The impact of the Covid-19 pandemic on companies and governments has put ratings under pressure around the globe. As the inevitable downgrades roll out, we look to our fundamental sovereign and corporate analysis to cut through the headlines and focus on what we can more reliably predict.
We prefer to look through the cycle to assess default risk, acknowledging that while winners and losers will emerge from the sharp, pandemic-driven economic contraction, the situation won’t last forever. However, we’ve observed during past market crises that rating agencies have tended to reflect nearer-term negativity in their actions and may be even quicker to downgrade emerging market (EM) issuers. Indeed, during the current crisis rating agencies have taken swift action across regional markets and across the rating spectrum – a trend that will likely elevate rates of “fallen angels” (entities downgraded from investment grade to “junk” or high yield) among EM corporate issuers.
While topline expectations for the rate of fallen angels among EM investment grade corporates may cause concern, a closer look at the factors contributing to those expectations reveals greater stability than may be perceived – along with potential opportunities that downgrades may present to EM investors. While downgrades are inevitable, we assessed the risk of the deterioration in credit ratings and found that the damage may not be as clear-cut (or as severe) as the headlines might suggest.
To date, nearly 250 EM corporate and quasi-sovereign issuers have been downgraded in 2020, compared with just 20 upgrades1. The sharp increase in downgrades follows a period of positive rating momentum, as net upgrades had been trending higher since 2015.
The downgrades include the nearly 8% of EM investment grade corporate and quasi-sovereign issuers that have been cut to high yield, with Mexico’s Pemex accounting for the lion’s share: nearly $60 billion in Pemex bonds, representing 6.6% of the EM investment grade market, have been lowered to speculative grade1. In addition, negative rating outlooks and near-term macroeconomic challenges factor into market expectations that the percentage of fallen angels among EM corporates in 2020 is likely to be materially higher (at around 14%) than for developed market (DM) corporates, potentially setting a new record if it surpasses the 2015 total of 13.6%. Importantly, rating agencies set ceilings on corporate ratings relative to their respective sovereigns. As in 2015, when sovereign downgrades of Brazil and Russia were outsize contributors to the record levels of fallen angels, sovereign risk is the main factor driving expectations in 2020.
When excluding issuers whose downgrade risk emanates from a negative sovereign outlook, fallen angels in EM are expected to range from 4% to 5% in 2020 on a standalone basis, not much higher than in the US (at 3.7%) or the EU (at 4.3%).1
Our analysis shows there are currently US $215 billion in BBB- rated securities outstanding, representing 21% of the investment grade EM corporate and quasi-sovereign market, with downgrade risk varying across and within regions.2
Latin America is expected to contribute roughly 75% of EM fallen angels in 20201, with the majority concentrated in two countries with negative sovereign rating outlooks: Mexico (dominated by Pemex) and Brazil. Within both countries, escalating risk at the sovereign level due to political turmoil and ambitious fiscal responses to Covid-19 will place a number of investment grade issuers under rating pressure.
While Asia accounts for nearly 50% of investment grade EM corporate and quasi-sovereign issuance, the majority is highly rated, at BBB or higher1. While a sovereign downgrade presents a potential risk of fallen angels among India’s corporate issuers, we expect India will maintain its investment grade ratings. As such, we believe fallen angel risk within Asia is low and issuer-specific, and that the region will contribute less than 2% to the overall full-year total.
Turning to EMEA, we don’t believe sovereign risk in the Middle East will factor much into fallen angel risk, as more than 90% of the region’s IG issuance is from countries rated A or higher1. We see just one fallen angel candidate in the Middle East, a state-owned port operator that underwent a leveraged recapitalization that continues to stretch its balance sheet. Europe is a much smaller component of the IG market, and although Russia – with low BBB ratings by Moody’s and S&P – could be a source of sovereign risk, we note that the sovereign is an upgrade candidate thanks to a robust policy framework and accumulated reserves.
