Why the Rate of Fallen Angel Corporate Bonds is ‘Extremely Low’: Goldman Sachs

US companies are fiercely guarding their investment grade credit status, with a remarkably low number slipping into riskier, high-yield tiers, according to a note published by Goldman Sachs Asset Management. The volume of US debt stripped of its investment grade rating, or fallen angels, has reached its lowest level in about 25 years.

Stephen Waxman, head of the Global Investment Grade Research team at Goldman Sachs Asset Management, attributes this trend to several factors:

• Strong Economic Growth and Earnings: The US economy has been steadily growing, supporting robust earnings for many investment-grade companies. EBITDA has increased around 5% and may climb even higher next year. This strong growth environment and conservative allocation of cash flows have limited debt creation on balance sheets, particularly in the past two years.
• Benefits of Inflation: While inflation has been a concern, some corporations with high-grade credit have benefited from its impact on their fixed-rate debt. The impact of higher interest rates has been mitigated by higher nominal sales as prices increased. Companies also pulled back on expenditures like stock buybacks in response to rising rates, strengthening their credit metrics.
• Shift in Corporate Behavior: The financial crisis of 2008 led to a shift in corporate behavior. Management teams have become more cautious about increasing leverage and losing their investment-grade status. Activist investors are now more focused on operational improvements rather than financial engineering, further contributing to the decline in fallen angels.

While the overall number of fallen angels remains low, there has been a shift in the distribution of investment-grade ratings. A number of borrowers have fallen from A to BBB status, but very few are descending from BBB to BB.

This shift reflects the period between 2013 and 2019 when companies were more focused on "inorganic growth" activities like stock buybacks and mergers and acquisitions. This led to a surge in the BBB-rated market, which now makes up below 50% of the investment-grade bond market.

Goldman Sachs anticipates that the Fed's rate cuts will impact the broader economy rather than having a direct impact on the higher-rated companies, which are generally less sensitive to interest rates.

The US presidential election is another factor to consider, as market prices have not yet fully reflected potential policy changes from the federal government.