Credit Rating Rollercoaster (data as of 9/10/2009)
Chart of the Week for September 11 - September 17, 2009
S&P credit ratings are important tools for bond investors because they act as an independent assessment of the risk of default for a given bond. Typically, when a bond is downgraded or upgraded, the change has a significant impact on the price of the security. The chart above illustrates the trend in credit ratings during the last decade. The yellow portion of the bars represents the number of credit rating downgrades (declining financial health) that occurred during the given quarter, while the blue portion of the bars represents the total number of credit rating upgrades (improving financial health). The green line tracks changes in the up/down ratio, which is calculated as the number of upgrades divided by the number of downgrades.
From 2004 to 2007, credit upgrades outnumbered credit downgrades during several quarters. In other words, more companies were believed to have improving, rather than declining, financial health. Beginning in 2007, however, the number of downgrades began to increase. Between the third quarter of 2007 and the third quarter of 2008, the number of downgrades almost tripled. Downgrades spiked to 781 during the first quarter of 2009, driven up by a worsening economic environment and the bankruptcy of several companies. Ratings agencies received criticism over the last few years for being too slow to react and for downgrading bonds only after it was too late for investors to avoid potentially large losses.
Judging from the most recent quarterly trend, the bond market appears to be on the mend. Although there are still two weeks remaining in the third quarter of 2009, the up/down ratio has jumped from 0.24 in the second quarter of 2009 to 0.59 so far in the third quarter. This may be an indication that the default risk for bonds is moderating, which could lead to a contraction in yield spreads and, consequently, a potential increase in bond prices.
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