Fallen Angel 

In investments, the term “fallen angel” holds a distinctive meaning. It refers to bonds that were initially rated as investment-grade but have subsequently been downgraded to junk status due to the issuer’s declining financial health. These bonds present both challenges and opportunities for investors, making them a noteworthy subject in the fixed-income market. 

What is a Fallen Angel? 

A fallen angel is a bond that begins with an investment-grade credit rating but is later downgraded to high-yield or “junk” status by major credit rating agencies such as Moody’s, Fitch, or Standard & Poor’s. This downgrade typically signifies a decline in the issuer’s financial stability or creditworthiness. While the term is most commonly associated with bonds, it can also describe stocks significantly declining from all-time highs. However, for this discussion, we will focus on fallen angel bonds. 

Understanding Fallen Angel Bonds 

Fallen angel bonds occupy a unique space within the high-yield bond market. They differ from typical junk bonds because companies initially issued them with firm credit profiles. These bonds often belong to large, established corporations that have faced temporary setbacks rather than smaller, riskier issuers. 

Key Characteristics 

• Higher Credit Quality: Because of their investment-grade origins, fallen angels are generally considered higher quality than other junk bonds. 

• Price Volatility: These bonds experience significant price fluctuations before and after downgrades due to selling pressure and speculative buying. 
• Potential for Recovery: Many fallen angels can regain investment-grade status if their issuers recover financially. 

Causes of a Fallen Angel Status 

Several factors can lead to a bond being downgraded to fallen angel status: 

1. a) Declining Revenues

A drop in revenue can jeopardise an issuer’s ability to meet interest payments on its debt. For example, industries like oil and gas often face downgrades during sustained low commodity prices. 

1. b) Rising Debt Levels

An increasing debt burden relative to earnings can trigger a downgrade. Companies that take on excessive leverage for acquisitions or expansions may find themselves in this position during economic downturns. 

1. c) Industry Disruption

Technological advancements or shifts in consumer preferences can render a company’s products or services obsolete. For instance, companies that failed to adapt during the transition from DVDs to streaming services experienced financial declines. 

1. d) Broader Economic Conditions

Recessions or financial crises can weaken even well-established firms, leading to downgrades. For example, municipal bonds may lose their investment-grade status if local governments face declining tax revenues and mounting debt obligations. 

Impact on Investors 

Fallen angels present both challenges and opportunities for investors: 

1. a) Risks

• Credit Risk: The downgrade reflects an increased likelihood of default by the issuer. 

• Liquidity Risk: These bonds may become more challenging to sell due to reduced demand from institutional investors restricted from holding junk-rated securities. 

• Price Volatility: Prices often drop sharply following a downgrade, exposing investors to potential losses. 

1. b) Opportunities

• Higher Yields: Fallen angels offer higher returns than investment-grade bonds, compensating investors for the increased risk. 

• Potential for Price Rebound: If the issuer recovers financially, these bonds can regain value and even return to investment-grade status, offering substantial capital gains. 
• Contrarian Investing: Fallen angels attract contrarian investors who see value in oversold securities with recovery potential. 

Examples of Fallen Angels 

In the investment world, “fallen angels” refer to bonds that were initially rated as investment-grade but have been downgraded to junk status due to the declining financial health of the issuer. Here are some notable real-world examples from the United States: 

1. Newell Brands

Newell Brands, known for products like Sharpie pens and Crock-Pots, experienced a downgrade in 2019. Standard & Poor’s lowered Newell’s rating to BB on November 1, 2019, following earlier downgrades by Fitch in February of the same year. This shift resulted in Newell’s removal from the Bank of America Merrill Lynch U.S. Investment Grade Index and its inclusion in the High Yield Index. This led to an immediate widening of spreads across Newell’s capital structure by approximately 50 basis points.  

2. Ford Motor Company

Ford Motor Company, a major player in the automotive industry, faced financial challenges that led to its bonds being downgraded to junk status. The company’s increasing debt levels and declining revenues contributed to this downgrade, reflecting the broader struggles within the automotive sector during economic downturns.  

3. Boeing (Potential Downgrade)

As of late 2024, Boeing, a leading aerospace company, was on negative watch by rating agencies due to significant financial difficulties, including substantial losses and job cuts. While not yet downgraded, Boeing’s precarious credit rating highlighted the potential for becoming one of the most prominent fallen angels in history, underscoring the impact of industry-specific challenges on investment-grade ratings.  

These examples illustrate how companies, despite their established reputations, can experience financial downturns leading to their bonds being downgraded to junk status, becoming fallen angels. 

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