What is a fallen angel?
A Fallen Angel is a bond that has received a higher quality rating but has since been reduced to the status of unwanted bond due to the weakening of the issuer’s financial condition. It is also a title that has dropped considerably from its historic highs. The line is thin between fallen angel bonds and value stocks, which have the potential to recover from short-term challenges, and securities that head straight for bankruptcy.
Fallen Angel Explained
Fallen angel bonds, which can be corporate, municipal or sovereign debt, have been downgraded by a rating service such as Standard & Poor’s, Fitch or Moody’s Investors Service. The main reason for downgrades is a drop in revenues, which compromises the ability of issuers to repay their debt. When the decline in income is combined with increased debt levels, the potential for downgrading increases considerably.
Fallen angels are often attractive to counter-current investors looking to take advantage of the issuer’s recovery potential after a temporary setback. In these circumstances, the downgrade process usually begins with placing debt on negative credit watch, which may require portfolio managers to sell positions, depending on the fund’s covenants.
Actual demotion to undesirable status generally results in increased sales pressure, particularly from funds that are limited to the exclusive holding of high quality debt securities. Therefore, fallen angel bonds may have a value in the high yield category, but only when the issuer has a reasonable chance of recovering from the conditions that caused the downgrade.
Examples of fallen angels
For example, an oil company that has reported sustained losses over several quarters as a result of falling oil prices may see its premium bonds downgraded to junk status due to the increased risk of default. Due to the downgrade, the company’s bond prices are falling and yields are rising, making debt attractive to contrarian investors who see low oil prices as a temporary condition.
There are, however, several conditions under which fallen angel bond issuers may not recover. For example, companies whose revenues decrease due to the introduction of products superior to theirs may completely disappear. The progression from VCRs to DVDs and video streaming is one example.
Municipal and sovereign debt issuers could also see their high-quality bonds downgraded to junk status due to a combination of stagnant or declining tax revenues and an increasing level of debt. In many cases, these conditions translate into a self-reinforcing downward spiral towards default, as shortages of revenue resulting from challenges related to increasing tax revenues require the continued issuance of debt to finance local bonds. or sovereign.