We use cookies that are necessary to make our site work as well as analytics cookie and third-party cookies to monitor our traffic and to personalise content and ads.
Please click “Cookies Settings” for details on how to withdraw your consent and how to block cookies. For more detailed information about the cookies we use and of who we work this see our cookies policy
Necessary cookies:
Necessary cookies help make a website usable by enabling basic functions like page navigation and access to secure areas of the website and cannot be switched off in our systems. You can set your browser to block or alert you about these cookies, but some parts of the site will then not work. The website cannot function properly without these cookies.
Statistic and marketing cookies:
Statistic cookies help website owners to understand how visitors interact with websites by collecting and reporting information
Marketing cookies are used to track visitors across websites. The intention is to display ads that are relevant and engaging for the individual user and thereby more valuable for publishers and third party advertisers. We work with third parties and make use of third party cookies to make advertising messaging more relevant to you both on and off this website.
Winter was an unusually busy period for fallen angels with ratings activity across sectors such as real estate and automotives
In our ‘Top of mind’ section we explain how our Fallen Angels Recovery strategy increases liquidity in the segment
Considering the macro backdrop and current environment, why is it a potentially opportune time to invest in fallen angels?
In this issue of Fallen angels radar we provide a rundown of new fallen angels1, and explain how our Fallen Angels Recovery strategy expands the universe of eligible bonds. We also discuss why the combination of a growth-positive agenda and considerable uncertainty created by the new US administration mean now is potentially an opportune time to invest in the asset class.
Charting changes in the fallen angels investable universe
Traditionally a slow period for markets, the last few months have seen an unusually high level of activity in the fallen-angels universe. Bonds from names across multiple sectors joined the index2, while one name fell lower into high yield and left the universe.
Prospect Capital Corp.3
Cut to Ba1 by Moody's and BB+ by S&P in December 2024
Rationale for ratings action
Prospect Capital Corp. is a US-based business development company focused on making debt and equity investment in middle-market businesses across a range of sectors. S&P’s decision to downgrade was driven chiefly by ongoing deterioration in the company’s asset quality, together with greater exposure to payment-in-kind (PIK) notes and overall weaker performance relative to peers. Moody’s downgraded the company weeks later, citing similar concerns around PIK arrangements with weaker borrowers, along with lower earnings, higher investment losses and a poorer asset-to-debt ratio.
Longer term view
While these downgrades are justified given the contributing factors, we believe the outlook for the company is stable. Founded in 2004, Prospect Capital is a mature business with a diverse portfolio, including exposure to real-estate investment trusts (REITs), healthcare providers and consumer finance. It also benefits from an experienced management team, less than 1.5x leverage and strong liquidity of around USD 1 billion – versus debt maturities of less than USD 200 million over the next 12 months.
We note that Prospect had already been addressing the key issue of reducing its exposure to PIK notes, which fell from 18.6% to 16.9% of income between June and September 2024. Overall, with the firm’s USD 2.1 billion revolving credit facility (RCF) final maturity more than four years away, we believe the company will be able to overcome current challenges.
Lar España3
Cut from BBB to BB- by Fitch in December 2024
Rationale for ratings action
Fitch’s downgrade of Spanish REIT Lar España Real Estate SOCIMI (LRESM) was prompted by the plans of its new private owners. To finance a tender offer for shares, Hines European Real Estate Partners III and Grupo Lar announced their intention to re-leverage the company to around 60% loan-to-value (LTV). The new owners’ re-leveraging strategy requires major debt restructuring and will result in a significant rise in the company’s average cost of debt. According to Fitch’s calculations, this will result in a net-debt to EBITDA ratio of 12.5x by the end of 2025, with a much tighter interest coverage ratio of 1.4x (compared to 5.2x in 2023).
Longer term view
In our view, LRESM will be left with considerably less financial flexibility in the wake of the deal. LRESM has two bonds outstanding (1.75% notes due 07/22/2026 and 1.843% notes due 11/03/2028). Both are priced around par and yield just 2%4 – not what we would usually expect for a recently downgraded fallen angel, let alone one that has been downgraded four notches instead of the more typical single notch. This unusual price action reflects the inclusion of a change of control clause in the bond documentation which is triggered by this transaction; the clause allows bondholders to put the bonds back to the company at a price of 101 once the transaction to take the company private has gone through. Any bonds not put back to the company (which will be a very small quantity) are highly likely to reflect the increased risk associated with the rating and have a much greater yield or lower price than they do now, in our opinion.
