Federal Reserve’s Fallen Angel Bond Buying Won’t Catch Them All

(Bloomberg) -- The Federal Reserve is throwing a lifeline to some companies that have suddenly dropped into risky junk debt after expanding its corporate bond-buying program to include fallen angels. But it won’t catch every one.

The central bank will now buy debt of companies that were investment-grade rated as of March 22, and subsequently downgraded to no lower than BB-, or three levels into high-yield, according to a statement Thursday. That date, which determines whether bonds are eligible for purchase, heralds winners and losers among the recent crop of issuers that have lost their high-grade standing.

A record $92.8 billion of bonds fell into the Bloomberg Barclays U.S High-Yield Index in March. About $70 billion of that was from Ford Motor Co. and Occidental Petroleum Corp. Ford and Macy’s Inc. both stand to benefit given the timing of their downgrades. The automaker’s bonds rallied more than 10 cents after the bazooka was announced, according to Trace pricing data.

“The Fed, the Treasury and Congress are providing unprecedented support to the credit markets,” said Bill Zox, chief investment officer for fixed income at Diamond Hill Capital Management. “There will still be credit defaults and losses but the benefits will extend to borrowers even if they aren’t yet under the umbrella of these programs.”

Occidental looks set to miss out under current provisions. The company, which has $35 billion of index-eligible debt outstanding, fell into junk territory on March 20 with a cut to BB+ by Fitch Ratings following an earlier action by Moody’s Investors Service.

Its bonds still rallied by more than 10 cents, however, amid a broad-based rally in junk bonds and after major oil producers agreed to slash output. The company also said it’s seeking financial aid from the U.S. government for the nation’s oil industry.

“With the understanding that the Fed can change provisions as it sees fit, as currently disclosed, they wouldn’t qualify,” said Bloomberg Intelligence analyst Noel Hebert, of Occidental. “You have a lot of inflows into the asset class, oil is climbing and they were pretty cheap in spread terms.”

Strategists say the recent wave of fallen angel debt is just the beginning. Several, including those at JPMorgan Chase & Co., anticipate the total will exceed $200 billion this year. S&P Global Ratings and Moody’s are downgrading U.S. companies at the fastest pace in more than a decade.

Eligible bonds for the relief program need to have a remaining maturity of five years or less. In addition, the Secondary Market Corporate Credit Facility may also buy U.S.-listed ETFs that buy U.S. corporate bonds and the Fed’s Term Asset-Backed Securities Loan Facility would buy some CLO tranches.

“Central banks will continue to use unprecedented tools to intervene in capital markets,” said Christian Hoffmann, a portfolio manager at Thornburg Investment Management. “Until something breaks and their powers are reconsidered.”

The Fed’s widening net may also spur more high-yield issuance, Diamond Hill’s Zox said, just as it did with investment-grade rated debt. The junk-bond market opened up last week, ending a near monthlong drought, with investors piling billions of dollars of cash into offerings for companies ravaged by the coronavirus, including cruise line operator Carnival Corp.

©2020 Bloomberg L.P.

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