History is weighing against many energy companies who have seen their credit ratings fall below investment grade but expect they will return some day to investment-grade status. According to a 16-year study by Standard & Poor’s Ratings Services (S&P), only one quarter of these “global fallen angels” (downgraded to ‘BB+’ and below from ‘BBB-‘ and higher) returned to investment- grade status; three quarters did not.

About 21% of the fallen angels in the utility sector returned to investment grade and 33% in the exploration and production sector were able to return. But over the past three years, only one of 161 issuers that fell to speculative grade returned to investment grade for credit-related reasons, S&P said.

In the past, the largest number of first-time fallen angels came from the financial, consumer products and utility (mainly power) sectors. And the return to investment grade over the same period was led by financial (mainly banks), consumer products, and forest products & building materials issuers.

Going forward, S&P believes those most likely to return to investment grade will be in the financial, consumer products, high technology and retail/restaurants sectors based on the number of issuers with a ‘BB’ rating and with either a positive or stable outlook or listed on CreditWatch with positive implications. The energy sectors were conspicuously absent from the list.

“By sector, banks, consumer products, and forest products & building materials showed comparable propensity for recapturing investment-grade status,” said Diane Vazza, head of global fixed income research at S&P. A number of banks declined to “fallen angel” status during the late 1980s as the U.S. economy went into decline — two-thirds of all fallen angels tracked in this study were U.S. domiciled. These credits were subsequently upgraded following the economic recovery of the mid 1990s and then the cycle repeated itself in the late 1990s.

Similarly, consumer product companies were among the leading targets of the late 1980s leveraged buyout craze, which led to an increased number of fallen angels. By the early 1990s, consumer product companies, with consistent cash flows, were more easily able to repair balance sheets and regain investment-grade status.

“Globally, the record high annual count of 67 fallen angels occurred in 2002, up from a record low of six in 1994,” Vazza said. “With over 60 issuers currently identified as having the near-term potential to become fallen angels (issuers rated ‘BBB-‘ with either a negative outlook or listed on CreditWatch with negative implications), 2003 is expected to see a high number of fallen angels.”

Vazza said the short-term prospects for the 383 global fallen angels tracked in the study to return to investment-grade ratings remain limited since very few currently carry a ‘BB’ rating with either a positive outlook or are on CreditWatch with positive implications. The second largest fallen angel on the list right now behind WorldCom is El Paso Corp. (affecting $20.9 billion). It is currently at B+ on a negative outlook.

The study, entitled “S&P Global Fallen Angels: Fallen and Can’t Get Up? A 16-Year Study,” covers a population of 383 parent level issuers across the globe (259 U.S and 124 non-U.S.) that became fallen angels for the first time as indicated by their issuer credit rating or financial strength rating between Jan. 1, 1987 and year-end 2002. Contact Diane Vazza for a copy at (212) 438-2760.

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