What would the price of a bond go up after after a downgrade?
A newb here. What are the possible explanations for a corporate bond's price increasing after a downgrade (from non-investment grade to non-investment grade)? The spread has been narrowing since late January. I'd appreciate any insights.
interested in this as well
Ratings for many companies are often irrelevant to investors (a high-yield bond going from B+ to B for example) in many situations as the market typically prices in good/bad news more quickly than the agencies (a rating downgrade could come months after bad news impacted bond prices). There are other situations (CCC for loans as CLOs become less likely to buy, investment grade companies getting downgraded to high yield (BBB- to BB+) where ratings are more relevant, but I wouldn't necessarily assume that changes to ratings will drive spreads in the near-term for most credits.
Very helpful. I appreciate it.
In the case of IG to HY...you will expand the buyer universe, which on a technical basis can push the price up. HY investors that may have been prohibited from buying IG but may like the credit/yield will now become the marginal buyer pushing up prices.
To add, there are occasionally situations where an IG -> HY downgrade will trigger additional covenant protections to the bond and so investors may pay up for the credit enhancement.
Potentially a call option on the debt if it gets downgraded?
Also, forgot to mention, this wouldn't be applicable in this example of IG to HY...but once you get to more CCC land...downgrades can be actually huge credit positives but the agencies treat certain events as negative. For example, say a company has bonds trading at a large discount, 60c, and they buy back a decent slug on the open mkt with cash. This is great, company retiring outsized amount of debt relative to cash. However, the rating agencies will consider this a distressed exchange and downgrade the credit even though as a creditor the profile had just improved dramatically. Likewise, if you're in a more secured tranche and the company does an actual exchange offer on the unsecureds, again huge positive, but ratings will still downgrade for being a distressed exchange. Tons of examples like this. Overall point being is rating are but one factor and don't always think about credit the same way as an investor does.
Thanks for this. Very helpful. May I ask an unrelated question? I appreciate there are differing risk appetites, but what is the typical return distressed funds are looking for?
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