New pandemic-related restrictions will not lead to a repeat of the 2020 spike in “fallen angels” (investment-grade companies downgraded to speculative-grade) in developed European markets and the US, Fitch Ratings says. Outstanding debt issued by potential fallen angels in sectors that are most sensitive to such restrictions, including transportation and lodging, represents a small share of all corporate issuers subject to fallen-angel risk.
Based on ratings, Outlooks and sector exposure to the Covid-19 crisis, the oil and gas sector still accounts for the largest share (by debt) of potential fallen angels, just as it did during the fallen-angel peak in March and April 2020.
However, the risk of sharp downward pressure on hydrocarbon prices has reduced due to OPEC+ production cuts, reduced oil inventories and increased investor optimism, supported by the vaccine roll-out in many countries. This is dramatically different to the situation in spring 2020 when OPEC+ countries failed to agree output cuts and threatened to increase supply while demand reduced dramatically.
The sectors most exposed to the new restrictions include transportation; aerospace and defence (particularly issuers that have a high dependence on civil aviation); gaming, lodging and leisure; and non-food retail (issuers with limited online sales). The risk increases if these restrictions do not end by 2Q21 (as we currently expect) and last into 3Q21.
Travel restrictions have delayed the aviation sector’s recovery and indirectly increased pressure on aerospace companies. This is especially the case for companies exposed to widebody aircrafts that are mainly used for long-haul travel, although long-term order backlogs cushion the impact. The lodging and leisure and non-food retail sectors are also affected by reduced mobility.
However, these four sectors account for about 12% of the debt issued by investment-grade companies that are the most at risk of being downgraded to speculative-grade. In addition, most investment-grade issuers took advantage of buoyant capital markets to improve their liquidity positions, which will help them to weather the most acute period of restrictions. Furthermore, many governments in developed markets have extended their support measures, such as furlough schemes, which alleviate lockdown-related stress.
Pressure on potential fallen angels in many other sectors has reduced from the peak downgrade period of March and April 2020, as these companies adjust to the pandemic environment. This has reduced the migration into speculative-grade rating categories, despite a small spike in downgraded debt in November 2020, which was caused by the downgrade of one particularly large issuer. Many commodity prices have been rising, supporting companies in the natural resource sectors. Pent-up demand in sectors such as autos have led to a faster-than-expected recovery.
Even though corporate sectors will face challenges in 2021, we do not expect these challenges to be of the same magnitude as those of 2020, when the annual fallen-angel rate reached a record high. We anticipate a recovery in 2022 and a progressive reduction in the cohort of companies exposed to fallen-angel risk.
