Falling angels: mounting debt has U.S. companies on the edge of danger
U.S. companies have amassed roughly $10 trillion of debt since 2001, taking advantage of more than a decade of low interest rates and economic expansion. More than half of corporate bonds are classified by ratings agencies as risky, known as junk. An additional 30% are hovering one notch above.
As the economy effectively shuts down to combat the coronavirus, the U.S. Federal Reserve has pledged trillions of dollars to keep cash in the credit markets flowing. That support, however, is only available to companies with investment-grade debt.
Companies on the line just above junk could be exposed if their debt is downgraded, as seems almost certain given the unprecedented state of the economy. Already in March Standard & Poor’s has issued hundreds of ratings actions, including consigning Ford Motor Co to junk last week. That leaves such “fallen angels,” as they are known on Wall Street, in a difficult situation.
S&P ratings actions related to coronavirus
How did we get here?
In 2018, banking regulators lowered the threshold at which banks were allowed to lend to already heavily indebted companies, accelerating the accumulation of debt.
Bonds outstanding
Bonds due within year three
As a result, last year corporate debt as a percentage of gross domestic product overtook consumer debt for the first time in nearly 30 years.
Credit relative to GDP
Percentage of GDP
The Fed and economists around the world warned about the risks of mounting corporate debt even before the coronavirus outbreak, concerned that a shock to the economy could set off a wave of downgrades, which would push a large and growing number of companies into junk territory.
Ratings of corporate issuers
Percentage
About 51% of investment-grade corporate bonds globally were rated just above junk last year.
Investment grade bonds
When bonds become junk, many investment funds are contractually obligated to sell them. Forced sales can set off negative cycles.
Money is tight, companies
default on bond payments
Companies cannot issue new bonds to raise money
Credit ratings are lowered, bonds fall into risky debt category
Risk-averse market is unwilling to purchase those bonds
Some investors forced to purge risky bonds from their funds
Money is tight, companies
default on bond payments
Companies cannot issue new bonds to raise money
Credit ratings are lowered, bonds fall into risky debt category
Some investors forced to purge risky bonds from their funds
Risk-averse market is unwilling to purchase those bonds
Some investors expect the Fed and the U.S. Treasury - whose job it is to work together to keep the U.S. economy on a steady footing - to reach further down the ratings ladder to help non-investment grade companies. At present, it has no plans to extend its safety net to junk.
What happens next?
The world economy is undergoing a historically high level of financial stress, shown below in an index which combines company stock values, creditworthiness, funding availability, cash flows and market volatility.
Financial Stress Index
Emerging markets
U.S.
Other advanced economies
Similar situations, such as the dot.com stock crash of 2000, the attacks of Sept. 11, 2001 and the global financial crisis of 2007-2009 each led to a cascade of downgrades in the years following.
Annual corporate ratings changes
DOWNGRADES
2001
UPGRADES
2002
After the dot.com crash many
companies were downgraded
2000
10%
2003
2016
5
2015
2012
Similarly, the last financial crisis sent credit ratings lower
2008
2009
DOWNGRADES
UPGRADES
After the dot.com crash many
companies were downgraded
2001
2002
2000
10%
2003
2016
5
2015
2012
2008
2009
Similarly, the last financial
crisis sent credit ratings lower
As a result of the economic shutdown, and not factoring in any help from the Fed, the most pessimistic estimates by Moody’s project that corporate junk bond defaults will rise to more than 20% by next year.
Default rates forecasts
Junk debt
Global
U.S.
E.U.
Whether that happens or not is dependent on the depth and duration of the economic shutdown caused by the coronavirus, and the Fed’s willingness to help companies with less than perfect credit - and prevent more fallen angels.
By Sarah Slobin and Feilding Cage Illustrations by Eric Palma Editing by Bill Rigby