Credit rating is usually not a one-off process as Rating Agencies are oftentimes seen as watchdogs. Rating Agencies assess a company or financial instruments like bonds on a regular basis while considering the qualitative and quantitative attributes of the entity in question. Such attributes include the basis of the debt, the capability to pay back, risks inherent and other relevant factors.
Investment grade is assigned to issuers who have strong financial strength, operating performances and profile. Speculative grade investments are high risk and assigned to companies with marginal, weak or poor profile, financial strength and operating performance.
Besides ratings, the agencies also issue whether the outlook is stable or negative. This signals the probability of a downgrade or upgrade in the near future.
Rating Agencies regularly monitor positive trends or stress factors to forecast the near-term outlook of a company and country. Continuous diminution in the economy, overdependence on a particular sector by the government, depreciation of a country’s currency, high inflation and high interest rates abates the chances of a rating upgrade. This is because they will impede growth in demand and affect profitability, operation, and stability.
Rating downgrade adds to the pressure on stocks since rating is used by most investors as a common yardstick to measure the financial health of an institution. A rating downgrade or upgrade gives an indication to investors about the company’s potential to make more profits without accumulating too much debt.
Both a rating and an outlook downgrade is never to be seen as a good sign. In event of a downgrade, the risk in lending to that company becomes higher. Subsequently, investors will have to provide funding at higher costs and a further fall would lead to junk rating. This makes raising foreign debt difficult for the institution.
Conclusively, the fact that CRAs raise red flags or are always on the watch does not imply that they predict all debt crises, though it is most likely a company or country is being downgraded rather than upgraded. This is why they are mostly conservative, but at times, skeptical.