Credit Ratings Migration Downward

Most participants in the US pension industry know that the credit rating downgrade trend has been occurring for quite some time, but they may not necessarily appreciate the magnitude. The US bond market has shifted heavily toward BBB from AA and A rated bonds as nearly 70% of new issuance has been BBB (see chart below).

At the conclusion of 1990 roughly 11% of the corporate bond market was rated AAA. Today, there are exactly 2 corporate bonds – Microsoft and Johnson & Johnson – that maintain a AAA rating. Incidentally, this rating remains one notch higher than the US government, which has had a AA+ rating from S&P since 2011. The BBB segment of the US bond market was roughly 25% of the investment grade (IG) universe in 1990. Today, more than 50% of the IG universe is BBB and there doesn’t seem to be any let up at this time, as cheap financing has led to this borrowing craze.

Fortunately, default rates have remained incredibly low since the Great Financial Crisis for all credit ratings within the IG universe. We, at Ryan ALM, have taken full advantage of the growing BBB segment within our cash flow matching portfolios providing our clients with a terrific yield advantage relative to the pricing of their plan’s liabilities (ASC 715 AA corporate bond yield curve discount rates). Also, it should be pointed out that credit spreads for AA bonds have tightened significantly relative to BBB bonds elevating credit spread duration risk for that segment of the IG universe.

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