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Market Conditions in the Spotlight - The Rise of BBB

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A Change in Credit Markets

Credit markets are changing in fundamental ways. More corporate debt is being issued than at any other time in history. At the same time, the balance (in terms of the value of rated debt) has shifted away from ‘A’ –rated debt to ‘BBB’-rated debt.

As part of S&P Global Ratings’ credit risk analysis, we have been observing closely the conditions surrounding the emergence of ‘BBB’ debt as the dominant form of corporate debt in credit markets.

  • What is Happening?

    In the U.S., the amount of rated long-term bonds within the ‘BBB’ category rose nearly 40% between the end of 2015 and mid-2019. A similar trend has been observed in Europe.

  • Why is this happening?

    This pace of growth in the 'BBB' market in recent years is in part the result of very low interest rates since the financial crisis in both the U.S. and Europe. Years of monetary stimulus in the form of lower policy rates, and various forms of quantitative easing have pushed corporate borrowing costs down, while investors have pursued a years-long hunt for yield.

  • This has allowed 'BBB' companies to issue debt at interest rates once enjoyed by 'A' and even 'AA'-rated issuers. In fact, many higher-rated firms have been adopting more aggressive financial policies (such as debt-funded mergers and acquisitions and returning money to shareholders) that have led to downgrades to 'BBB', in part due to the minimal difference in the relative cost of funding.

Credit Trends

This large buildup in debt one rating category above speculative grade (speculative-grade debt is rated 'BB+' or lower) is raising concerns among some stakeholders over the risk of companies becoming fallen angels (issuers downgraded to speculative grade from investment grade) and the ability of the speculative-grade market to absorb potentially large amounts of downgraded debt.

But current and historical data over the past four decades (including the financial crisis) provides a counterpoint to those concerns, for a number of reasons including the following:

  • - 84% of US ‘BBB’ companies are at the middle-to-higher end of the rating category while 92% of these companies exhibit what we score in our analysis as satisfactory to excellent business risk profiles, which indicates a stronger resilience to a turn in the economic and credit cycle.

  • - Overall median leverage in the ‘BBB’ category has increased only moderately since 2009, finishing 2017 at 2.3 (from 2) and approaching 2.1 by the end of 2019.

  • - However, the speculative-grade market has shown its ability to absorb large amounts of downgraded 'BBB' debt in the past.

U.S. Speculative Grade Market Can Endure BBB Downgrades

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That said, we have flagged potential vulnerabilities coming from concentration risks: the 10 largest ‘BBB’- rated issuers account for nearly 1/3 of the non-financial corporate ‘BBB’ segment in the U.S., and nearly 30% in EMEA. Among these, there is some exposure to cyclical industries such the telecom and auto.

Most of these companies are rated either 'BBB+' or 'BBB' (rather than ‘BBB-‘) and display somewhat lower risk of downgrades compared to the broader 'BBB' segments in these regions (the U.S. and EMEA). This is not to say that there is no downgrade risk, but rather that the chances of a wave of significant downgrades among the largest issuers is currently limited, based on our examination of these largest 20 issuers.

In the U.S., 25% of 'BBB' category bonds are rated 'BBB-', the lowest rating within investment grade, while the 'BBB-' share for the top 10 is somewhat lower, at 18%. In EMEA, the shares rated 'BBB-' are a bit smaller, at 17% of the total 'BBB' category and 14% for the top 10. A larger share of the bonds from the top 10 issuers in EMEA are rated 'BBB+' (which is three notches above speculative grade), at 58%, compared to 40% in the U.S.

We will continue to share our views on credit trends in the ‘BBB’ category through our published research, including the quarterly ‘BBB Pulse’ report.