the 1990s, 83% of new real estate issuers were rated investment grade. This shifted sharply toward speculative grade in the 2000s, when Standard & Poor's assigned speculative-grade ratings on 67% of new issuers in the sector. From 1981-1985, just 17% of incoming telecommunications issuers were speculative grade. That proportion increased to 95% from 2006-2010. The speculative-grade share of new issuers in the transportation sector jumped sharply from 14% in 1981-1985 to 62% during 1986-1990, eventually reaching 93% more recently. 27. In the speculative-grade category, 'B' rated entities have gained prominence since the 1980s. In the early 1990s, companies that were initially assigned ratings at the 'B' level primarily came from less volatile industries such as retail/restaurants and health care. But, by the late 1990s, during the technology boom, the demand for newly rated companies at the 'B' level spread to industries such as telecommunications and high technology. 28. As investor sentiment evolved, the funding mix changed in the high technology/office equipment sector. From the 1980s through the early 1990s, technology companies tended to fund themselves with either equity or equity-like convertible debt-demonstrating the need for growth capital to support a more volatile business risk. This growing preference for debt within the capital structure led to an increase in the number of new, lower-rated companies in this sector. 29. Most of the newly rated technology companies are speculative grade, though a few high-profile investment-grade exceptions exist. We rated Microsoft Corp. 'AA' in 1996, and then 'AAA' in 2008. In 2010, Google Inc. was rated 'AA-', and Adobe Systems Inc. 'BBB+'. In addition, Standard & Poor's upgraded a few technology companies to investment grade. For example, Standard & Poors assigned a 'B' rating on Amazon.com in 1998. The rating reflected our view of the companys negative operating cash flow and rapid growth in an evolving marketplace. In 2009, we upgraded the company to 'BBB', investment grade, reflecting our view of Amazon.coms strong brand, robust performance, and improved credit metrics. In December 2011, we withdrew the rating on Amazon because the company has a relatively low amount of debt and no rated debt. In another example, Standard & Poors assigned a 'BB-'rating to Dell Inc. in 1991. Within five years, the company was upgraded to investment grade, reflecting its improved market position, consistent profitability and stronger financial profile, offset by highly competitive industry conditions. Dell is currently rated 'A-'. 30. From 2001-2010, more than 90% of new issuers in the consumer and service sector were rated speculative grade. Not surprisingly, the share of speculative-grade entities in the sector increased substantially to 70% in 2011 from 55% in 2001 and 30% in
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1981. This sector comprises both consumer products and retail companies. Changing consumer demand within the consumer and service sector led to the rise of specialized retailers such as Best Buy Co. Inc., Home Depot Inc., Staples Inc., and Starbucks Corp. Although these companies were born into speculative grade in the 1980s and 1990s, they became rising stars and are all currently rated investment grade.

In The Nonfinancial Sectors, New Speculative-Grade Issuers Outnumber Fallen Angels Every Year Since 1981
31. The number of new issuers rated speculative grade exceeds the number of fallen angels in every year since 1981 among the nonfinancial sectors and, in most years, among financials too (see chart 9). Thus, new ratings contribute more to the rising tide of speculative-grade nonfinancials than fallen angels do. However, in the financial sectors, there have been a few stress periods during which fallen angels far outnumbered new speculative-grade issuers, largely because of the relatively low number of new speculative-grade financial issuers during those times. The total count of nonfinancial fallen angels has outnumbered financial fallen angels in almost every year since 1981. Only during the fallout from the great recession in 2009 and 2010 did financial fallen angels outnumber nonfinancial ones.
Chart 9. Ratio of Fallen Angels to New Speculative-Grade Issuers
Financials: Ratio of Fallen Angels To New Spec. Grade Ratings Nonfinancials: Ratio of Fallen Angels To New Spec. Grade Ratings 7 6 5 4 3 2 1 0

*As of 9-30-11, Source: Standard & Poor's Global Fixed Income Research; Standard & Poor's CreditPro

32. The ratings on airlines illustrate how some companies have migrated between investment grade and speculative grade. As of the beginning of 1981, Delta Air Lines Inc. and United Air Lines Inc. (now United Continental Holdings) were investment grade, and US Airways Inc. was upgraded to investment grade in
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20 11 *

19 99

20 01

20 07

20 03

19 85

19 83

19 81

19 93

19 95

19 89

19 91

19 97

19 87

20 05

20 09

mid-1981. Over the following years, we downgraded each of these companies to speculative grade, and, in the aftermath of Sept. 11, 2001, the rating deterioration worsened. During that time, the airline industry was particularly vulnerable to heightened awareness of terrorism risk and volatile oil prices. United Continental Holdings Inc. filed for bankruptcy protection in 2002, followed by US Airways in 2004, and Delta in 2005. 33. In the automotive/aerospace/capital goods/metals sector, many U.S. automakers experienced downgrades to speculative grade in the 2000s, along with significant industry consolidation and opportunities for small, newly rated companies. At the end of 1981, Standard & Poor's Ratings Services rated two of the Big Three U.S. automakers investment grade: General Motors Co. ('AA+') and Ford Motor Co. ('A'), while Chrysler Corp. was rated CCC. Daimler-Benz AG bought Chrysler in 1998 and eventually sold the company to an affiliate of Cerberus Capital Management L.P. in 2007. Standard & Poor's downgraded General Motors and Ford to speculative grade in 2005. All three of these automakers defaulted on at least a portion of their outstanding debt in 2009.

Most Of The U.S. Companies Currently Rated Speculative Grade Were Born That Way
34. There are many types of speculative-grade companies. Some are fallen angels that were once rated investment grade, though these are by far outnumbered by entities that were initially assigned speculative-grade ratings. Of those born into speculative grade, a few will thrive and eventually reach investment grade, others will default, and many will continue doing business, issuing debt, and merging with others in the ever-evolving corporate landscape.
For more information and analysis, please see the following reports available on RatingsDirect: Credit Trends: A Snapshot Of The Corporate Ratings Distribution For The U.S., Europe, Emerging Markets, And Other Developed Region, published Oct. 6, 2011 Credit Trends: Global Ratings Distribution: Investment-Grade Ratings Predominate In The Financial Sector While The Majority Of Nonfinancial Companies Are Rated Speculative Grade, published July 14, 2011 Default, Transition, and Recovery: 2010 Annual Global Corporate Default Study And Rating Transitions, published Mar. 30, 2011 A Look At the U.S. Nonfinancial AAA Ranks Through the Decades, published Dec. 23, 2008 The Leveraging of America: LBOsThe Good, The Bad, and The Ugly, published Nov. 26, 2007

Born This Way: Acceptance Grows For New Speculative-Grade Companies Through 30 Years of LBOs, Bank Loans, and Falling Interest Rates Page 16

The Leveraging Of America: Recent Leveraged Buyouts Drive Credit Risk Higher As The Market Churns, published Aug. 6, 2007 25 Years of Credit: The Decline of RatingsA Three-Act Play, published Feb. 16, 2007 25 Years of Credit: A World of Change For Financial Markets, published Feb. 15, 2007 The Rise of B Rated Companies And Their Staying Power As An Asset Class published Dec. 29, 2006 Credit Trends: Oh Where, Oh Where Have the AAAs Gone?, published July 29, 2002

We would like to thank our colleague, Debabrata Das, at Standard & Poor's/CRISIL, for his assistance with this report.

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