Dispersion Revisited

Summary

• Dispersion in financial asset performance has intensified, creating a bifurcation between borrowers able to secure mainstream financing and those trading at outsized spreads.
• CCC-rated loan spreads have widened by over 300 basis points this year, while BB-rated loan spreads have tightened to yield just over 6%.
• Leverage on CCC-rated loans has increased while other rating categories have not, validating market concerns that weaker credits cannot handle elevated interest rates.
• Software and IT services sectors account for over 40% of overall distress in the senior loan market due to investor fears regarding AI antiquating business models.
• Software exposure represents over 20% of the direct lending market, raising concerns about concentration risks following $400 billion in deal activity during 2021 and 2022.
• Payment-in-kind (PIK) reliance represents approximately 10% of total interest for public BDCs and 4% for perpetual BDCs, with PIK loans currently marked at 91 cents on the dollar.
• Perpetual BDCs have experienced redemptions exceeding the standard 5% threshold this quarter, leading many funds to limit redemptions to avoid forced sales.
• The sub-IG credit universe totals approximately $6 trillion, split roughly equally between senior loans, private credit, and high yield bonds.
• The federal funds rate remains between 3.50% and 3.75% as resurgent inflation fueled by rising energy costs persists.
• UK 10-year gilt yields reached levels not seen since the Global Financial Crisis, German bunds hover around 3%, and the U.S. 10-year Treasury rose over 40 basis points between late February and late April.
• Recovery rates in the leveraged finance universe remain low, with first-lien loans at approximately 40% and high yield bonds near 35%, both below long-term averages.
• Repeat default actions comprised a record 41% of default activity last year, often resulting from liability management exercises that disrupt pro rata treatment of lenders.
• Leveraged loans yielded 4.8% on April 30, 2021, compared to 8.6% currently, causing borrower coupon payments to jump 70%.