The rise and fall of fallen angels: A study of credit downgrades and recovery

Expert view / 1 August, 2024

Fallen angels are companies that once enjoyed investment-grade status but were later downgraded to sub-investment grade ratings. These downgrades often result in increased borrowing costs and a reduced investor base. However, not all fallen angels remain in this state permanently; some manage to regain their former glory and return to investment-grade ratings.

A recent study by Fitch Ratings sheds light on those fallen angels from 2006 and 2019. The report looks at the trends and outcomes these organisations have faced up to 2023. You can view the full report here. Note that a Fitch Ratings account may be required to view the document.

Reasons for downgrades

Cyclical economic pressures: Recessions and commodity price swings can lead to downgrades as companies struggle with reduced revenues and profitability.
Regulatory pressure: Changes in regulations can impact companies' operations and financial stability, leading to downgrades.
Company-specific actions: M&As, LBOs, and significant changes in financial policies can strain a company's balance sheet and result in downgrades.
Acute liquidity issues: Companies facing severe liquidity crunches may also be downgraded to junk status.
Operational weaknesses: Increased competition, poor strategy execution, general market pressures and exposure to out of favour segments influence downgrades.

Rising stars and regaining IG ratings

The Fitch Ratings study provides a comprehensive analysis of 111 issuers that became fallen angels between 2006 and 2019. Here are some of the notable findings:

Cyclically driven recoveries: Approximately three-quarters of cyclically driven fallen angels managed to reclaim investment-grade ratings post-recession. Of the issuers downgraded during the GFC in 2008 and 2009 due to recession induced pressure, 80% returned to IG status. Similar patterns appear to be shaping up for the fallen angels of 2020.
Impact of company-specific actions: Issuers downgraded due to discretionary actions like M&A and LBOs faced greater challenges in recovering. Of the 39 issuers downgraded for reasons partly within their control, only 14 regained their investment- grade ratings, with those engaged in LBOs being the worst affected sub-set.
Default rates: The study found that 52% of the fallen angels managed to regain their investment-grade ratings, 32% remained below investment grade and 16% ultimately defaulted.
Variations by cause: Corporates downgraded due to external conditions fared better than those downgraded due to internal decisions. Of the 72 issuers downgraded for reasons outside their control, 61% returned to investment-grade status, compared to only 36% of those downgraded due to internal factors.
Timing: Prior to 2020, on average it took about 5 years for rising star issuers to return to IG. Currently the outcomes appear positive for downgraded issuers. Of the 35 downgrades of 2020, already 18 have made it back to IG.