Never Before Has the European Credit Landscape Been This Boring - or This Interesting
It's a B-B-Boring world in corporate bonds and investors just live in it.
The share of investment grade corporate debt rated BBB — or just above the cut-off point that turns into speculative high-yield territory — has never been higher in Europe, according to a new note by analysts at HSBC Holdings Plc. They argue that ultra-low interest rates and newly conservative rating agencies have effectively turned the market into a homogeneous clump ripe for differentiation by savvy investors.
"In a low rate environment, where many BBB companies can issue at less than 1 percent in euros, there is little incentive to be single A or higher," write analysts led by HSBC's Head of European Credit Strategy James Stuttard. Conversely, the proportion of bonds rated 'BB' - the top level of speculative or high-yield territory — has also been growing, as shown in the below right-hand chart.
While companies have few reasons to reduce their indebtedness and clamber up the ratings ladder at a time when the benefits in the form of lower borrowing costs seem slim, rating agencies have also played a role in terms of turning the credit world into shades of B-B-Brown.
Rating agencies accused of handing out undeserved triple-A designations ahead of the 2008 financial crisis have since tightened up their criteria somewhat — a trend that one might have expected to turn fixed income into variegated shades of credit ratings. Instead, the world's supply of top-tier, triple-A rated debt has shrunk massively and credit has increasingly clustered around the BBB/BB cut-off point.
"The ratings landscape in 2016, nine years after the financial crisis begun, is completely different to the pre-crisis era," write the HSBC analysts. "There are no 80-times levered structured credit structures, subprime securities and small countries with soon to be [more than] 100 percent debt-to-GDP [ratios] rated AAA. There were in 2006. Not even the U.S. Treasury is AAA-rated by all three major agencies."
The lack of variation among credits poses both an opportunity and a challenge for investors. Investment-grade investors who buy the debt issued by companies with relatively stronger balance sheets must beware of "fallen angels" — or firms that get downgraded into junk-rated territory. Conversely, investors may be able to find "rising star" companies that have been wrongly or preemptively classified as BB-rated junk and are ripe for an upgrade.
"Much of the ratings convergence in investment grade to the BBB area therefore is due to conservative measurement as much as a deterioration in the underlying," the analysts write. "Either way, the share of BBBs in European investment grade has never been higher. With credits having increasingly congregated in the BBB/BB area, the potential for more fallen angel and rising star activity has increased."