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Big Bad Bonds? US IG BBB Market Update
Zachary Griffiths CFA - Senior Analyst U.S. Strategy
EXECUTIVE SUMMARY
- We take a closer look at the IG BBB market, identifying drivers of growth, differences in sector composition, changes in duration and the largest issuers. The BBB market has grown to over $4.0 trillion, a 44% increase since 2017, with new debt from existing issuers representing the largest driver of growth.
- Falling rates and a frenzy of opportunistic issuance has pushed average BBB coupons lower since 2017, and, given very low borrowing costs, the increase in interest expense has not kept pace with the broader growth of the IG market.
- For investors considering BBB spreads relative to historic levels, we find that the BBB market is somewhat lower rated than in 2017 as BBB2s now account for a greater share of the overall market. This implies that spreads would have been modestly wider for BBBs in aggregate when we use the current rating mix. We also provide similar pro forma analysis for current duration and sector mix.
- Overall we find that BBB valuations, especially on a yield basis, are compelling when compared to pre-pandemic levels; while spreads are not outright cheap, the magnitude of recent spread widening on a percentage basis is in-line with historic medians. Relatively strong ‘starting’ fundamentals heading into an economic slowdown provides the BBB universe with a material liquidity cushion.
- For those who expect a hard economic landing that is coupled with a downgrade/default cycle, BBB valuations are less appealing as the recent wide in spreads (208 bp) is still well below the median peak in prior cycles (284 bp).
In our recent US Chart of the Day: 5-Year IG Index Growth, we examined the drivers of aggregate IG index growth since 2017. In this report, we take a closer look at the IG BBB market, identifying drivers of growth, differences in sector composition, changes in duration and the largest issuers. Taken together, these factors should be considered in assessing relative value and identifying entry/exit points.
Big Bad Bonds: The Shifting Mix of BBBs
Like the broader IG market, the BBB rated cohort has increased materially since 2017, to a face value outstanding of just over $4.0 trillion. This represents a 44% overall increase or 7.5% annualized growth rate, slightly behind the growth rate of the total IG market. The largest source of growth for BBBs has been from new debt issued by existing BBB-rated companies, which accounts for $846 billion or 21% of current BBB face value outstanding. This is followed by downgrades to BBB ($203 billion) and ‘other’ ($208 billion), which includes ticker changes related to M&A and name changes. New BBB rated issuers account for $182 billion of the increase in face value outstanding. Upgrades from HY, or rising stars, account for a mere $61 billion, while downgrades to HY reduce BBB face value outstanding by…
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