Corporate rating momentum

GICP expert view / 15 October, 2024

Research from Fitch Ratings has found an organization’s outlook is a stronger indication of the next rating movement that a previous rating action in negative credit developments. Issuers that were downgraded but with stable outlook were lowered again 9% of the time, whereas those affirmed with negative outlook were subsequently downgraded 24% of the time. Conversely the research found little evidence of momentum in the positive direction.

The research analyzed the momentum in corporate credit ratings, focusing on whether upgrades or downgrades signal future rating actions in the same direction. The research covered around 30,000 actions since 2013 where the previous rating was B- or above.

Below is a summary of the findings.

Negative momentum scenarios:

Rate of downgrade from a stable outlook:

Downgrade from stable outlook is rare, occurring about 3.5% of the time after an affirmation with stable outlook. These are normally associated with a quicker deterioration than expected and for ratings at the lower end of the rating scale.
When the previous action was a downgrade but the outlook was revised to stable, the downgrade rate increases to close to 10%.

Rate of downgrade from a negative outlook:

The rate of downgrade is 30% following a downgrade with negative outlook.
For issuers affirmed with a negative outlook, the downgrade rate is slightly lower at 24%.

Rate of multi-notch downgrade from a negative outlook:

Multi-notch downgrades occur 15% of the time following a previous downgrade with negative outlook.
This is significantly higher than the 5% rate after an affirmation with negative outlook.

Positive momentum scenario:

Upgrade rate from a positive outlook:

Whether a positive outlook is associated with an upgrade or affirmation seems to have minimal impact on its conversion rate into an upgrade. The authors suggest this reflects the minimal incentives for issuers to halt positive credit developments, or otherwise prevent upgrades.
New ratings with a positive outlook are less likely to receive an immediate upgrade in the following rating action. Instead, it may take several rating actions before an upgrade happens.

Implications for credit analysts:

Monitoring indicators: Analysts should pay close attention to outlook changes as they are strong indicators of future rating actions.
Although a less powerful signal than a negative outlook, the previous action being a downgrade is a relevant indicator of a higher likelihood of a forthcoming downgrade, especially in high yield, compared with issuers which have been affirmed.
Regional differences: Data for regions do differ from the global average. Emerging market exposure can be a differentiator.
Ratings actions: Whilst this research only considered two consecutive actions, it may take several ratings actions before a downgrade or upgrade happens.
Gradual upgrades: Positive outlooks on new ratings should be seen as a long-term positive indicator rather than an immediate precursor to upgrades, requiring sustained positive credit developments.

The full article ‘Corporate Rating Momentum’ is available here. Note that a Fitch Ratings account may be required to access the document.