At PineBridge, we maintain active coverage of more than 260 investment grade corporate and quasi-sovereign issuers3, each of which is assigned a fallen angel probability. While such forward-looking analysis is always important, it is even more essential in periods of short-term economic contraction like we’re seeing today, as the near-term negative rating trend increases the downside risks associated with a potential record level of fallen angels.
Our assessment of fallen angel risk relies on collaboration between sovereign and corporate research to gain a comprehensive understanding of which issuers might be downgraded. Our analysis suggests a fallen angel rate of just over 11% of the total EM corporate IG market, which is several percentage points lower than consensus estimates. Nearly 8%1 of the expected fallen angels have already occurred, paced by the record Pemex downgrade. This leaves just over 3.5%1 of the IG market likely to fall into high yield for the remainder of the year, which is not substantially higher than we might expect in a normal year.
Source: J.P. Morgan and PineBridge Investments as of 21 May 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Forecasts are valid as of the date indicated and are subject to change.
The increase in BBB ratings within investment grade credit markets is often cited as a sign of an overall deterioration in credit fundamentals. To support outdated assumptions about underlying credit risk within the EM corporate market, skeptics may point to the higher concentration of BBB securities within EM corporate IG indices versus their developed market counterparts (at roughly 60% of the JPMorgan CEMBI Broad Diversified IG Index, compared with 47% of the Bloomberg Barclay US Corporate Bond Index). Notably, however, EM corporate indices do not include many highly rated issues from two key market segments of the investable universe: quasi-sovereign issuers, and many short-term securities issued by highly rated Asian financial companies (due to maturity constraints). When including these market segments, the concentration of BBB credit within EM essentially matches the 47% found within the US corporate market. More importantly, due in large part to the rating agencies’ sovereign rating caps, BBB credits in EM typically feature stronger balance sheets than their US peers. This is evident in EM BBB corporate net leverage ratios, which are a full turn lower than their US counterparts (at 2.0x versus 3.0x).4
Source: BAML and PineBridge Investments. Leverage as of 30 June 2019; spread as of 30 April 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Just as quasi-sovereign issuers do not factor into corporate indices, they also are not captured in corporate balance sheet metrics. In the aftermath of Pemex’s record downgrade, and with many countries increasing fiscal programs to address the impact of Covid-19, scrutiny of quasi-sovereigns’ creditworthiness has increased. Quasi-sovereign issuers remain critical to their respective countries, and we would expect governments to provide increased support if fundamentals were to weaken. While fiscal deficits will increase this year, the ability of many sovereigns to issue debt at lower funding rates within their local markets should provide governments ample room to support their state-owned enterprises.
Fallen angels tend to be well-telegraphed, and market pricing typically follows a pattern of “sell the rumor, buy the fact” as rating-sensitive investors look to unload them before the downgrades actually occur. As a result, valuations tend to reflect a new rating paradigm before the downgrades take place, after which prices often rally as bonds find new sponsorship. The majority of EM corporate bonds are held either by local investors or dedicated EM investors, which are typically not rating-sensitive. As such, EM corporate bonds tend to be better insulated from some of the pre-downgrade selloffs that typically accompany fallen angels within DM credit markets. For EM investors who are not rating-sensitive, fallen angels with a high percentage of crossover ownership – meaning DM investors who typically are rating-sensitive – may present an opportunity to take advantage of attractive valuations that result from forced selling.
The repricing of EM corporate spreads during March reflected a level of risk aversion not seen since the global financial crisis. Although markets have stabilized and spreads have compressed since March, current pricing still reflects a more bearish outlook than we believe is warranted by market fundamentals. This is particularly true of the investment grade corporate market, where spreads per turn of net leverage are historically wide.
Given our expectation that fallen angel risk will be relatively well contained this year and driven primarily by sovereign risk (rather than systemic deterioration of credit metrics), we see an attractive opportunity to add exposure within the EM investment grade corporate market.
1 Source J.P. Morgan, S&P and Fitch as of 21 May 2020
2 Source: PineBridge as of 22 May 2020
3 As of 27 May 2020
4 J.P. Morgan as of 31 December 2019
Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.
