A significant deterioration in payday loans spreads • 11.11.09
Adowngrade into high yield may have the following effects:
- Forced selling activities from investment grade accounts
- Direct effect on the financial flexibility of a company (CP program, bank covenants triggered), may result in “financial distress” in a worst-case scenario
The spread behavior prior and after a downgrade into high yield or an upgrade into investment grade is of particular interest. The average spread for 15 companies’ 200 trading days before and after a downgrade into high yield. Day “0” is set as the day where the first downgrade from investment grade into high yield occurred either by Moody’s or S&P. The bonds we chose for this analysis were downgraded between 2002 and 2003 and are presented below.
It is noteworthy that a significant deterioration in spreads occurs long before the actual rating action takes place. At the day “0” obviously in most cases further spread widening/price fall takes place but this can be explained by technical factors. Forced sellers will emerge and in an illiquid market bid-offer spreads can be as wide as 3–4 price points and prices can deteriorate quickly if no buyers arise.