German auto parts supplier Hella is around 82% owned by French firm Forvia, so when its parent company was downgraded in October it was only a matter of time before Hella suffered a similar fate. Moody’s confirmed that the downgrade was driven by Forvia’s weakened credit profile, while maintaining a two-notch difference due to Hella’s stronger metrics.
Longer term view
Given Forvia’s significant controlling stake we believe the two companies should be rated equally, since Hella is no longer an independent concern. The firm has just one bond outstanding, (0.5% notes due 01/26/2027); no price action was in evidence in the wake of the downgrade. With this asset yielding less than an equivalent Forvia bond – we believe there is little value on offer.
Service Properties Trust3
Downgraded to Caa1 by Moody’s in October 2024, with a negative outlook
Rationale for ratings action
Moody’s decision to downgrade this US hotel and retail focused REIT was based on very high leverage and weak fixed charge cover, in turn caused by poor operating performance and deteriorating cash flow. Given the very limited headroom offered by the company’s bond and RCF covenants, there is also concern around whether it can refinance in the near term as its debt matures.
Longer term view
Our concerns relating to the company date back several years. In early 2023, our analysis raised issues around governance, business strategy and inconsistent financial policy that could impact the firm’s ability to refinance near-term debt maturities and potentially make it a falling knife. Falling knives are fallen angels that continue to suffer from a decline in creditworthiness. As such, the deterioration in the company’s situation is unsurprising.
Aptiv3
BBB ratings placed on review for downgrade by Fitch’s in January 2025
Rationale for ratings action
Auto-parts supplier Aptiv announced a plan to spin off its Electrical Distribution Systems subsidiary into a separate company by March 2026. As a result, Fitch placed its BBB ratings on review for downgrade. It also downgraded the subordinated bonds by one notch to high yield, to more closely align the rating with similar instruments; this effectively acknowledged the previous rating was incorrect. Both Moody’s and S&P’s ratings remained unchanged.
Longer term view
We expect the bonds to remain at Aptiv, which we believe is likely to maintain its investment grade rating. That would support a stable BB or BB+ rating for the subordinated bonds.
subscribe to investment insights and strategy updates
Preference Centre
Top of mind: liquidity
In this section, we answer the most common question we have received over the past quarter about investing in fallen angels.
Question:
“How does LOIM’s approach to fallen angels increase liquidity in the segment?”
Answer:
The fallen angels index comprises bond issuances that have been recently downgraded from investment grade to high yield. Our Fallen Angels Recovery strategy expands the universe to include any bond from a fallen angel issuer, whether the specific bond has been downgraded or not. This increases the overall size of the investible universe, enhancing fund liquidity and potentially reducing trading costs.
While monetary policy will remain important in 2025, it’s already clear that trade tariffs and fiscal policy will play an increasing role at a macro level – with important implications for fixed-income markets. These factors are likely to lead to a divergence in the growth and inflation trajectories of the US and Europe.
By comparison with 2024, which offered up some exciting opportunities to take advantage of spread tightening in sectors like real estate, the performance drivers look less obvious in 2025. Indications are that it will be a year of ‘carry’, but our years of experience suggest there will be unexpected shocks – and we need to be ready to take advantage, wherever they come from. While the shock tactics of the new US administration – particularly around tariffs – are generating a lot of headlines, the impact on credit markets is likely to be relatively muted given the lack of follow-through so far. Nevertheless, we are monitoring the situation carefully and suspect the opportunities may lie in the second order impact of these policy changes, rather than in those issuers directly impacted.
The uncertain but growth-positive environment is favourable for quality corporate bonds, which we believe currently offer a better mix of credit and duration risk than government bonds. In particular, corporate debt offers interesting opportunities at the higher quality end of high-yield credit, where fallen angels are to be found – offering the potential for wider spreads and the potential for strong returns.
One sector we have flagged previously that continues to face challenges is automotive. More sluggish than hoped for electric vehicle uptake in some markets is affecting overall production volumes, with component manufacturers most vulnerable to the consequences.
[1] Fallen angels are bonds that have been downgraded from investment grade to high yield credit ratings.
[2] The index refers to the Bloomberg Global Corporate ex-EM Fallen Angels 3% Issuer Capped.
[3] Fallen angels are driven by the bond rating being downgraded rather than the issuer rating. In this paper, we assume that the two ratings are the same, unless otherwise specified. Credit ratings are subject to change. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document. Important information on case studies: The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.
[4] Yields are subject to change and can vary over time. Past performance is not an indicator of future results.
important information.
For professional investors use only
This document is a Corporate Communication for Professional Investors only and is not a marketing communication related to a fund, an investment product or investment services in your country. This document is not intended to provide investment, tax, accounting, professional or legal advice.