PineBridge Investments is a group of international companies that provides investment advice and markets asset management products and services to clients around the world. PineBridge Investments is a registered trademark proprietary to PineBridge Investments IP Holding Company Limited.
Readership: This document is intended solely for the addressee(s) and may not be redistributed without the prior permission of PineBridge Investments. Its content may be confidential, proprietary, and/or trade secret information. PineBridge Investments and its subsidiaries are not responsible for any unlawful distribution of this document to any third parties, in whole or in part./p>
Opinions: Any opinions expressed in this document represent the views of the manager, are valid only as of the date indicated, and are subject to change without notice. There can be no guarantee that any of the opinions expressed in this document or any underlying position will be maintained at the time of this presentation or thereafter. We are not soliciting or recommending any action based on this material.
Risk Warning: All investments involve risk, including possible loss of principal. If applicable, the offering document should be read for further details including the risk factors. Our investment management services relate to a variety of investments, each of which can fluctuate in value. The investment risks vary between different types of instruments. For example, for investments involving exposure to a currency other than that in which the portfolio is denominated, changes in the rate of exchange may cause the value of investments, and consequently the value of the portfolio, to go up or down. In the case of a higher volatility portfolio, the loss on realization or cancellation may be very high (including total loss of investment), as the value of such an investment may fall suddenly and substantially. In making an investment decision, prospective investors must rely on their own examination of the merits and risks involved.
Performance Notes: Past performance is not indicative of future results. There can be no assurance that any investment objective will be met. PineBridge Investments often uses benchmarks for the purpose of comparison of results. Benchmarks are used for illustrative purposes only, and any such references should not be understood to mean there would necessarily be a correlation between investment returns of any investment and any benchmark. Any referenced benchmark does not reflect fees and expenses associated with the active management of an investment. PineBridge Investments may, from time to time, show the efficacy of its strategies or communicate general industry views via modeling. Such methods are intended to show only an expected range of possible investment outcomes, and should not be viewed as a guide to future performance. There is no assurance that any returns can be achieved, that the strategy will be successful or profitable for any investor, or that any industry views will come to pass. Actual investors may experience different results.
Information is unaudited unless otherwise indicated, and any information from third-party sources is believed to be reliable, but PineBridge Investments cannot guarantee its accuracy or completeness.
This document and the information contained herein does not constitute and is not intended to constitute an offer of securities or provision of financial advice and accordingly should not be construed as such. The securities and any other products or services referenced in this document may not be licensed in all jurisdictions, and unless otherwise indicated, no regulator or government authority has reviewed this document or the merits of the products and services referenced herein. This document and the information contained herein has been made available in accordance with the restrictions and/or limitations implemented by any applicable laws and regulations. This document is directed at and intended for institutional and qualified investors (as such term is defined in each jurisdiction in which the security is marketed). This document is provided on a confidential basis for informational purposes only and may not be reproduced in any form. Before acting on any information in this document, prospective investors should inform themselves of and observe all applicable laws, rules and regulations of any relevant jurisdictions and obtain independent advice if required. This document is for the use of the named addressee only and should not be given, forwarded or shown to any other person (other than employees, agents or consultants in connection with the addressee’s consideration thereof).
Disclosures by location:
Australia: PineBridge Investments LLC is exempt from the requirement to hold an Australian financial services license under the Corporations Act 2001 (Cth) in respect of the financial services it provides to wholesale clients, and is not licensed to provide financial services to individual investors or retail clients. Nothing herein constitutes an offer or solicitation to anyone in or outside Australia where such offer or solicitation is not authorised or to whom it is unlawful. This information is not directed to any person to whom its publication or availability is restricted.
Brazil: PineBridge Investments is not accredited with the Brazilian Securities Commission - CVM to perform investment management services. The investment management services may not be publicly offered or sold to the public in Brazil. Documents relating to the investment management services as well as the information contained therein may not be supplied to the public in Brazil.
