Falling angels: mounting debt has U.S. companies on the edge of danger

Falling Angels?

Data show how debt has U.S. companies on the edge of danger. The pandemic may push them over

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