Moodys Continues Downgrading Chinese Developers: What is a Downgrade?

Moody’s Continues Downgrading Chinese Developers: What is a Downgrade?

Moody’s issued 91 downgrades on high-yield Chinese property developers over the last nine months. What does this mean for investors?

What is a downgrade?

A downgrade is an unfavorable change in the rating of a stock’s financial performance, issued by an analyst at an investment bank or credit rating agency. It indicates that the company’s prospects and financial strength are expected to be weaker and, therefore, a riskier investment. 

Two types of downgrades get cited on Wall Street:

  1. The first is by an analyst at an investment bank. These ratings are forward-looking opinions of business and financial risks of a company. The stock is categorized by a buy, outperform, hold, underperform or sell rating in reference to its share price. A downgrade usually leads to a sell-off of the company’s stock as confidence in it falls.  
  1. The second type of downgrade is by a credit rating agency such as Moody’s Corporation (NYSE: MCO), S&P Global, Inc (NYSE: SPGI), and Fitch Ratings. These ratings are forward-looking opinions of the relative credit risks of bonds issued by non-financial companies. Each rating agency has a different but similar scale.

    For example, a AAA (S&P) or Aaa (Moody’s) rating is the highest credit rating available, indicating a 0.1% probability of default and allowing the company to offer low bond yields. However, a CCC rating exhibits a 56.8% probability of default, meaning the borrower has to propose massive bond yields to attract lenders if it is possible to entice any.

Why did Moody’s downgrade Chinese property developers?

Over the past nine months, Moody’s has issued 91 downgrades for Chinese property developers as worries grow over their ability to repay outstanding debts. This is a significant trend for investors as the company announced that, in the ten years to December 2020, it had only issued 56 downgrades. 

Moody’s said in a recent report that it covers 50 names in the industry, with over half having a negative outlook or are on review for downgrade. 

Downgrades usually result in a sell-off in both the company’s stocks and bonds. When a bond is sold, its price falls, increasing the yield and making future debt even more expensive. This, in turn, lowers the company’s profits and leads to a higher probability of default, further putting shareholders’ investments at risk.

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