Chile: PineBridge Investments is not registered or licensed in Chile to provide managed account services and is not subject to the supervision of the Comisión para el Mercado Financiero of Chile (“CMF”). The managed account services may not be publicly offered or sold in Chile.
Colombia: This document does not have the purpose or the effect of initiating, directly or indirectly, the purchase of a product or the rendering of a service by PineBridge Investments ("investment adviser") to Colombian residents. The investment adviser’s products and/or services may not be promoted or marketed in Colombia or to Colombian residents unless such promotion and marketing is made in compliance with decree 2555 of 2010 and other applicable rules and regulations related to the promotion of foreign financial and/or securities related products or services in Colombia. The investment adviser has not received authorisation of licensing from The Financial Superintendency of Colombia or any other governmental authority in Colombia to market or sell its financial products or services in Colombia. By receiving this document, each recipient resident in Colombia acknowledges and agrees that such recipient has contacted the investment adviser at its own initiative and not as a result of any promotion or publicity by the investment adviser or any of its representatives. Colombian residents acknowledge and represent that (1) the receipt of this presentation does not constitute a solicitation from the investment adviser for its financial products and/or services, and (2) they are not receiving from the investment adviser any direct or indirect promotion or marketing of financial products and/or services. Marketing and offering of products and/or services of a foreign financial [or securities related] entity represented in Colombia.
Promoción y oferta de los negocios y servicios de la entidad del mercado de valores del exterior [o financiera, según sea el caso] representada en Colombia.
Dubai: PineBridge Investments Europe Limited is regulated by the Dubai Financial Services Authority as a Representative Office and is making this document available to you. This document is intended for sophisticated/professional investors only and no other Person should act upon it.
Germany: This material is issued by PineBridge Investments Deutschland GmbH, licensed and regulated by the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).
Hong Kong: The issuer of this document is PineBridge Investments Asia Limited, a company incorporated in Bermuda with limited liability, licensed and regulated by the Securities and Futures Commission (SFC). This document has not been reviewed by the SFC.
Ireland: When this document is issued in the EEA, unless stated otherwise, it is approved and issued by PineBridge Investments Ireland Limited, licensed and regulated by the Central Bank of Ireland.
Israel: PineBridge Investments is neither licensed nor insured under the Israeli Investment Advice Law.
Japan: This document is not, and under no circumstances is to be considered as, a public offering of securities in Japan. No registration pursuant to Article 4 paragraph 1 of Japan’s Financial Instruments and Exchange Act (“FIEA”) has been or will be made with respect to any solicitation of applications for acquisition of interests of any vehicle or any account that may be undertaken, on the grounds that any such solicitation would constitute a “solicitation for qualified institutional investors” as set forth in Article 23-13, paragraph 1 of the FIEA. In Japan, this document is directed at and intended for qualified institutional investors (as such term is defined in Article 2, paragraph 3, item 1 of the FIEA; “QIIs”). If any offering is to be made, that would be made on the condition that each investor enters into an agreement whereby the investor covenants not to transfer its interests (i) to persons other than QIIs, or (ii) without entering into an agreement whereby the transferee covenants not to transfer its interests to persons other than QIIs.
Kuwait: The offering of any security in any vehicle has not been approved or licensed by the Kuwait Capital Markets Authority or any other relevant licensing authorities in the State of Kuwait, and accordingly does not constitute a public offer in the State of Kuwait in accordance with Law no. 7 for 2010 regarding the Establishment of the Capital Markets Authority and the Regulating Securities Activities (“CMA Law”). This document is strictly private and confidential and is being issued to a limited number of professional investors: A) who meet the criteria of a Professional Client by Nature as defined in Article 2-6 of Module 8 of the Executive Regulations No. 72 of 2015 of the CMA Law; B) upon their request and confirmation that they understand that the securities have not been approved or licensed by or registered with the Kuwait Capital Markets Authority or any other relevant licensing authorities or governmental agencies in the State of Kuwait; and must not be provided to any person other than the original recipient, and may not be reproduced or used for any other purposes whatsoever.
