So far in 2020, fallen angels (issuers downgraded to speculative grade from investment grade) total 24, with over $300 billion in rated debt (as of April 30). By comparison, this is the highest volume for fallen angels since 2015, when the Brazilian and Russian sovereigns, OAO Gazprom, Petrobras, and other related issuers accounted for nearly $1 trillion in fallen angel debt. In addition, pressure continues to build on 'BBB-' rated issuers. The number of potential fallen angels has risen to a record 111 issuers globally, compared with 96 in our last report. Potential fallen angels are issuers rated 'BBB-' with negative outlooks or ratings on CreditWatch with negative implications,

The negative bias for all investment-grade issuers--the proportion with negative outlooks or ratings on CreditWatch negative--rose to a post-financial crisis high of 25%, signaling an increase in credit pressure, even for comparatively strong issuers, as COVID-19, economic ramifications from social distancing policies, and a sharp drop in oil prices run their course.

Potential fallen angels are significant because the loss of investment-grade ratings typically carries both higher capital costs and sometimes the need to revise contracts with bondholders to protect investors (further adding to capital costs), or worse, could lead to the sale of the bonds in favor of more creditworthy companies. Of the 17 additions to the potential fallen angels list since our last report, seven are financial institutions, four are utilities, and one each in aerospace and defense, consumer products, media and entertainment, metals and mining, real estate, and transportation.

Chart 1

The most recent fallen angel, Hillenbrand Inc., a U.S. industrial manufacturer, occurred when S&P Global Ratings downgraded the issuer to 'BB+' from 'BBB-' because of the impact of the economic contraction stemming from COVID-19-related measures. This would increase the company's debt leverage, thus delaying its deleveraging following its acquisition of Milacron Holdings Corp. The rating outlook remains negative because of the potential for weaker demand, further pressuring cash flows (see "Hillenbrand Inc. Downgraded To ‘BB+’ As The Economic Slowdown Delays Its Deleveraging, Outlook Negative," April 21, 2020).

S&P Global Ratings also put its ratings on BlackRock TCP Capital on CreditWatch negative on March 24, 2020. However, in March, the issuer requested that the ratings be withdrawn. Following procedure, S&P Global Ratings waited 30 days to withdraw the rating, and prior to withdrawing, resolved the CreditWatch on April 24, 2020, by downgrading to 'BB+', with a stable outlook, from 'BBB-', reflecting its expectation that COVID-19 would increase credit losses and calls on liquidity to fund commitments, as well as worsen financing conditions (see "BlackRock TCP Capital Downgraded To ‘BB+’ On Expected Decline In Operating Results Due To COVID-19; Ratings Withdrawn," April 25, 2020).

Potential Fallen Angels Reach All-Time Highs

The precipitous rise in potential fallen angels comes as COVID-19, a deep and sudden dislocation of oil prices, and weak revenue prospects hurt a variety of corporations. Although, downgrades have disproportionately affected speculative-grade issuers, which is expected considering their typically more aggressive financial positions and higher susceptibility to market volatility.

Of the 17 additions to the potential fallen angels list, seven were financial institutions, as some banking systems could be significantly affected by COVID-19-related stresses despite highly supportive monetary policies globally.

In particular, S&P Global Ratings revised its outlooks on three Irish banks to negative following a downward revision of the Banking Industry Country Risk Assessment (BICRA) industry risk trend to negative for Ireland. Despite existing extraordinary fiscal and monetary support and our expectation for a gradual recovery in the Irish economy starting in the third quarter, prolonged weakness could further weigh on banks' ability to generate structural profitability and their asset quality (see "Outlooks Revised On Three Irish Banks On Deepening COVID-19 Downside Risks," April 29, 2020).

Chart 2

Similarly, S&P Global Ratings revised its outlooks on two Indian banks rated 'BBB-'--Axis Bank Ltd. and ICICI Bank Ltd.--to negative after the BICRA economic risk trend was revised downward to negative on the likely deterioration of asset quality and profitability as well as an increase in credit costs due to COVID-19. These could slow down the recovery of the banking system by about a year (see "Rating Actions On Some Indian Banks As Operating Conditions Worsen; Government Support Key For State-Owned Entities," April 17, 2020).

Meanwhile, the same rationale led to negative outlooks on four Indian nonbank financial institutions (and one downgrade), of which two were 'BBB-' (see "Various Rating Actions Taken On Indian NBFCs On Weakening Economic Conditions Due To COVID-19," April 17, 2020). This led to Power Finance Corp. Ltd. being added to the potential fallen angels list. S&P Global Ratings revised its outlook on Bajaj Finance Ltd. to negative and affirmed its 'BBB-' rating. However, we did not include it in the list of potential fallen angels because the list consists of companies with outstanding, rated public issuance.

Virgin Money U.K. was also added to the list of potential fallen angels, after S&P Global Ratings revised its outlook on the bank to negative and affirmed the rating, mainly because of increased economic risk (see "Virgin Money And Clydesdale Outlooks Revised To Negative On Economic Impact Of COVID-19; Ratings Affirmed," April 23, 2020). The BICRA for the U.K. has a negative economic risk trend. Also, we estimate systemwide domestic credit losses will rise to more than four times their 2019 level as a result of the radically more negative environment due to the COVID-19 pandemic. Consumer credit is likely to contribute most of the credit losses, followed by corporate loans in the most affected sectors. A deterioration in asset quality could pressure bank ratings should the economic contraction protract (see "COVID-19 Effects Might Quadruple U.K. Bank Credit Losses In 2020," May 4, 2020).

