Fallen-Angel Debt Could Reach USD400bn in EMEA Developed Markets and US

Tuesday, May 12, 2020 / 12:42 PM / By Fitch Ratings / Header Image Credit: Investopedia

"Fallen angel" debt in the US and EMEA developed markets (DMs) has reached more than USD150 billion on a combined basis since 1 March 2020, says Fitch Ratings. We estimate that a second wave of fallen angels could be larger than the first, especially in the US, in the event that economic conditions decline in a more protracted and severe manner in line with Fitch's downside scenario. This could bring the total amount of debt migrating from investment-grade (IG) ratings to sub-IG ratings to around USD400 billion, which is equivalent to 13% of total Fitch-rated 'BBB' category debt at end-2019.

The debt that has transitioned to sub-IG since 1 March is within the USD105 billion-215 billion of debt we previously estimated would be at risk in the event of a downturn. However, that estimate was based on peak one- to three-year transition rates during the 2008 financial crisis, but almost all recent downgrades occurred in a period of less than three weeks due to much more rapid revisions of economic expectations.

We classified our 'BBB' portfolio as of 1 March into two classes to assess the magnitude of debt at risk of migrating to sub-IG: "elevated risk" and "moderate risk", based on a combination of rating level, sector exposure to the pandemic and headroom in the rating level. Under this approach, around 15% of issuers were in the elevated-risk category and 11% were in the moderate-risk category.

Companies considered to be at elevated risk are those rated low-IG or 'BBB-' with high sector risk, those with low rating headroom and medium sector risk, or those on a Negative Outlook or on Rating Watch Negative. We also consider risk to be elevated for mid-IG companies rated 'BBB' with low rating headroom and high sector risk. In our portfolio, 54% of issuers we deem to be at elevated risk are rated 'BBB-' with a Negative Outlook or Watch, about 30% are rated 'BBB-' with a Stable Outlook, and the remaining 16% are rated 'BBB' with a Negative Outlook.

Fitch continues to assess issuers on a through-the-cycle basis, with an emphasis on the credit profile at the exit of the crisis. A downgrade to sub-IG reflects the fact that the downgraded issuer is likely to suffer a lasting weakening of its credit profile due to the impact of the crisis on cash flow and profitability, and will not be returning to within guidelines for an IG rating by end-2021. The unprecedented number of fallen angels reflects the magnitude of the health-related shock relative to a typical business cycle.

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