What is a ‘Fallen Angel’
A fallen angel is a bond that was given an investment-grade rating but has since been reduced to junk bond status due to the weakening financial condition of the issuer. It is also a stock that has fallen substantially from its all-time highs. There is a fine line between fallen angel bonds and value stocks, which have the potential to recover from short-term challenges, and those that are headed straight toward bankruptcy.
Explaining ‘Fallen Angel’
Fallen angel bonds, which can be corporate, municipal or sovereign debt, have been downgraded by a rating service such as Standard & Poor’s, Fitch or Moody’s Investors Service. The primary reason for downgrades is a decline in revenues, which jeopardizes issuers’ capabilities of servicing debt. When declining revenues are combined with expanding debt levels, the potential for a downgrade increases dramatically.
Examples of Fallen Angels
For example, an oil company that has reported sustained losses over several quarters due to falling oil prices may see its investment-grade bonds downgraded to junk status due to increasing risk of default. As a result of the downgrade, the prices of the company’s bonds decline and yields increase, making the debt attractive to contrarian investors who see low oil prices as a temporary condition.
Further Reading
- Fallen angels and price pressure – jfi.pm-research.com [PDF]
- Forced selling of fallen angels – jfi.pm-research.com [PDF]
- Business angel investment activity in the financial crisis: UK evidence and policy implications – journals.sagepub.com [PDF]
- Effect of being a fallen angel on bond ratings and yields – jot.pm-research.com [PDF]
- High-Yield (Junk) Bonds as Investments and as Financial Tools – heinonline.org [PDF]
- The Impact of Fallen Angels on Investment Grade Corporate Bonds Portfolios: Evidence from the European Market – onlinelibrary.wiley.com [PDF]
- How are the mighty fallen: Rejected classic articles by leading economists – www.aeaweb.org [PDF]
