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Credit Markets: Pace of Ratings Reductions Speeds Up -- WSJ

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04/03/2020 | 02:48am EDT

By Sebastian Pellejero

U.S. corporate bonds are being downgraded at breakneck speeds, highlighting the threat posed to companies' balance sheets by the coronavirus crisis.

The pace of downgrades over the last two weeks was the fastest on record in one major corporate-bond index going back to 2002, according to BofA Global Research.

The index, known as the ICE BofAML U.S. Corporate Index, has suffered $569 billion in downgrades since March 16, said Bank of America.

Credit-ratings firms downgraded a net $560 billion of investment-grade corporate bonds in the index last month, the bank added. While total downgrades remained lower than at the same point during the financial crisis, the pace accelerated in recent weeks as ratings firms and investors reassessed the ability of borrowers to repay their debts.

Fears that the crisis will spur bankruptcies and a prolonged recession have helped drive the Bloomberg Barclays U.S. corporate investment grade index down 3.9% in the first quarter of 2020, the worst performance since the end 2016. Analysts said there is still room for more companies to fall down the ratings ladder, with businesses closed and consumers stuck at home, despite the Federal Reserve's recent extraordinary efforts to support the corporate debt market.

"The Fed programs cannot stem the negative actions that credit rating agencies have already taken and will continue to take," said UBS senior credit strategist Barry McAlinden. "Downgrades are a normal part of an economic down cycle, and the anticipation for negative rating actions is a reason why [investment-grade bond] spreads are where they currently stand."

Investors are being compensated more to hold corporate bonds. Adjusted for options, the spread, or extra yield investors demanded to hold investment-grade U.S. corporate bonds in the Bloomberg Barclays index over Treasury bonds increased by 1.79 percentage points during the first quarter -- a record, according to Dow Jones Market Data.

Investors watch downgrades because it is one sign of deteriorating conditions in the corporate sector. Many funds also can't hold debt below investment-grade, so downgrades could put added pressure on the debt market in an already difficult trading environment.

"A wave of downgrades would unquestionably cause disruption given the swell of new names into the high-yield market," said Mike Terwilliger, portfolio manager at Resource America. "The market would absorb the paper, but it would definitely bring a temporary downdraft."

Downgrades haven't stopped a deluge of new bonds being sold by investment-grade companies. A record amount was issued last week, and in recent days, some speculative-grade companies have joined in. After Yum Brands Inc. completed the first high-yield bond sale in nearly a month on Monday, more have followed. Sales by aerospace manufacturer TransDigm Group Inc., fast-food operator Restaurant Brands International Inc. and Tenet Healthcare Corp. were expected to close on Thursday.

U.S. Treasury yields were down on Thursday. The benchmark 10-year yield fell to 0.624%, according to Tradeweb, from 0.630% at Wednesday's close. The intraday yield of the 30-year bond fell to 1.268%, from 1.285%.

As downgrades from ratings firms like S&P and Moody's accelerate, more companies at the lower rungs of the investment-grade bond market are at risk of having their ratings pushed into junk territory, becoming what is known on Wall Street as fallen angels. More than $97 billion in debt tied to 13 companies including Ford Motor Co., Occidental Petroleum Corp., and Western Midstream Partners LP lost investment-grade status in March.

Wall Street analysts say more fallen angels are likely, with many triple-B bond investors demanding larger spreads compared with their speculative-grade counterparts. Around $343 billion of triple-B rated bonds issued in developed markets trade at a higher premium over U.S. Treasurys than double-B rated bonds, says Bank of America.

Cruise operator Carnival Corp., which is under review for downgrades, sold $4 billion of new triple-B bonds Wednesday at an initial yield of 11.9%. T-Mobile Inc. was set to sell triple-B bonds to pay down a bridge loan used to fund its purchase of Sprint Corp.

--Sam Goldfarb contributed to this article.

Write to Sebastian Pellejero at sebastian.pellejero@wsj.com


Stocks mentioned in the article
ChangeLast1st jan.
CARNIVAL CORPORATION & PLC 0.42% 16.87 Delayed Quote.-66.95%
CARNIVAL PLC -1.01% 1123 Delayed Quote.-68.87%
FORD MOTOR COMPANY 0.51% 5.9 Delayed Quote.-36.88%
OCCIDENTAL PETROLEUM CORPORATION 6.81% 14.75 Delayed Quote.-66.49%
T-MOBILE US 0.71% 100.41 Delayed Quote.27.14%
TENET HEALTHCARE CORPORATION -0.63% 22.11 Delayed Quote.-41.49%
TRANSDIGM GROUP INC. -1.45% 432.44 Delayed Quote.-21.64%
WTI 4.69% 37.125 Delayed Quote.-42.57%
YUM BRANDS 1.87% 92.21 Delayed Quote.-10.14%
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