Joe Rennison reports for the Financial Times that “fallen angel” downgrades could test the high yield debt market. He writes:
When S&P withdrew General Motors’ top-quality credit rating in May 2005, sending $41.5bn of debt crashing into junk territory and creating the largest ever “fallen angel”, it triggered the biggest sell-off in corporate bond markets since the dotcom bust.
Along with the simultaneous downgrade of Ford, which remains the second-largest fallen angel after its $40.8bn of debt was docked, the bedrock of corporate America shook.
“It is not just they that have a problem,” Gary Jenkins, a credit strategist at Deutsche Bank, said at the time. “We all have a problem.”
In the 1960s, GM, Ford, and their Detroit-based rival Chrysler made nine out of every 10 cars and trucks sold in America. The companies’ debt was seen as a benchmark for the health of the world’s biggest economy. By 2005, much of that debt had been stuffed into structured products that had been heralded for their resilience.
“People grew up with these companies,” Mr Jenkins, now an independent consultant in London, told the Financial Times this week. “They learned to drive in their cars; they had first dates in them. When [the companies] got downgraded, it had an emotional impact as well. If they could get downgraded, what could people trust any more?”
This week two other big bellwethers fell from grace, as department store Macy’s and Kraft Heinz were cut to junk. The ketchup maker stands out as the seventh-largest fallen angel in history, with almost $22bn of bonds outstanding. Analysts are now wondering what to make of the double downgrades; and if parallels with GM and Ford are overblown.
By the time of S&P’s announcement in early May, 15 years ago, GM’s fate had been effectively sealed by a profit warning a couple of months earlier. The company’s bonds maturing in 2016 had sunk from trading above par at the end of February, to 80 cents on the dollar on the day of the downgrade. By the end of the year, after a further ratings downgrade, the debt slumped to 65 cents. There was a mini-revival the following year but in 2009, in the wake of the global financial crisis, GM finally went bust.
Ford followed a similar trajectory and despite avoiding bankruptcy still found its 2018 debt trading at an all-time low of 16 cents on the dollar during the financial crisis.
Some fallen angels do fine in their new surroundings. Marty Fridson, chief investment officer of Lehmann Livian Fridson Advisors, noted that the majority of bonds downgraded to junk have provided market-beating returns over the past decade.
But the bigger they are, the harder they fall, says BofA Global Research, which this week published an analysis of the dozen largest downgrades to junk through history. Sales of bonds that would easily be digested by investors in the investment-grade market suddenly become much harder to do, BofA found, significantly raising the costs of borrowing.
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