The Next Rising Stars of the Debt World? Probably corporate fallen angels

What goes around comes around. That’s why investors are on the lookout for “rising stars,” or credit rating improvements, in US corporate debt after last year saw a record pile of nearly $ 250 billion of “fallen angels.” “ANGL, + 0.06% degradations.

The pandemic may have changed a lot, but bond ratings remain important, particularly for companies recently downgraded to speculative or “junk” territory or those elevated to the coveted investment grade level. “It‘s a one-way deal,” said Michael Collins, senior investment officer at PGIM Fixed Income, of his expectations for a wave of improvements this year from the riskier rating tranches. “We’re going to see one of the best years for earnings growth,” Collins said, pointing to forecasts calling for highly-rated US companies to experience earnings growth of nearly 25% from a year ago, already that first quarter earnings start next. week. This chart from Goldman Sachs shows the historic flurry of fallen angels into speculative grade or “junk bond” territory, from investment grade in 2020.

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Record debt falls from investment grade to junk territory. Data from Bloomberg, Goldman Sachs

More broadly, Collins also expects companies’ cash flows to rise, the costs of debt burden to fall, and companies to continue to borrow cheaply at today’s low rates, while improving their balance sheets. “We are in a rare part of the cycle where credit quality will improve over the next two years,” he told MarketWatch. “That’s an environment where you want to have long credit risk.” That’s a sea change in tone from last year, when the Federal Reserve first started buying corporate debt, amid fears that fallen angels could flood the smaller market with junk bonds and create chaos. Read: Why The Fed’s New Index Approach To Buying US Corporate Debt ‘Changes Everything’ For This Summer, Moody’s Investors Service Forecasts The Rising Star Rate To Increase To 11.3% During The 12 Months Ending July in 2021, compared to 3.4% the previous year. looking at the share of US corporate bonds that are about to see ratings rise to investment grade from the highest category of Ba1 “junk”. “This forecast, if fulfilled, will be in line with patterns after the 2001 and 2008 recessions, when the comparable rate rose to about 10% a year after post-recession lows of 4.3% and the 6.3%, respectively, “the Moody’s team wrote in a note this week. Investment-grade companies still make up the majority of the US $ 10.6 trillion corporate bond market, and often provide access to more abundant and cheaper financing than companies in the nearly $ 10.6 trillion junk category. $ 1.5 trillion. “This year, as vaccines were rolled out and the economy began to stabilize, the pace of markdowns has slowed over the last quarter,” said Manuel Hayes, Mellon’s senior portfolio manager. But Hayes also sees the “winners and losers” emerging as larger swaths of the economy reopen, which could provide fodder for another round of up to $ 100 billion of downgrades of corporate credit ratings to junk. “There is a lot of overlap between the two universes,” Hayes told MarketWatch, adding that many of the biggest fallen angels in the market are generally “big issuers that were born and raised as investment grade companies,” he said. “Once you have access to that type of capital, there are many incentives to go back to that cheaper level of financing.” Ford Motor Co. F, -1.47%, Occidental Petroleum Corp. OXY, -0.20% and Kraft Heinz Co KHC, -0.15% were among the largest fallen angels last year, representing almost $ 95 thousand million of the total for the year, according to MarketWatch. bill. Last month, analysts at BofA Global estimated that the forced sale, triggered by rating downgrades, cost around 47 basis points a year for investors in A-rated bonds that fell to BBB territory, while it cost investors about 35 basis points a year in bonds with original BBB rating. that were reduced to rubbish. On the other hand, investors like Hayes have long been preparing for rating changes that lead to forced selling or buying. “For the rising stars, you see forced buyouts,” Hayes said. “As these companies upgrade, now all of a sudden investment grade managers have a new company in their universe. And as an index manager, you buy it because you need that exposure. ”