More US high-grade borrowers at risk of downgrade as economy slows
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A rising share of the $8.9tn high-grade US corporate bond market is at risk of being slashed to junk status, with rating agencies’ expectations of downgrades exceeding upgrades for the first time since the end of 2021.
The proportion of the lowest-quality investment-grade bonds that rating agencies have on so-called “negative watch” or “negative outlook” — meaning their ratings are more likely to be downgraded — stood at 5.7 per cent this week, according to analysis by BofA Securities, including names such as Paramount Global and Charter Communications. That is almost double the level of 2.9 per cent at the start of this year.
In contrast, the percentage of these bonds on “positive watch” — meaning they are more likely to be upgraded — stood at 5.3 per cent, down from 7.9 per cent in early January.
While the share of bonds at risk of downgrade is still relatively small compared with the total, the shift highlights the challenges facing pockets of corporate America as economic growth slows by more than expected this year in the face of high borrowing costs.
BofA noted that while investment grade credit fundamentals are “generally strong, the risk of downgrades [of some bonds] to high yield has increased recently”.
The broad shift in rating dynamics comes after a year in which upgrades from junk to investment grade — known as “rising stars” — drastically exceeded moves in the opposite direction — so-called “fallen angels” — as the US economy defied fears of a recession to rank as the world’s fastest-growing advanced economy.
Data from Goldman Sachs shows that net rising stars totalled $119bn in 2023, the highest figure in records going back to at least 2010.
In comparison, this year’s net rising stars stand at just $20bn, according to Goldman’s figures, signalling a normalisation away from dramatic volumes of upgrades.
Helping drive the greater share of bonds on negative outlook than positive outlook this year are a number of big companies with large amounts of borrowing. BofA highlights Paramount and Charter as two such names.
Strategists at the bank noted that Boeing, with a $46bn capital structure, was recently cut to the lowest rank of investment-grade and put on negative outlook by Moody’s. However, BofA’s analyst sees a downgrade to junk as a “low probability event”.
Moody’s said in April that “the negative outlook captures the material degree of execution risk in Boeing’s plan to restore compliance and higher quality to its commercial aircraft assembly operations.”
Large volumes of new bonds entering the high-yield market can cause changes in pricing, leading to spreads — the premiums over government yields paid by borrowers to issue debt — rising. Currently the entire double-B universe is worth just $667bn, according to Ice BofA data, down from an all-time peak of more than $830bn in late 2021.
However, investor demand for credit has been particularly strong this year. Cash-laden buyers, keen to lock in attractive yields before the Federal Reserve begins to cut US interest rates from their current 23-year highs, are coming off the sidelines to scoop up corporate paper.
Analysts suggested that this should mean any new supply is more easily absorbed than it would be in less favourable market conditions.
“Usually, when there are big downgrades, it’s negative for spreads,” said Yuri Seliger at BofA. But this time “it will probably be not as bad as it was before.”
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