Volume of 'fallen angels' entering junk territory still far below analysts' worst-case expectations
While analysts had every reason to expect a record number of corporate bonds shedding their investment-grade status because of the pandemic, that’s not what has played out so far in the U.S. fixed-income space.
According to data from Intercontinental Exchange, the value of corporate bonds downgraded to junk status this year has already hit record levels by some estimates, but is still far short of worst-case estimates issued by many analysts in spring, reported the Wall Street Journal.
Last November, the U.S. and European credit strategy team at Morgan Stanley had predicted that 2020 would see some US$100 billion of fallen-angel debt; after the pandemic, they revised their prediction to US$300 billion by the first quarter of 2021, the Journal said. But based on actual fallen-angel volumes observed by the team, actual volumes of fallen angels have reached only half of that amount as of early September.
Estimates from JPMorgan Chase showed fallen angels cresting in March, when approximately US$83 billion of investment-grade corporate bonds were demoted to junk status. In April, the Federal Reserve entered the picture with an announced extension of its corporate-bond purchase programs to include issuers that lose their investment-grade ratings after the pandemic’s late-March onset.
“That action from the Fed really helped open up the funding markets and probably contributed to the lower number of fallen angels,” Eric Beinstein, who heads the U.S. investment-grade research activity at JPMorgan, told the Journal. He had predicted there would be US$215 billion of fallen angels in 2020, but is now of the view that the full-year total would be far less than that.
Another reason why the worst-case scenario has been averted is a widespread rush among companies to borrow cash. Following the Fed’s move to cut interests to near zero, many swapped shorter-term borrowings for longer-dated debt, then kept the proceeds on their balance sheets to help them weather the outbreak.
“That was a major factor in alleviating investors’ concern about their ability to withstand the crisis,” Shobhit Gupta, head of U.S. credit strategy at Barclays, told the publication.
As debt loads swelled and earnings took a hit, many companies exhibited greater levels of leverage. Airlines, retail companies, and oil-and-gas operators – representing industries most impacted by the downturn – started showing more unsustainable debt loads, resulting in some of the heaviest downgrades.
Still, some of those companies have retained their investment-grade ratings. Among them is Delta Airlines, whose debt load Moody’s estimated was at 13.4 times earnings – higher than usual for investment-grade companies – as of June. The ratings agency, however, said that the airline’s operations provided “a solid foundation for eventual recovery from the coronavirus pandemic.”
Some investors are concerned that ratings are a lagging indicator of market stress, as credit-ratings firms have had a history of being slow to downgrade some issuers after their debt loads spiked.
In statement, Frederic Gits, Fitch’s group credit officer for corporate debt, said the company seeks a long-term view on companies’ creditworthiness as it evaluates their grades.
“This long-term approach explains why the number of downgrades has not been greater despite the magnitude of the crisis,” Gits said, adding that a slower-than-expected economic recovery could lead to a resurgence of fallen-angel activity.
