TEXT-S&P rpt:Europe's fallen angels help transform credit markets

Fri Nov 30, 2012 4:48am EST

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(The following statement was released by the rating agency)

Nov 30 - With the crisis in the eurozone deepening in 2012, country risks in the region are rising, which has been a key factor behind many of the corporate downgrades and the growing number of fallen angels (those companies crossing to speculative grade ratings from investment grade) in Europe in 2012, says Standard & Poor's Ratings Services in a new report published Nov. 29, 2012: "How New Speculative Grade Issuers Are Helping To Transform Europe's Credit Markets".

The downgrade of Portugal to 'BB' with a negative outlook on Jan. 13, 2012 resulted in four Portuguese companies joining the ranks of fallen angels. These actions, triggered by rising country risk, accounted for 33% of the downgrades to speculative-grade corporates this year.

Historically, when a company is downgraded from investment grade ('BBB-' or higher) to speculative grade ('BB+' or lower), it can negatively affect the company's ability to finance itself. As well as the psychological barrier, some funds have investment mandates that require them to sell assets rated lower than 'BBB-', which can push up borrowers' funding costs in a way that other rating changes do not. In Europe's debt markets, these "fallen angels" have traditionally been stigmatized; however, that may be changing.

"In the current environment, with greater investor liquidity, flatter yield curves, and a compression of yields between rating categories, we think the 'BB' rating categories are likely to prove more sustainable for European corporates," said Taron Wade, Associate Director, Corporate Research. She continues, "In our view, fallen angels can benefit the high yield market by adding depth, diversification, and greater liquidity."

This year fallen angels have managed to maintain very good access to capital market funding, albeit at a higher cost. While there might be some reallocation across investor portfolios when companies fall into speculative grade, Standard & Poor's see signs that investor mandates are adapting. That said, this does not necessarily mean an acceptance of a "new normal". In fact, we expect it will be some time yet before more non-private equity owned European corporates are comfortably operating on a longer-term basis within the speculative-grade category.

But, in the current market environment, companies that have been downgraded to speculative grade in Europe may not find it as straightforward to return to investment grade quickly due to depressed economic conditions and elevated country risk. With greater investor liquidity and the cost of funds at low levels, the 'BB' broad category may represent a more sustainable rating level for corporates in Europe than it has ever been before--a shift that may align the distribution in Europe more closely to that of the U.S. In our view, overcoming the psychological distinctions between investment-grade and speculative-grade, while focusing on fundamental risk considerations, could help Europe continue to develop a sustainable and robust market for lower-rated debt.

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