Fallen Angels Stoking Junk-Issuer Credit Risk, Moody's Says

Former investment-grade companies are contributing to a surprising number of higher-ranked junk-bond issuers showing early signs of distress, according to Moody’s Investors Service.

So-called fallen angels swelled the number of at-risk companies to 22 percent of firms with Moody’s second-highest junk grade, analysts led by Gianmarco Migliavacca said in a statement Tuesday. Downgraded firms wouldn’t ordinarily be expected to show early default signs as they usually retain some investment-grade characteristics, such as a strong business profile, the analysts wrote.

“There is a surprising pattern of flagged companies,” Moody’s said. “The factors behind their downgrade persist and now constitute early-warning signs.”

Excessive leverage and weak liquidity are among the chief warning signs flashed by troubled issuers in Moody’s three highest non-investment grades. The analysis of more than 500 companies in Europe, the Middle East and Africa, gauged the likelihood of default according to measurable metrics, such as cash flow, as well as subjective criteria, including exposure to cyclical industries.

Moody’s forecasts global default rates will rise to 4.2 percent early next year, more than double the figure in January 2015. Meanwhile, investors have lost money on junk bonds this year, with returns on Bank of America Merrill Lynch’s Global High Yield Index at minus 1.1 percent.

Companies showing multiple early-warning signs are more common in industries with a negative outlook, such as the energy and commodity sectors. Those in sectors with a stable outlook but a higher concentration of leveraged buyouts, such as retail and consumer packaged goods, also display warning signs.

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