Apr. 26 2019 — Since 1991, the 'BBB' category has grown from the runt of investment grade, with fewer issuers than either the 'AA' or 'A' categories, to the top dog, as the majority of investment-grade issuer credit ratings globally are now 'BBB'. The share of 'BBB' has risen to 52% of investment grade (based on the count of issuers) at the end of 2018 from less than 25% in 1991, as shrinking funding costs and growing risk appetites after the financial crisis enabled this downward drift in credit quality as companies have adopted more aggressive financial policies to fund shareholder-friendly actions.
The 'BBB' category has swelled as 25% of the current 'BBB' issuers have been downgraded from a higher rating category, while 14% of current 'BBB's are rising stars--that is, that they have been upgraded to investment grade from speculative grade (see chart 2).
The 'BBB' rating category is the lowest that is considered by investors to be investment grade. The debt associated with 'BBB' companies is more than 1.5x the amount associated with the entire speculative grade ('BB' category and lower) market. Investors are increasingly focused on the concentration of 'BBB' issuers within investment grade and the capacity of the speculative-grade market to absorb a large influx of new debt in the event of downgrades.
The downgrades from the 'A' category (or higher) into the 'BBB' category include companies that have pursued more aggressive financial policies to fund mergers and acquisitions and shareholder distributions, as well as companies that have encountered business or operating challenges.
- Recent examples of companies that were downgraded as they announced more aggressive financial policies include: Altria Group Inc., which S&P Global Ratings downgraded following its agreement to purchase JUUL Labs Inc., and Lowe's Cos. Inc., which was downgraded as the company adopted a less conservative financial policy to increase shareholder returns.
- Meanwhile, General Electric Co. is an example of a company downgraded to the 'BBB' category as it faced operating challenges, and this downgrade followed after the company announced the replacement of its CEO, declining cash flow and earnings, and a write-off of power-related goodwill in fourth-quarter 2018.
Additionally, S&P Global Ratings has downgraded many financial institutions to the 'BBB' category over the past decade, and this has further contributed to the expansion of this category of debt relative to that of the 'A' category.
- In mid-2015, outstanding global credit market debt, including bonds, notes, loans, and revolving credit facilities, rated in the 'A' category exceeded that of the 'BBB' category by $206 billion.
- Since that time, the amount of 'BBB' corporate debt outstanding globally has risen to just over $7 trillion as of the beginning of 2019, while the 'A' category currently stands at near $5.3 trillion (see chart 3).
- 'BBB' debt surpassed 'A' category debt in the fourth quarter of 2015, when the bank holding companies of several globally systemic financial institutions, including Bank of America Corp., Citigroup Inc., The Goldman Sachs Group Inc., and Morgan Stanley, were all downgraded to the 'BBB' category following the adoption of resolution programs--or so-called living wills--that were required under regulations. These downgrades brought nearly $600 billion in associated financial services debt into the 'BBB' category from the 'A' category.
'BBB' category issuers globally have bought back nearly $1.4 trillion in shares in 2013 through 2018, and these buybacks have exceeded those of 'A' category issuers in four of the last six years (see chart 4).
- The total amount of shares repurchased by 'BBB' issuers in 2013-2018 exceeded the amount repurchased from 'A' category issuers by 14% and from 'AAA'/'AA' category issuers by 84%.
- While the 'BBB' category leads by aggregate size of share buybacks, the 'AAA'/'A' and 'A' categories, with fewer issuers each, exhibited a higher level of buybacks per issuer.
- From 2017 to 2018, share buybacks from 'BBB' issuers fell, while repurchases from 'A' category issuers rose by 38%. Meanwhile share buybacks from issuers in the 'AAA'/'AA' category more than doubled in 2018, largely from Apple Inc.'s (rated 'AA+') announced share repurchase plan for up to $100 billion worth of common stock.
Part of the attraction to 'BBB' is that this has been a relatively inexpensive way for companies to boost shareholder returns.
- The current yield on a 'BBB' corporate bond is more than two percentage points lower (at 4.3%) than it was at the end of 2007.
- The 'BBB' composite spread stood at 181 bps, and the 'A' spread at 114 bps, as of April 1, 2019.
- The 'BBB' composite credit spread remains below its average level of 197 bps since the end of 2010, and the difference between the 'A' and 'BBB' spread is currently slightly tighter than its average over this period (see chart 5).
- With spreads this tight, 'BBB' seems poised to remain the top dog of investment grade as the credit market provides little incentive for a company to move higher up the rating scale.