Four utilities were also added to the list of potential fallen angels since our last report, of which two were Indonesian. The outlook on PT Perusahaan Gas Negara (PGN) was revised to negative--reflecting the outlook on the Indonesia sovereign rating--which also affected PGN's parent, PT Pertamina. Nonetheless, S&P Global Ratings continues to expect the company to receive extraordinary support from the government if required, through its parent (see "PT Perusahaan Gas Negara 'BBB-' Ratings Affirmed On Ability To Withstand Lower Cash Flows; Outlook Negative," April 27, 2020).

In contrast, S&P Global Ratings revised its outlook on PT Pelabuhan Indonesia III to negative because it sees a lower likelihood of extraordinary government support for government-related entities that it does not consider essential (see "Various Rating Actions Taken After Reassessment Of Support For Indonesian Government-Related Entities," April 27, 2020).

Chart 3

Nearly One-Quarter Of Potential Fallen Angels Are On CreditWatch Negative

Crucially, 26 of the 111 potential fallen angels have ratings on CreditWatch negative, which carries a shorter timeline for potential downgrades (within 90 days) compared with a negative outlook (two years). The record-high number of issuers with ratings on CreditWatch negative indicates the fragility of credit conditions amid the economic and financial pressures from COVID-19 (see chart 4).

Chart 4

Of these, seven are in lodging and leisure. We had highlighted this sector in our last report, noting that restrictions on travel and consumer activity are causing significant declines in revenue (see "Various Ratings Actions Taken On 34 Companies In The Lodging And Leisure Sector," March 21, 2020).

The auto sector comes in second in the number of potential fallen angels with ratings on CreditWatch negative, with four (half of the sector's total potential fallen angels). The sharp decrease in global demand due to the recession led S&P Global Ratings to expect global light-vehicle sales to drop 15%-20% in 2020, which could lead to weakening credit quality for automakers. A number of manufacturers already have shut down plants across the globe (see "COVID-19 Will Batter Global Auto Sales And Credit Quality," March 23, 2020). Importantly, this comes in a context of a gloomy industry outlook, with weakening auto sales across regions and rising negative ratings bias in the pre-COVID-19 world (see "Industry Top Trends 2020: Autos," Nov. 18, 2019).

Chart 5

Although financial institutions have the most potential fallen angels, the sector only comes in fifth in terms of issuers on CreditWatch negative, pointing to a less immediate risk of downgrade. Nevertheless, specific financial institutions most exposed to sectors affected by COVID-19 are vulnerable to credit losses and subsequent downgrade pressures.

The Ratio Of Fallen Angels To Total Investment-Grade Issuers Surpasses Its 10-Year Average…

Fallen angels this year have already surpassed the full-year 2019 total, which has led to a spike in the ratio of fallen angels to total investment-grade issuers. The ratio reached 1.9% as of April 30, 2020, surpassing its 10-year-trailing average for the first time since December 2016 (see chart 6). With 111 potential fallen angels, 26 of which are on CreditWatch negative, there is a possibility of this ratio climbing significantly higher.

Chart 6

…While The Jump In Financing Costs Of Being Downgraded To Speculative Grade Remains Elevated

The difference in option-adjusted spreads for U.S. corporate entities rated 'BBB-' and 'BB+' (in basis points) reflects the increase in financing costs when being downgraded to 'BB+' from 'BBB-' (see chart 7). With risk aversion still relatively high, this difference peaked at 284 bps toward the end of March, higher than the peak during the financial crisis (247 bps). While it has eased since then, it remains elevated at 234 bps as of April 30.

Chart 7

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Related Research

• COVID-19 Effects Might Quadruple U.K. Bank Credit Losses In 2020, May 4, 2020
• Outlooks Revised On Three Irish Banks On Deepening COVID-19 Downside Risks, April 29, 2020
• PT Perusahaan Gas Negara 'BBB-' Ratings Affirmed On Ability To Withstand Lower Cash Flows; Outlook Negative, April 27, 2020
• Various Rating Actions Taken After Reassessment Of Support For Indonesian Government-Related Entities, April 27, 2020
• BlackRock TCP Capital Downgraded To 'BB+' On Expected Decline In Operating Results Due To COVID-19; Ratings Withdrawn, April 25, 2020
• Virgin Money And Clydesdale Outlooks Revised To Negative On Economic Impact Of COVID-19; Ratings Affirmed, April 23, 2020
• Hillenbrand Inc. Downgraded To 'BB+' As The Economic Slowdown Delays Its Deleveraging, Outlook Negative, April 21, 2020
• Rating Actions On Some Indian Banks As Operating Conditions Worsen; Government Support Key For State-Owned Entities, April 17, 2020
• Various Rating Actions Taken On Indian NBFCs On Weakening Economic Conditions Due To COVID-19, April 17, 2020
• Fallen Angels Rose Sharply In First-Quarter 2020 Amid COVID-19 And Oil Price Shocks, April 16, 2020
• COVID-19 Will Batter Global Auto Sales And Credit Quality, March 23, 2020
• Various Ratings Actions Taken On 34 Companies In The Lodging And Leisure Sector, March 21, 2020
• Industry Top Trends 2020: Autos, Nov. 18, 2019