Fallen angels are managing to stay on their feet...for now

The impact of Covid-19 on company earnings has been significant - even if equity markets may reflect a quite different story. Few, if any, predicted the v-shaped recovery we have witnessed to be quite so sharp in rebounding. Similarly, but perhaps in less spectacular fashion, the corporate bond market's performance has also surprised investors.

The worry for those in the corporate bond market was that many corporate bonds would lose their investment-grade status and be downgraded to junk - bonds where this happens are known as "fallen angels". The share of corporate bonds rated triple-B (the lowest level before being downgraded to junk) sits at 50% and is at the same level it was at 2019.

This is great news for these companies as junk status comes with a smaller pool of investors who can buy their debt as well as a higher cost of borrowing. It is also great news for the wider financial markets however as there was fear that there could be significant and widespread volatility if there were a plethora of downgrades following the significant amount of borrowing by corporates over the previous decade.

Morgan Stanley's Head of US and European Credit, Srikanth Sankaran increased his estimates for fallen-angels debt in 2020 from $100 billion to $300 billion as the pandemic hit. However, at the time of writing, the figure is a just a little over half that estimate.

JP Morgan suggest that March saw the bulk of fallen angels this year as around $83 billion worth of corporate bonds were downgraded to junk. The flow was then stemmed as the Fed extended its corporate bond-purchasing programmes in April to those issuers who lost their investment-grade status as a result of the pandemic. JP Morgan predict that given the Fed's intervention there will be no more than $200 billion of fallen angels for 2020.

The dash for cash has been another reason for fallen angels staying on their feet so far. Companies took out loans as interest rates have been cut to near zero with many swapping their short-term borrowings for longer-dated loans in order to improve the health of their balance sheet. Barclays notes that both investment-grade and junk-rated borrowers have been borrowing at the fastest rate on record this year. As a result, the improved balance sheets for many companies has helped alleviate concerns amongst investors for firms to weather the pandemic storm.

There is of course a side effect to this for companies as with earnings falling and borrowings skyrocketing, their leverage increases significantly. Firms most in the need of borrowing such as those in airlines and retail have as a result taken on particularly high levels of leverage. Many, including Delta, have also escaped downgrades to their debt as the credit rating agencies such as Fitch and Moody's often take a longer-term view on a company's financial health.

For now, fallen-angel activity remains subdued, but amidst a background of rising Covid cases and an economic outlook far from certain on many fronts, there is still time in 2020 to witness the fallen-angels raining down once more.