Investors Brace for Fallen Angels as Rating Firms Clip Wings

The long slump in commodity prices has opened the gates for the largest migration in the history of credit markets as rating companies review $160 billion of high-grade bonds that could end up as junk.

That’s the amount sold by companies in the energy and basic-materials industries being reviewed for potential cuts or tagged with negative outlooks by Standard & Poor’s or Moody’s Investors Service, according to data compiled by Bloomberg. Any cuts would add to the more than $10 billion of so-called fallen-angel securities that have found a new home in the Bloomberg high-yield bond index, led by notes sold by Transocean Ltd., the world’s largest offshore driller.

A more than six-year Federal Reserve policy of suppressing interest rates in order to spur growth has pushed investors toward riskier assets, leading to the nearly doubling of the size of the high-yield bond market. Curtailed access to capital amid a slump in global commodity prices could trigger the next wave of ratings cuts, according to a Bloomberg Intelligence report Friday.

“If you looked for a frothy part of the debt-issuance market, it was perhaps the energy market,” Chris Lafakis, an economist at Moody’s Analytics in West Chester, Pennsylvania, said in a telephone interview. “We had ripe financial conditions in the lead-up to the energy bust. What really caught people off guard is the magnitude of the price drop.”

Tightening Markets

An extreme move by the rating companies may dwarf the previous two cycles, with $81 billion of auto-company debt falling to high yield in 2005 and $52 billion of financial-industry notes dropping to junk in the aftermath of the collapse of Lehman Brothers Holdings Inc., according to the Bloomberg Intelligence report.

The amount of high-yield energy debt has more than doubled to $213 billion in the last five years, according to Bank of America Merrill Lynch index data. Energy companies now face the risk of trying to tap tightening markets when they need to obtain financing.

“While markets anticipate higher credit risk due to commodity prices, the full effect may not be apparent until ratings actions are complete,” Rich Salditt, a Bloomberg Intelligence analyst, said in a telephone interview. “A significant growth in debt of these two sectors may present an extremely high concentration of commodity exposure that would need to be mitigated.”

Energy investors are finding some comfort in the April rebound in oil prices, with the commodity rising 18 percent and set for its biggest monthly gain in five years.

Energy-company bonds have gained 3.4 percent this month, following a 13 percent plunge in the second half of 2014, Bank of America Merrill Lynch index data show.

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