Capital Markets

S&P Cites Rise in Credit Downgrades

Last year, ''fallen angels'' outnumbered ''rising stars'' by the highest margin since 1997.
Stephen TaubJanuary 9, 2006

Last year the number of fallen angels — companies whose credit rating was knocked down from investment grade to speculative grade — exceeded the number of such companies for the previous year, according to a new report from Standard & Poor’s.

What’s more, in 2005 fallen angels lagged rising stars, S&P’s term for companies that were upgraded from junk to investment grade. In fact, fallen angels outnumbered rising stars by 19 — the highest margin since 1997.

Worldwide S&P counted 41 fallen angels in 2005 on rated debt worth a total of $520.6 billion, compared with 25 companies and $55.2 billion of debt in 2004. Last year, 27 of the fallen angels were U.S.-based, with debt worth $499.2 billion, including the worldwide leaders in this category, General Motors Corp. and Ford Motor Co.

The credit-rating firm did note, however, that the number of entities at risk of becoming fallen angels decreased last year. As of January 5, 2006, according to the report, 40 entities worldwide with rated debt totaling $58.6 billion were at risk of becoming fallen angels. In December 2004, only 30 global companies were in that position.

Standard & Poor’s defines potential fallen angels as companies rated ‘BBB-‘ with either a negative outlook or ratings on CreditWatch with negative implications.

According to S&P, 2002 was the historical peak for fallen angels; 146 such companies accounted for 4.65 percent of the 3,139 investment grade-rated issuers in that year. The previous peak was in 1986, when 56 fallen angels constituted 4.21 percent of issuers.

The ratings firm pointed out that over the long term, the number of fallen angels mirrors broader trends in credit quality, as measured by the ratio of downgrades to total rating actions. In addition, added the report, “fallen angel incidence generally increases during periods of weak real GDP growth and declines when GDP is growing strongly.”

The main reason: Companies frequently take on more leverage at the top of the economic cycle, making them more vulnerable to potential credit downgrades when economic conditions deteriorate. Other important factors that increase the number of fallen angels include industry deregulation as well as technological change within an industry.

At present, wrote S&P, the media and entertainment, capital goods, high technology, and retail/restaurants sectors are most vulnerable to generating fallen angels.