The loan market has been under pressure in 2023 but is proving tenacious in the face of adversity. This article explores factors that led to the current context for loans and indicators to watch as the year the market strengthens.
The failure of some regional banks earlier in the year coupled with rising oil prices and rapid increases in interest rates painted a grim outlook for the loan market in 2023. However, the economy proved more resilient than expected, and with economists at big banks pushing recession expectations out further than originally anticipated, an onslaught of borrowers flooded the market in September. Senior secured debt—just as in down cycles before— has proven to withstand the economic pressures and remains an attractive asset for investors.
In fact, the “current environment is favorable for credit, with high yields, above-trend growth, decent credit fundamentals and positive technicals,” Barclays analysts, led by Bradley Rogoff, wrote in a September 22 research report. Goldman Sachs lowered its probability of a U.S. recession to 15% from 20% in September while Bank of America revoked their forecast for a recession.
Amid the improved-risk sentiment, loan secondary prices rallied to a 2023 peak and investor demand returned to the asset class. As such, borrowers flooded the leveraged loan market and drove new issue volume in the third quarter to the highest quarterly tally since the U.S. Federal Reserve began raising rates in 2022.
Yet, with the Fed indicating rates will be “higher for longer,” much of the activity has been addressing 2024 and 2025 debt maturities. As such, the 2024 maturity wall has been reduced to $20.1 billion, from $74.9 billion at year end, according to the Morningstar LSTA US Leveraged Loan Index. As a result—and in the absence of a robust M&A pipeline— refinancings, amend-to-extend deals and repricings are surging.
That said, M&A volume in the second quarter of the year totaled a paltry $1.25 billion, the lowest quarterly tally since the Global Financial Crisis, according to Pitchbook/LCD. In that vein, institutional loan issuance through the first half of the year amounted to $102.9 billion, the lowest half-year total since 2010.
Private Credit Market: Sharing the Market or Taking Market Share?
Banks, facing the prospect of increased regulation, have been retreating from lending, as they strengthen their balance sheets and as the cost of their deposit funding has increased. As a result, borrowers that relied on banks for loans previously have been turning to the spigot of direct lenders. Private credit has emerged as a viable alternate source of financing.
To be sure, borrowers are increasingly turning to the private credit market for deals that those same borrowers and equity sponsors had previously financed in the broadly syndicated loan market.
Investors have been drawn to this emerging asset class by the attractive yields and the security of lending to companies with credit protection covenants. The ongoing tightening of credit standards by banks will likely continue to drive the migration of corporate borrowers to the private debt market, prompting Apollo and Marathon to refer to this as “the Golden Age.”
Despite Defaults, Loan Yields Lure Investors
Amid the tighter credit conditions and higher borrowing costs, more companies are struggling to service their debt, and defaults are edging higher. Standard & Poor’s Global Ratings tracked 16 global corporate defaults in the month of August, the most for any August since 25 that were recorded in 2009. Nine of the defaults recorded were from the U.S.
With growth projections for companies eroding from the higher rate environment, the default forecast is trending upward. Standard & Poor’s Global Ratings predicts 2.75% of issuers in the Morningstar LSTA US Leveraged Loan Index could default by June 2024. That’s up from 1.86% by issuer count at the end of August.
For now, stable credit conditions—barring any exogenous events—and attractive yields will continue to draw investors to the asset class. A slowing economy could change the paradigm. High interest rates, high gas prices, and resumption of student loan payments may curtail consumer spending at some point, and that will test investor risk appetite. Yet, the resilience of leveraged loans as seen in the attractive yields and senior standing in the capital structure should help weather adversity as it has done in previous market slowdowns.
Managing Director, Loan Agency 612.509.2323
Renee is the managing director for the Loan Agency Group for SRS Acquiom. As an accomplished financial industry professional, she leads the loan agency product.
Before joining SRS Acquiom, Renee served as an administrative vice president at Wilmington Trust, N.A., most recently leading the loan agency and restructuring products. In addition to her 10 years at Wilmington Trust, she also worked for Wells Fargo Bank, N.A. in the corporate trust and shareholder services departments.
Renee has a Juris Doctorate from Mitchell Hamline School of Law in Minnesota, and a B.A. in political science and history from Azusa Pacific University in Azusa, California.