More High-Rated U.S. Borrowers at Risk of Downgrade as Economy Slows

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A growing proportion of the $8.9 trillion U.S. high-quality corporate bond market is at risk of being downgraded to junk status, and ratings agencies’ expectations that downgrades outweigh upgrades for the first time since the end of 2021.

The proportion of lower-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 percent this week, according to an analysis. by BofA Securities, including names like Paramount Global and Charter Communications. This is almost double the level of 2.9 percent earlier this year.

In contrast, the percentage of these bonds under “positive watch” – meaning they are more likely to be upgraded – stood at 5.3 percent, up from 7.9 percent in early January.

While the share of bonds at risk of downgrade is still relatively small compared to the total, the change highlights the challenges facing U.S. companies as economic growth slows more than expected this year amid high costs. of debt.

BofA noted that while the fundamentals of investment grade credit are “generally strong, the risk of downgrades (of some bonds) to high yield has increased recently.”

The broad shift in ratings dynamics comes after a year in which upgrades from junk grade to investment grade (known as “rising stars”) dramatically outpaced moves in the opposite direction (so-called “fallen angels”). ”), as the US economy defied fears of a recession to position itself as the world’s fastest-growing advanced economy.

Data from Goldman Sachs shows that rising stars netted $119 billion in 2023, the highest figure on record since at least 2010.

By comparison, this year’s net rising stars amount to just $20 billion, according to Goldman figures, indicating a normalization away from dramatic volumes of improvements.

A number of large companies with large amounts of debt are helping to drive the higher proportion of bonds with negative than positive outlooks this year. BofA highlights Paramount and Charter as two of those names.

Bank strategists noted that Boeing, with a capital structure of $46 billion, was recently downgraded to the lowest investment grade range and given a negative outlook by Moody’s. However, the BofA 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 in its commercial airplane assembly operations.”

Large volumes of new bonds entering the high-yield market can cause price swings, leading to widening spreads (the premiums over government yields that borrowers pay to issue debt). Currently, the entire double B universe is worth just $667 billion, according to data from Ice BofA, down from an all-time high of more than $830 billion at the end of 2021.

However, investor demand for credit has been particularly strong this year. Cash-laden buyers, eager to lock in attractive yields before the Federal Reserve begins cutting U.S. interest rates from their current 23-year highs, are stepping out on the sidelines to snap up corporate securities.

Analysts suggested this should mean any new supply will be absorbed more easily than under less favorable market conditions.

“Normally, when there are big downgrades, it’s negative for spreads,” said Yuri Seliger of BofA. But this time “it probably won’t be as bad as before.”

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