Checking In On BBBs In 2023

By Kristin Cejda

We believe that the BBB segment remains a “sweet spot” for investors and issuers alike.

The BBB Industrial portion of the investment grade credit market is no stranger to scrutiny, especially in times of changing market dynamics. As we think about a return to the “old normal” discussed in our firm’s Solving for 2023 outlook, we seek to anticipate how this important part of the IG market could behave in an environment of slowing growth and structurally higher interest rates. In our view, overall starting fundamental conditions may be better than in past periods of market and economic stress, but the answer on BBBs may very well depend on individual credit dynamics.

The growth of the Industrial BBB cohort has been led by consumer non-cyclicals. While consumer cyclicals, mostly autos, were a big part of the space 10 years ago, today sectors like healthcare, pharma, telecom and technology dominate in size. We believe certain untested business models within healthcare warrant monitoring, but for the most part these sectors have more defensive cash-flow characteristics that should prove more resilient in a downturn. Certain consumer cyclical sectors, such as retail and autos, warrant more caution in a weaker consumer-spending environment, but are admittedly a smaller part of the BBB cohort than at previous times of market volatility.

For those BBB companies that find their credit metrics deteriorating, we still think that the bias on the part of corporate managers will be to defend credit profiles as needed. This may mean slowing share repurchases or curtailing capex and conserving cash flow. These actions may be more difficult in an environment of heightened shareholder pressure for return, but we still think bad behavior, from a credit perspective, will likely be an exception. The COVID liquidity crisis and backstop provided by the Federal Reserve for investment grade issuers are fresh memories that have solidified the long-term value of IG ratings for corporate leadership.

As companies recalibrate their business models to a structurally higher cost of debt, we still expect BBB to be an attractive capital structure on a relative basis, remaining a “sweet spot” for issuers and investors alike. As such, we continue to have an attractive view of the market segment, although credit selection will be especially important as the “old normal” takes shape.

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