Fallen Angels: A Preponderance of REITs

The positive momentum gained by fallen angels (as represented by the ICE US Fallen Angel High Yield 10% Constrained Index, “H0CF”) in the final quarter of 2023 carried over into January, surpassing broad high yield (as represented by the ICE BofA US High Yield Index, “H0A0”) by 56bps (0.58% vs 0.02%). This outperformance can be attributed primarily to the unique security and sector exposure offered by fallen angels, with Real Estate, Retail, Telecom and lack of Media, contributing almost 100% of the 56bps. In our January note from last year, we highlighted the remarkable track record of the January effect for fallen angels. This trend has persisted, now with 17 out of the last 20 calendar years showing a positive total return in January, and of those 17, 15 concluded the calendar year with positive total returns. Amid a mix of factors such as benign inflation news, resilient growth data, the U.S. Federal Reserve (Fed) signaling reluctance towards a potential rate cut in March and an exceptionally strong jobs report, 2024 has commenced on a robust note for fallen angels.

Fallen Angels and Rising Stars Scenarios: JP Morgan has provided insights into prospective candidates for fallen angels and rising stars in the coming months. Key takeaways are as follows:

A significant amount of bonds, totaling $1.05tn, are currently rated BBB- by at least one of the three rating agencies; a sizeable amount relative to the $1.3 US HY market. $111bn of BBB- bonds are currently on negative watch by at least one rating agency, $38bn in bonds one or two negative rating action away from becoming fallen angels and $101bn of BBB- non-financials were trading with a spread above the BB average spread.

Within HY, there is a total of $263bn rated BB+ by at least one of the three rating agencies, with approximately 21% on positive watch. $27bn of bonds are one or two positive rating actions away from becoming rising stars and $115bn of BB issuers were trading with spreads that were tighter than the BB average spread.

In short, the list of near-term fallen angels remains limited, and we expect most of the downgrade volume in the coming months to be idiosyncratic in nature. Sector-specific weakness (e.g., Real Estate) may continue to manifest in downgrades, and even a modest slowdown in growth could lead to a meaningful increase in fallen angel volume given the high level of BBB- debt outstanding. Overall, we expect to see more fallen angels than rising stars this year.

According to Citi, High Yield ETFs experienced approximately $2.8bn in inflows, but it was IG Corporates that brought in the most, at $9bn. In terms of duration, Intermediate duration strategies saw the highest inflows, at $19.2bn, while Ultrashort experienced $2.1bn in outflows.

Fallen Angels Overall Statistics: Yields and spreads were relatively flat for fallen angels while both saw an uptick in broad HY. Fallen angels market value, despite a new fallen angel adding $1,650mn in par amount, was flat for the month as some bonds were removed due to their impending maturity within the next 12 months. Broad HY had one issuer default (Audacy Capital Corp, the second-largest U.S. radio company) to start the year with $994m par outstanding.

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Broad HY: ICE BofA US High Yield Index. OAS refers to “option-adjusted spread.” Please see definition for this and other terms referenced herein in the disclosures and definitions portion of this blog. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest in an index.

New Fallen Angels: In January, Hudson Pacific Properties (HPP) became the newest addition to the index, marking the third Real Estate Investment Trust (REIT) inclusion in the last five months. Moody's originally downgraded HPP in July 2023 which was driven by its anticipation of a decline in the REIT's leverage and coverage metrics throughout 2023, with a projection of continued weakness into 2024. HPP was further downgraded to BB+ from BBB- by S&P in mid-January, making it the latest fallen angel. S&P echoed similar views to Moody’s, noting that HPP is under sustained pressure due to lease expirations, which could lead to further deterioration in occupancy levels. This is particularly relevant in the commercial property market, where office vacancies persist below pre-COVID levels. The challenges in the commercial property sector are exacerbated by the fact that there is over $2.2tn in U.S. commercial property loans set to mature by 2027. Most of these loans will need to be refinanced at higher rates, adding additional financial strain to the sector.

Source: ICE Data Services, VanEck. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Past performance is no guarantee of future results. Not a recommendation to buy or sell any of the names/securities mentioned herein. Index performance is not representative of fund performance. It is not possible to invest in an index.

Rising Stars: None.

Fallen Angels Performance by Sector: With the addition of HPP, the Real Estate sector's representation in the index has now reached double digits, alongside Energy, Retail and Telecom. Retail has emerged as the sector with the highest exposure, surpassing Energy, which experienced a reduction as a Southwest Energy issue was removed due to its imminent maturity within the next 12 months. While spreads across sectors remained largely stable, the Real Estate sector witnessed a significant tightening of spreads by 100bps. Despite this improvement, Real Estate continues to have the widest spreads, exceeding 500 bps. In terms of attribution relative to broad high yield, the outperformance in January was notably influenced by the Real Estate sector (benefiting from fallen angels overweight), Media (with no exposure in the fallen angels index and wider spreads in broad high-yield, possibly due to a default), Retail (fallen angels overweight) and Telecom (fallen angels overweight). These sectors collectively played a significant role in driving outperformance during the month.

Source: ICE Data Services, VanEck. Returns are based on partial period data. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Not intended as a recommendation to invest or divest in any of the sectors mentioned herein. Index performance is not representative of fund performance. It is not possible to invest in an index.

Fallen Angels Performance by Rating: The CC bucket, led by one issuer, Diversified Healthcare Trust (a REIT), posted the best performance in terms of rating categories. Other than this single issuer, higher quality fallen angels outperformed lower quality in the first month of the year.

Source: ICE Data Services, VanEck. Returns are based on partial period data. Fallen Angels: ICE US Fallen Angel High Yield 10% Constrained Index. Not intended as a recommendation to invest or divest in any of the sectors mentioned herein. Index performance is not representative of fund performance. It is not possible to invest in an index. BB index: ICE BofA BB US High Yield Index; Single-B index: ICE BofA Single-B US High Yield Index; CCC & Lower rated index ICE BofA CCC & Lower US High Yield Index.