What is a 'Fallen Angel'

A fallen angel is a bond that was given an investment-grade rating but has since been reduced to junk bond status due to the weakening financial condition of the issuer. It is also a stock that has fallen substantially from its all-time highs. There is a fine line between fallen angel bonds and value stocks, which have the potential to recover from short-term challenges, and securities that are headed straight toward bankruptcy.

BREAKING DOWN 'Fallen Angel'

Fallen angel bonds, which can be corporate, municipal or sovereign debt, have been downgraded by a rating service such as Standard & Poor’s, Fitch, or Moody’s Investors Service. The primary reason for downgrades is a decline in revenues, which jeopardizes issuers’ capabilities of servicing debt. When declining revenues are combined with expanding debt levels, the potential for a downgrade increases dramatically.

Fallen angel securities are often attractive to contrarian investors seeking to capitalize on the potential for a recovery by the issuer from a temporary setback. Under these circumstances, the downgrade process usually starts with debt being placed on negative credit watch, which may require portfolio managers to sell positions, depending on fund-specific covenants.

The actual downgrade to junk status usually drives more selling pressure, particularly from funds that are restricted to holding investment-grade debt exclusively. As a result, fallen angel bonds can present value within the high-yield category but only when the issuer has a reasonable chance of recovering from the conditions that caused the downgrade.

Examples of Fallen Angels

For example, an oil company that has reported sustained losses over several quarters due to falling oil prices may see its investment-grade bonds downgraded to junk status due to increasing risk of default. As a result of the downgrade, the prices of the company’s bonds decline and yields increase, making the debt attractive to contrarian investors who see low oil prices as a temporary condition.

There are, however, several conditions under which fallen angel bond issuers may not recover. For example, companies experiencing declining revenues due to the introduction of products superior to theirs may disappear altogether. The progression from VCR tapes, to DVDs, to streaming video is one such example.

Municipal and sovereign debt issuers may also see their investment-grade bonds downgraded to junk status due to a combination of stagnant or declining tax revenues and increasing levels of debt. In many cases, these conditions result in a self-reinforcing downward spiral toward default as revenue shortages resulting from the challenges of increasing tax receipts necessitate the ongoing issuance of debt to fund local or sovereign obligations.

RELATED TERMS
  1. Angel Bond

    Investment-grade bonds that pay a lower interest rate because ...
  2. Downgrade

    A downgrade is a negative change in the rating of a security. ...
  3. High-Yield Bond

    A high-yield bond pays a higher yield due to having higher risk ...
  4. Credit Market

    Credit markets are where investors go to buy bonds, mortgages, ...
  5. Bond

    A bond is a fixed income investment in which an investor loans ...
  6. Issuer

    A legal entity that develops, registers and sells securities ...
Related Articles
  1. Investing

    Newly Launched: Fallen Angels iShares ETF (FALN)

    Bond investors seeking high returns may be interested in the recently issued fallen angel corporate bond ETF called FALN.
  2. Investing

    Another Way to Think About Junk Bond ETFs

    Fallen angel bonds can be a fine complement or alternative to traditional high-yield bonds.
  3. Investing

    Investment Grade Vs. Junk Bonds: Which for 2016?

    Understand why investors are fleeing junk bonds amid global economic uncertainty, and learn why investment-grade bonds might be a better choice in 2016.
  4. Investing

    Junk Bonds: Everything You Need To Know

    Don't be fooled by the name - junk bonds may be for you if you know how to analyze them.
  5. Investing

    Is the Junk Bond Market Signalling a Correction?

    Is the junk bond market signalling a correction?
  6. Investing

    High-Yield Corporate Bonds: Issuers and Investors

    High-yield bonds play a significant role in various investment portfolios. An examination of the issuers' and investors' side is vital.
  7. Investing

    How Rising Interest Rates Affect Junk Bonds

    We examine the impact of rising interest rates on higher-yielding bonds.
  8. Investing

    Will The High Times In High Yield Continue?

    With junk bond yields at around 5% now, investors are wondering whether the risk is worth the reward.
  9. Investing

    High Yield Bond Investing 101

    Taking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
  10. Investing

    How Rising Interest Rates and Inflation Affect Bonds

    Understand bonds better with these four basic factors.
RELATED FAQS
  1. How long are credit ratings valid?

    Learn how credit ratings are issued and how long they are valid. Investors look to credit ratings to determine risk associated ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center