Finance

Fallen Angel

FALLEN ANGEL

What Is Fallen Angel

The fallen angel is a term used in finance to describe an organization that was given an investment-grade status but due to its declining financial condition, the organization had been reduced to junk bond status. The fallen angel is also used to describe stocks whose price has been reduced drastically from the all-time high position.

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Explain The Reasons For The Fallen Angel 

Fallen angels are securities of an organization whose ratings have been downgraded by the major credit rating companies like S&P 500, Fitch, and Moody’s. These securities can be corporate bonds, municipal bonds, sovereign debts, or any other bonds or debts.

Some of the reasons for such downgrade in the organization’s rating are as follows

  1. One of the most common reasons is the organization is facing a financial crisis where their condition is detorting due to which they are unable to pay the interest due on their securities.
  2. Due to such a financial crisis, the organization’s earnings might decline also considering the increasing amount of debt will result in the downgrade of such organization.
  3. Once the organization’s status is reduced to junk bond the selling pressure increases which leads to worsening of the organization’s situation.
  4. To summarize, downgrading takes place when the organization’s financial health deteriorates or when the rating agency intercepts such financial problems that might lead to the default of the organization.

Risks Involved In Investing In The Fallen Angel

  1. Due to the declining price of the organization’s securities, there is an increase in the organization’s yield. Since price and yield are inversely proportional. Contrarian investors find such a situation as an opportunity to invest since they speculate such a situation as a temporary situation.
  2. In case, the anticipated temporary situation of the organization’s securities becomes permanent the investors who have invested in such securities face heavy losses. Hence it is advised to perform a proper valuation of the organization before investing in such securities.
  3. Fallen angels are known to be undervalued, risky, or valued investments, bad investments where the organization is facing bankruptcy. Such securities increase the possibility of high returns.

How To Recover From The Fallen Angel

  1. Underperformance in a specific segment of the business might result in a downgrade of the organization. To recover the organization can sell such business segments or work on the improvement of that segment. The organization can divert its resources towards segments that display high-profit potential and focus on improving the profitable segments.
  2. The other option for recovering is adapting the expenditure reduction strategy. This strategy involves limitation or terminating resources that contribute less to the overall process. The organization can limit the resources by using material that is similar but is cheaper. The organization can automate some processes and they can reduce benefits like health care and pension policies. Other strategies like outsourcing can also be adopted.
  3. The organization can make changes to its capital development to recover itself from the downgraded situation. They can allocate capital resources to segments that are performing well while reducing the allocation towards underperforming segments. The organization can sell some assets for raising additional capital, which will help them fund their restructuring business.

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Final Thoughts

A fallen angel is a security that has lost its investment-grade status to junk status. Such securities pay higher returns but are very risky. Speculators find them as an opportunity to earn higher returns as they anticipate it to be a temporary situation. A fallen angel can recover if they take the proper measures.

 

Author – Divyashri Kadam

About The Author – Divyashri is a Bachelor’s Degree Holder in Accounting and Finance. Also, a Certified Financial Modeling and Valuation Analyst (FMVA). She is enthusiastic to learn more about financial markets, financial analysis, and anything relating to stocks.

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