One of the biggest surprises involving the ongoing collapse of troubled California utility PG&E is how it was possible, that with the company reportedly contemplating a DIP loan ahead of a possible bankruptcy filing which sent PCG stock plunging and its bonds cratering to all-time lows, that rating agencies still had the company rated as investment grade.

Late on Monday, this question got some closure after S&P became the first rating agency to take a machete to its rating for PG&E, when it downgraded the company by five notches, from BBB- to B, the fifth-highest junk rating; S&P warned that more cuts are imminent.

As we reported previously, PG&E's shares plunged as much as 25% then as much as another 17% on Tuesday, to their lowest level since 2003, as investors worried about the potential for the company to file for bankruptcy as California investigators have been looking into whether the utility’s equipment ignited the deadliest blaze in state history in 2018 as well as fires in 2017, probes that could leave the company with legal liabilities topping $30 billion.

A spokesman for PG&E said in an email Tuesday the company’s board is “actively assessing” operations, finances, management, structure and governance while maintaining a commitment to improving safety.

As Bloomberg notes, PG&E’s record-low bond prices underscore how much more the company will have to pay to borrow in the future, even if California comes up with a legislative bailout. "It also highlights how vulnerable even highly regulated, traditionally dependable stocks like utilities can be to natural disasters such as wildfires and hurricanes."

Meanwhile, as we discussed last Friday, whatever PG&E ultimate fate, it "will ultimately increase costs to California ratepayers and taxpayers, which already face a high cost of living,” S&P analyst Gabriel Petek, who rates the state of California, not PG&E, said in an email Monday. “The important takeaway to me is that these fires and how the ‘fire season’ is virtually a year-round phenomenon now represent a material consequence of climate change.”

In addition to the plunge in the utility's notes due in 2034, the company's 3.5% bonds due next year are currently yielding more than 9.9%, far above where most high-yield securities are paying and a level reserved for deeply distressed credits. As shown in the chart below, B-rated debt, the mid-tier of junk bonds, yields on average 7.5% as of Monday’s close, according to Bloomberg index data.

But while S&P took the axes to its ratings of PG&E, Fitch and Moody have yet to slash the company's investment grade. And when they do, the next major headache will emerge for both management, shareholders and bondholders, as a similar "junking" by Moody’s to high-yield would result in a rerun of the AIG death sprial, as at least once cash collateral call for PG&E of at least $800 million - to guarantee power contracts - will be triggered according to a regulatory filing (according to Bloomberg no other ratings triggers have been disclosed, although as AIG demonstrated, these tend be hidden deep inside ancillary contracts and only a downgrade will reveal just how insolvent the company is).

An $800 million collateral call would be a major problem for PG&E, as the company only had $430 million of cash on its books at the end of September. To preserve liquidity, PG&E suspended its dividend and fully drew its lines of credit, an event which we said is the first flashing red light that a liquidity crisis now appears inevitable. Meanwhile, as reported last Friday, the company is considering filing for bankruptcy as soon as February.

And while state lawmakers and regulators are looking at options including allowing the company to issue bonds to pay its liabilities, or breaking up the utility, no decision had been reached yet.

At the end of the day, however, even the $800 million urgent cash need would merely be a milestone on the company roads to assured bankruptcy if PG&E is ultimately held responsible for the Camp Fire, as that would put it on the hook for billions of dollars of potential liabilities, by some calculations far more than the company has access to. Yet because the company has filed for bankruptcy before, it and lawmakers would probably try to avoid a repeat, said Ryan Brist, head of global investment-grade credit and portfolio manager at Western Asset Management, who however likely understands that a bankruptcy may be inevitable.

“That was a disastrous time for all participants involved,” Pasadena, California-based Brist said. “It would be my guess that the same parties would want to pursue a much less volatile solution this go around when faced with the tough problems of statewide wildfires.”

However, with about $18.6 billion of long-term debt as of the end of September, PG&E may be incentivized to file for bankruptcy, CreditSights analyst Andy DeVries said in a report Monday. Such a filing would give the company bargaining power with insurance companies as it tries to settle customer claims at a discount, he said.

But before any possible filing, the next immediate step will be more downgrades by rating agencies, perhaps as soon as tomorrow.

Fitch analyst Philip Smyth said that a determination by California regulators that PG&E’s equipment was involved in the Tubbs Fire in 2017 or last year’s Camp Fire would be the strongest impetus to cut the rating.

“Right now, there is no investigation that says with any clarity that has determined that their equipment was the catalyst,” Smyth said in an interview Monday. “Since we downgraded in November, I don’t think things have gotten meaningfully worse since then.”

Finally, the imminent - and aptly called - fall from grace for PG&E is just the harbinger of the mass downgrade wave among investment-grade rated companies, expected to hit once the economic cycle turns, potentially flooding the more than $1.19 trillion high-yield market with new issues (as Jeff Gundlach discussed earlier today). The silver lining here, if any, is that PG&E’s relatively small debt load on its own wouldn’t bring the flood that strategists at Morgan Stanley have warned could exceed $1.1 trillion.

Xerox was the most recent company to join the "fallen angel" ranks, while Altria was downgraded from single A to BBB. Whether PG&E avoids bankruptcy remains to be seen, but one thing is certain: the California utility will be the next prominent "Fallen Angel."