The general trend of gradual improvement in credit quality continued into August. French hotel chain operator Accor S.A. was the sole addition to the fallen angel tally in August (issuers downgraded to speculative grade from investment grade). This brought the total number to 41, representing $350 billion in rated debt. This is the lowest number of additions to the list since April this year.

As a result, this issuer has been removed from the list of potential fallen angels. (Potential fallen angels are issuers rated 'BBB-' with negative outlooks or ratings on CreditWatch with negative implications.) In addition, we've removed another seven from the list, bringing the tally down from 120 to 119 despite having added seven issuers. This continues the downtrend from a record high of 126 in May and June. Moreover, for the first time this year, the majority of the removals from the list were due to outlook revisions to stable on 'BBB-' rated issuers, as opposed to transitioning to either actual fallen angels or being withdrawn. Of the other seven removals, American Equity Investment Life Holding Co., Brunswick Corp., Conagra Brands Inc., PotlatchDeltic Corp., and Tabcorp Holdings Ltd. saw revisions to stable outlooks.

Fallen Angel Risk Remains Highest In Lodging/Leisure

April's rapid rise in fallen angel incidence followed the rapid dislocation of credit markets due to the COVID-19 pandemic and knock-on effects on the economy, capital markets, and revenue generation of many corporations. While both the economy and revenue generation remain strained, access to capital markets significantly improved since late March and early April.

This month's only fallen angel, Accor S.A., was downgraded to speculative grade as S&P Global Ratings revised its view on earnings and debt metrics on the company in light of the pandemic (see "Accor S.A. Downgraded To 'BB+' On Likelihood Of Weaker Metrics Until 2022 Due To COVID-19 Impact; Outlook Negative," Aug. 17, 2020). That there was only one addition has at least paused the upward trend in the ratio of fallen angels to investment-grade issuers.

Chart 1

As we have highlighted over the past few months, lodging and leisure (a subset of the media and entertainment sector) has seen the highest potential fallen angel risk stemming from COVID-19. Besides Accor's downgrade, we continue to see this sector lead the tally of potential fallen angels among nonfinancial corporations. It also holds one of the highest proportions of those with ratings on CreditWatch negative at 36%, suggesting a more imminent risk of downgrade (90 days) as opposed to negative outlooks (six to 24 months).

Chart 2

Potential Fallen Angel Trends Point To Further Stabilization In Credit Quality

The slight increase in new additions to potential fallen angels is counterbalanced by the continued decline in the overall tally, and especially the five removals driven by outlook revisions to stable.

Three new additions from utilities (all electricity/gas distributors) led this sector to rank second among nonfinancial corporates, behind media and entertainment. Unlike the latter, however, all utilities on the list are on negative outlook, and not CreditWatch. In fact, none of the seven new additions in August were on CreditWatch negative.

Chart 3

More generally, the proportion of potential fallen angels on CreditWatch with negative implications fell to 11% from 13% last month, well below its five-year high of 27% in April. This smaller proportion points to a less immediate credit risk and, potentially, a slower pace of new fallen angels in the near term. A negative outlook potentially leaves more time for the issuer to recover from current challenges.

Chart 4

The Stabilization In The Potential Fallen Angel Tally Is Also Reflected In Market Pricing

The gradual stabilization in fallen angel risk is not only apparent in the decline of the potential fallen angel tally and the proportion of negative CreditWatch placements. It appears that the markets are also pricing in less risk relative to the peak of the COVID-19 crisis.

We collected the average spread to worst for the current crop of potential fallen angels in each sector for which data was available and found that these have come down significantly almost across the board. The exception was financial institutions, which saw the smallest increase in spreads during the crisis in the first place. The spread compression has been most pronounced for the sectors that led the additions to the potential fallen angel tally during the worst months of the pandemic--media and entertainment, oil and gas, and metals and mining. Nonetheless, these sectors continue to see spreads that are far higher than at the beginning of this year, along with retail and restaurants, travel, and real estate.

Chart 5

Just as the decline in the number of potential fallen angels does not mean that credit deterioration is over, neither does the decline in spreads. There is, however, a gradual improvement in the pricing of risk among these credits.

Fallen Angels Still Exhibit A General Tendency For Stability After Being Downgraded

Meanwhile, among those issuers that actually became fallen angels and were downgraded to speculative-grade, there has been a historical tendency to maintain the same credit rating afterwards. A majority of fallen angels retain the same credit ratings within a year after being downgraded (see chart 6). This is especially true in the first five months after becoming fallen angels, where only about a fifth or less of fallen angels have historically experienced one or more further downgrades.

This year, that historical trend continues despite the extraordinary stress period caused by COVID-19. In fact, this year has generally shown slightly more credit rating stability (so far) after downgrades into fallen angels than the historical norm. For the current crop of fallen angels, less than 15% have experienced further downgrades within the first five months (see chart 7). The six-month category is a special case, as these were the five issuers that became fallen angels in February prior to the COVID-19 and oil-price-related credit stresses in March. That suggests that their credit quality had already deteriorated prior to the pandemic, such that when it hit, three of them saw further weakening (being that speculative-grade companies would not tend to be able to absorb such significant shocks as well as an investment-grade company would).

This exception aside, the current crop of fallen angels, especially those that were downgraded during the pandemic, have so far displayed stability commensurate with historical norms. This is a positive sign for further stability, should the existing gradual trend of overall improvement in economic/health outcomes, credit quality, and credit conditions continue.

Chart 6

Chart 7

Two New Rising Stars But No Additional Potential Rising Stars

There were two new additions to the rising star tally in August (issuers upgraded to investment-grade from speculative-grade)-- Sobeys Inc. and Mediacom Communications Corp.--bringing this year's total to four. Both were upgraded on improved earnings and debt-to-EBITDA metrics, with the latter being upgraded two notches to 'BBB'. Meanwhile, Sobeys Inc. comes from last month's list of potential rising stars (issuers rated 'BB+' with positive outlooks or ratings on CreditWatch with positive implications). With no new additions and one removal (Triton International Ltd.), there are seven remaining potential rising stars this month.

Nonetheless, the gap between rising stars and fallen angels this year remains the widest since the 2008-2009 financial crisis.

Chart 8

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Related Research

• American Equity Investment Life Outlook Revised To Stable From Negative; All Ratings Affirmed, Aug. 21, 2020
• Mediacom Communications Corp. Upgraded To 'BBB' On Reduced Leverage And Financial Policy Clarity, Outlook Stable, Aug. 21, 2020
• U.S.-Based PotlatchDeltic Corp. Outlook Revised To Stable From Negative On Improving Leverage, Ratings Affirmed, Aug. 20, 2020
• Tabcorp Holdings Outlook Revised To Stable Following Proposed Equity Raising; 'BBB-' Ratings Affirmed, Aug. 19, 2020
• Sobeys Inc. Upgraded To 'BBB-' From 'BB+' On Improved Operating Performance; Outlook Stable, Aug. 18, 2020
• Accor S.A. Downgraded To 'BB+' On Likelihood Of Weaker Metrics Until 2022 Due To COVID-19 Impact; Outlook Negative, Aug. 17, 2020
• Conagra Brands Inc. Outlook Revised To Stable From Negative; Ratings Affirmed, Aug. 6, 2020
• Brunswick Corp. 'BBB-' Rating Affirmed On Recovering Demand For Marine Products; Outlook Stable, Aug. 5, 2020