Malaysia: PineBridge Investments Malaysia Sdn Bhd is licensed and regulated by Securities Commission of Malaysia (SC). This material is not reviewed or endorsed by the SC.
Netherlands: PineBridge Investment Ireland Limited, Netherlands Branch is licensed and regulated by The Dutch Authority for the Financial Markets (AFM). This is a branch office of PineBridge Investments Ireland Limited, licensed and regulated by the Central Bank of Ireland.
Peru: Specifically, the Interests will not be subject to a public offering in Peru. The Interests described herein have not been and will not be approved by or registered with the Peruvian Superintendency of Capital Markets (Superintendencia del Mercado de Valores, or the “SMV”) or the Lima Stock Exchange (Bolsa de Valores de Lima). Accordingly, the Interests may not be offered or sold in Peru except, among others, if such offering is considered a private offer under the securities laws and regulations of Peru. The Interests cannot be offered or sold in Peru or in any other jurisdiction except in compliance with the securities laws thereof. In making an investment decision, institutional investors (as defined by Peruvian law) must rely on their own examination of the terms of the offering of the Interests to determine their ability to invest in the Interests. All content in this document is for information or general use only. The information contained in this document is referential and may not be construed as an offer, invitation or recommendation, nor should be taken as a basis to take (or stop taking) any decision. This document has been prepared on the basis of public information that is subject to change. This information may not be construed as services provided by PineBridge Investments within Peru without having the corresponding banking or similar license according to the applicable regulation.
Singapore: PineBridge Investments Singapore Limited is licensed and regulated by the Monetary Authority of Singapore (MAS). In Singapore, this material may not be suitable to a retail investor. This advertisement or publication has not been reviewed by the MAS.
Sweden: PineBridge Investments Ireland Limited Sweden filial is licensed and regulated by Finansinspektionen. This is a branch office of PineBridge Investments Ireland Limited, licensed and regulated by the Central Bank of Ireland.
Switzerland: This material is issued by PineBridge Investments Switzerland GmbH and classes this communication as a financial promotion which is intended for Institutional and Professional clients as defined by the Swiss Federal Financial Services Act ("FinSA") and its implementing ordinance, the Federal Financial Services Ordinance ("FinSO"). PineBridge Investments Switzerland GmbH is affiliated with the Swiss Chambers’ Arbitration Institution (SCAI), 4, boulevard du Théâtre, P.O. Box 5039, 1211 Geneva 11, Switzerland, Tel: +41 (0)22 819 91 57.
Taiwan: PineBridge Investments Management Taiwan Ltd. Is licensed and regulated by Securities and Futures Bureau of Taiwan (SFB). In Taiwan, this material may not be suitable to investors and is not reviewed or endorsed by the SFB.
United Kingdom: This material is issued by PineBridge Investments Europe Limited, licensed and regulated by the Financial Conduct Authority. In the UK this communication is a financial promotion solely intended for professional clients as defined in the FCA Handbook and has been approved by PineBridge Investments Europe Limited. Should you like to request a different classification, please contact your PineBridge representative.
In the UK, this material may also be issued by PineBridge Benson Elliot LLP, registered in England (company number OC317119) with its registered address at 50 Hans Crescent, London, SW1X 0NA. PineBridge Benson Elliot LLP is authorised and regulated by the Financial Conduct Authority.
Uruguay: The sale of the securities qualifies as a private placement pursuant to section 2 of Uruguayan law 18.627. The issuer represents and agrees that it has not offered or sold, and will not offer or sell, any securities to the public in Uruguay, except in circumstances which do not constitute a public offering or distribution under Uruguayan laws and regulations. The securities are not and will not be registered with the Central Bank of Uruguay to be publicly offered in Uruguay. The securities correspond to investment funds that are not investment funds regulated by Uruguayan law 16,774 dated 27 September 1996, as amended.
Last updated 3 June 2021