We’re running out of time.
As of this writing, politicians are still bickering over the debt ceiling.
And even if they do manage to avoid a default, the damage may already be done.
I’m talking about the United States’ credit rating.
It’s been all over the news in recent days. But for those who may not be familiar with what it is and who gets to decide it…
There are three major credit rating agencies: S&P Global, Fitch, and Moody’s. They help investors understand the risks of investing in bonds by assigning a credit rating to each company (or government) that issues debt.
Most people consider U.S. government debt to be “risk-free.” That means it’ll always pay it back in full and on time.
Right now, Moody’s and Fitch give Treasury debt an AAA rating. That’s the highest possible rating. It means the issuer has an “extremely strong” capacity to meet its financial commitments.
But S&P Global has Treasury debt rated at AA+. That’s one notch below the max rating. (They cut the rating after the 2011 debt crisis when it was unclear whether the U.S. government would pay back its debts.)
I don’t know about you, but after all the drama and suspense on the debt ceiling these last few weeks, I have some questions, too.
For now, the credit rating agencies are keeping their ratings as-is. But last week, Fitch issued a negative rating watch on U.S. debt. That means it could downgrade the rating if politicians don’t pass a bill to raise the debt ceiling.
Because if you can’t sleep well at night knowing the bonds you invested in will be paid back on time, they probably don’t deserve the highest rating.
Here at Intelligent Income Daily, we’re focused on finding the safest income investments on the market. A credit rating downgrade isn’t the end of the world. But it makes things more complicated for investors looking for “risk-free” places to put their hard-earned money.
Today I want to share how you can profit from the debt ceiling drama. Most people don’t think about it when they think of defensive plays right now.
And although I believe it’s unlikely we’ll default in the next few days… this is something you’ll want to keep your eye on for a steady source of growing income if things go south.
Ratings Agencies Are More Powerful Than You Might Think
Debt is all about trust.
When you lend money to someone, you’re trusting them to pay you back in the future. And you build that trust by having a close relationship and a history of kept promises.
But what if a stranger asks you for a large sum of money? Unless you’re a philanthropist, you’re going to want some assurances they’ll be able to pay it back.
That’s where credit rating agencies come in. They give investors a reputable third-party opinion on how trustworthy companies are when it comes to paying back their debts.
Credit rating agencies began popping up in the early 1900s, as railroad companies looked to raise large amounts of debt to finance building rail connections across the country.
In 1936, new regulations prohibited banks from investing in speculative “junk” bonds. Later, insurance companies would also be forced to invest only in “investment grade” bonds.
And since it was the credit rating agencies that determined which bonds were junk or investment grade based on their ratings, they became an essential part of the financial system.
Over the years, the credit rating agencies have expanded their coverage to more and more types of financing, including government debt and structured notes.
And for income investors like us, here’s where things get interesting…
Did you know you can own stock in credit rating agencies? Most people hear the word “agencies” and think they’re part of the government. But they’re not. They’re ordinary companies.
Fitch is privately owned. But you can also buy shares of Moody’s (MCO) or S&P Global (SPGI).
And they’re incredibly attractive businesses. The law requires banks and insurance companies to use their ratings to manage their debt investments. And when big issues like the debt ceiling pop up, the research and ratings they provide become more important than ever.
Credit Ratings Matter – And That Will Never Change
A better rating means that the debt is less risky. And investors are willing to accept lower interest rates on debt that has less risk.
Here are the current effective yields for corporate debt at different ratings:
Even though a few fractions of a percentage point may not seem like much, it adds up to a lot of money over time. Companies with better credit ratings have a significant advantage because they can borrow at cheaper rates.
And if the U.S. government’s credit rating gets downgraded, it will mean paying higher interest rates on its debt.
Now that you know why credit ratings are so essential, you can see why the companies providing them are such great businesses to own.
They’ve built up trust and a strong reputation for nearly a century and are firmly entrenched in our financial system. And that resilient business has helped them reward shareholders with growing dividends:
- Moody’s has grown its dividend for 14 years. It currently yields 1%.
- S&P Global has grown its dividend for 50 years. It currently yields 1%.
These companies rarely trade at a discount because investors recognize the high quality of their business. And although their yields don’t seem impressive, it’s sure to be reliable in case of a crisis event.
Warren Buffett even has Moody’s as one of Berkshire Hathaway’s top 10 holdings.
So put them on your watchlist today and look for an opportunity to buy if the market crashes because of the debt ceiling debacle. Because you may not have another opportunity like this one to buy them at a discount.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research