Question

What does a credit rating downgrade imply about credit risk/default risk? How do a

firm’s benchmark spreads change when a rating downgrade occurs?
a. Related: what does a credit rating upgrade imply about credit risk?

Answer 1

Hi,

Please find my answer as below:

If a company has a high debt levels and companies finance deteriorating, there is a chance that company may not be able to repay its debt as per schedule or, in some cases, may even default. So, there is a high risk and rating agencies downgrade the credit rating due to high credit or default risk.

If a companies credit rate downgrade then it reduces the ability to borrow funds from market. Lenders may hesitate lending money with a uncertainty to get refund from such companies. Even lenders may not even roll-over (refinance) existing debt. It may turn to impact the future growth plans of the company. At a same time, Investors seek higher returns for the additional risk they take resulting high cost of borrowing funds for the company. Based on the rating downgrade, immediately company’s stock price falls, impacting your equity investments in the short run. Investors may loose confidence and withdraw their invested money. Even your debt mutual fund investments can be adversely impacted. A ratings downgrade is an alarm bell and if it downgrades you need to take corrective action and revisit your financial policies and future plan and go through the explanation provided by the company in response to its rating downgrade and analyse it and take necessary action.

A credit rating upgrade imply that company is moving from positive to stable condition and there is a low risk for the lenders to get refund their money which they have invested in the company. Investors get confidence on the company future plan and policies and easily company may borrow funds from market.

Hope this helps :)