Warner Bros. Discovery Inc. has experienced a notable upswing in its junk bonds this week, marking a significant moment for investors who took a chance on the company during a period of uncertainty. As the entertainment giant contemplates a potential acquisition by Paramount Skydance Corp., investor confidence has surged, causing the company’s 5.05% notes due in 2042 to increase by over 13 cents on the dollar. This brings their value to approximately 82 cents, a remarkable turnaround given that these securities were downgraded from investment-grade to junk status earlier this year.
The downgrade followed Warner Bros.’ announcement of a split into two companies and a subsequent debt refinancing initiative. According to portfolio manager Eric Williams of Loomis Sayles & Co., opportunistic investors who purchase bonds from companies that have recently lost their investment-grade status—often referred to as “fallen angels”—can find lucrative prospects. These companies typically possess comparatively stronger business fundamentals than many other high-yield entities.
When a company is downgraded to speculative grade, institutional investors categorized as high-grade must usually divest within a short timeframe, while those focusing on long-term investments may take longer to assess and potentially buy into the now-junk rated bonds. Williams noted that “despite the near-term volatility,” many such companies may simply be facing challenging conditions rather than fundamental business issues.
The trend of fallen angels is increasingly pronounced, with six issuers totaling approximately $57.4 billion in notes witnessing downgrades to junk status this year alone. Strategists at JPMorgan Chase & Co. indicated that a significant share of this deterioration can be attributed to Warner Bros. Furthermore, data from Loomis Sayles suggests that the existing volume of fallen angels is on track to hit its highest level in five years.
However, the economic landscape remains uncertain. A record revision to US payroll data, coupled with the largest spike in unemployment benefit applications in four years, hints at potential economic distress ahead. Inflation metrics disclosed this week also indicate enduring price pressures, constraining the Federal Reserve’s options for interest rate adjustments. “The clouds are on the horizon; the economy is moderating, and it’s going to get tougher for companies to stay in that BBB space,” cautioned Paul Benson, head of systematic fixed income at Insight Investment.
In the vast arena of US corporate bonds, the high-grade market is valued at approximately $7.5 trillion, while the junk market hovers around $1.45 trillion. This disparity often leads to fewer investors having the capacity to hold bonds once a company is demoted from investment-grade status, heightening the potential for volatility.
The rebound for Warner Bros. is unusual in its swiftness. Companies that find themselves labeled as fallen angels have a natural motivation to ascend back to investment-grade standing, noted Benson. “These companies, having been born and bred in investment-grade territory, they have become very accustomed to funding themselves frequently and in size.”
Nonetheless, market sentiment can sometimes overlook associated risks. Recent strong demand has driven down junk bond risk premiums to their lowest levels in years, while spreads in the investment-grade sector are nearing the tightest rates since the late 1990s. Such tight spreads are often indicative of a market that’s underestimating risk.
Brian Gelfand, co-head of global credit at TCW Group Inc., remarked on the historical performance of fallen angels, noting that they often provide considerable returns when trades are strategically timed—typically before a downgrade reflects in the bond’s pricing. “Once downgraded, they actually tend to perform quite well,” he asserted.
With ongoing market fluctuations, further developments in the realm of junk bonds are anticipated, especially as firms navigate the complex interplay of economic conditions and investment strategies.
