Stock Declines Hurt Ratings of 'Confidence-Sensitive' Firms

It should be self-evident by now as the subprime mortgage crisis has morphed into a credit and banking crisis.

A company’s stock price should never be the main factor in rating creditworthiness, but it does figure prominently in confidence-sensitive industries such as banking and financial services, according to S&P Credit Research.

“Confidence-sensitive” companies, such as securities firms, banks, and insurers, offer a powerful example of how stock prices (and spreads on credit default swaps) can reflect real changes in a company’s ability to operate.

Financial stocks can decline as a sector without materially harming the health of the companies, S&P said, but any sudden downdraft in the equity of financial firms must be carefully evaluated. That’s because securities firms, banks and insurers rely on the confidence and trust of counterparties with whom they trade.

A sudden change in the stock price of a securities firm can be caused by normal market volatility. On the other hand, it can reflect a loss of confidence by lenders and trading partners. In the latter case, the company’s operating capabilities may be suddenly and severely impaired, with a potentially significant impact on its creditworthiness.

Securities firms in particular rely on short-term funding such as repurchase agreements and commercial paper. A drop in counterparty confidence in a firm as reflected in its stock price may mean that the firm is no longer able to raise short-term funds.

For details, see “How Stock Prices Can Affect An Issuer’s Credit Rating.”