The Making of Fallen Angels—and What QE and Credit Rating Agencies Have to Do with It

The Making of Fallen Angels—and What QE and Credit Rating Agencies Have to Do with It – Liberty Street Economics

Riskier firms typically borrow at higher rates than safer firms because investors require compensation for taking on more risk. However, since 2009 this relationship has been turned on its head in the massive BBB corporate bond market, with risky BBB-rated firms borrowing at lower rates than their s…

✒ One unintended consequences of quantitative easing is the issuance of trillions of bonds by US companies in the BBB-rated category.

Buyers searching for yield pile heavily into lower rated — but are still investment grade — debts. As a result of such surging demand, some of these “prospective fallen-angels” have even lower borrowing than other high-rated companies.

This created an ideal environment for prospective fallen angels to meet the demand by issuing bonds to finance mergers & acquisitions. By presenting rosy forecasts about synergy and growth, BBB acquirers promise cost savings to pay off debt thus avoiding a downgrade.

The Fed researchers found that confidence was often misplaced. BBB acquirers regularly paid so much for targets that their credit metrics fell into junk territory. However, rating agencies remained lenient and resisted downgrading companies to this “fallen angel” status.