(Aug 4): Oracle Corp and Stellantis NV are among a group of high-grade companies with debt that has recently traded close to junk levels, putting the bond market on watch for a new era of fallen angels.

About US$100 billion (RM409.56 billion) in bonds in US dollar and euro investment-grade indexes are trading at wider spreads than the double-B — or junk — curve, based on data compiled by Bloomberg. That indicates a large amount of potential fallen angels — market parlance for investment-grade companies cut to junk status.

An ICE BofA Index of US companies that have already crossed that threshold is at its highest level since the start of 2024, following Fitch Ratings’ downgrade of Paramount Skydance Corp earlier this year.

The cohort is growing as companies grapple with rising financing costs, the impact of war in the Middle East and the rapid accumulation of debt to fund artificial intelligence ambitions. For Oracle, a huge spending spree on data centres has made it the credit market’s poster child for AI risk. Stellantis, meanwhile, has been under pressure from Chinese competition, turning the maker of Jeep sport utility vehicles and Ram trucks into Europe’s worst-performing stock this year.

Representatives for Oracle and Stellantis didn’t respond to requests for comment.

“We’re entering late credit cycle dynamics,” said Paul Benson, head of systematic fixed income at Insight Investment, citing softness in recent jobs data, a consumer-spending slowdown and higher financing costs.

There are also a lot of new risks related to AI, including for companies “seen as incredibly safe, solidly in the IG space, that now the future may be a little bit less clear”, he said. Benson helps oversee a rules-based fallen angel fund, which can automatically buy bonds that are cut to junk.

Previous waves of such downgrades have occurred during times of market turmoil, like after Russia’s invasion of Ukraine in 2022 and the coronavirus pandemic in 2020.

Losing high-grade status is arguably the most consequential credit rating change for any company. Suddenly, funds that are only allowed to invest in investment-grade debt find themselves forced to sell. And because the high-yield market is significantly smaller, there are typically far fewer buyers willing to scoop up the bonds. Anything below S&P Global Ratings’ BBB- or the Moody’s Ratings equivalent, Baa3, is classified as junk.

In benign markets, this type of rating change mostly happens to individual companies that have fallen on hard times, left behind by competition or technological obsolescence. In times of turmoil, fallen angel downgrades can grip entire sectors.

The coronavirus pandemic and the effective shutdown of large parts of the global economy triggered the biggest downgrade wave in history, swelling the ranks of ICE BofA’s fallen angels indexes. A few years later, when war in Ukraine triggered runaway inflation and rapid central bank interest rate hikes, Europe’s real estate sector saw a number of downgrades to junk or near-misses as higher debt costs put the industry’s entire business model under threat.

Aside from the company-specific cases of Oracle and Stellantis, the group of potential fallen angels that the market is currently watching includes the bonds of business development companies and private credit firms, which are closely linked to the software industry. That sector has seen a widespread selloff this year over fears of AI displacement.

“Fallen angels do well when everybody else does badly because we buy those bonds at very cheap prices,” said Ashton Parker, a portfolio manager at Lombard Odier Investment Managers, who helps oversee fallen angel strategies. “It’s a contrarian strategy.”

Parker sees opportunities emerging in the chemicals sector, which has been struggling for years amid soaring energy prices and Chinese competition, while “anything consumer facing” should be under pressure as rising inflation, interest rates and fuel costs impact consumer demand.

To be sure, traders are normally quicker to react — in either direction — than rating companies. That means a bond’s spread can hit junk levels and then pull back without the rating ever changing in between. Oracle’s spreads, which breached junk levels in July, tightened again in recent days to fall back below double-B levels by the start of August.

And credit scorers also typically take a longer-term approach than markets, evaluating metrics of creditworthiness through the economic cycle.

Fitch Ratings looks at revenue growth, margins and cashflow generation to assess whether issuers will be able to pay back their debt, said Carla Taylor, senior director at Fitch Ratings Inc. “Our leverage metric forecasts, as we’re very forward-looking in our credit analysis, play a very large part in terms of what could trigger a downgrade.”

Still, there has been an unusually large amount of bonds with spreads breaching the double-B curve over the past month — and an atypical amount of large companies entering the potential fallen angels group.

“Corporates have had it pretty easy after Covid-19” as central banks swooped in to prop them up, said Insight Investment’s Benson. “With higher rates, it’s not as straightforward anymore. So you’ve got more volatility around that.”

“If you look at the IG sector, it’s definitely not immune to this.”

Uploaded by Arion Yeow