Performing Credit Quarterly 1Q2023: Flight Risk

Summary

• The collapse of Silicon Valley Bank, rescue of Signature Bank, and takeover of Credit Suisse in mid-March were accompanied by plummeting Treasury yields, widening yield spreads, and falling equity prices.
• By quarter-end, fears about deposit flight had eased, the Federal Reserve and European Central Bank proceeded with expected interest rate hikes, and most markets strengthened.
• Seven large companies accounted for roughly 90% of the S&P 500 Index's return in March, while small cap stocks recorded significant losses.
• Investors flooded into investment grade bonds and continued to price in multiple interest rate cuts before year-end.
• The ICE Bank of America MOVE Index reached its highest point since 2008 on March 15, eclipsing levels from early 2020.
• The yield of the 2-year Treasury declined by 61 basis points on March 15, marking the largest one-day drop since 1987.
• Financial conditions have tightened since the SVB failure and remain substantially tighter than they were at the beginning of 2022.
• Regional U.S. banks are major providers of capital to small businesses and real estate developers, so weakness at these institutions may weigh on economic activity.
• The Atlanta Fed's GDPNow tracker anticipates growth of 2.5% in the first quarter, which is below the 3.2% recorded in the fourth quarter of 2022.
• Private payrolls increased by only 145,000 in March, compared to 261,000 in February.
• Jobless claims figures topped 200,000 for ten consecutive weeks.
• The number of job openings in February fell below 10 million for the first time in almost two years.
• The ISM Services Purchasing Managers' Index fell to 51.2 in March from 55.1 in the prior month.
• Banks are likely to continue curtailing lending activity following the collapse of SVB due to potential regulatory changes, scrutiny of vulnerabilities, \& legacy issues.
• Private credit funds may have significant opportunities to fill funding gaps related to large-scale leveraged buyouts.
• The average loan price in the collateralized loan obligation market is near 93 cents on the dollar, with roughly 16% of loans trading below 90 cents.
• Default rates in U.S. leveraged finance markets are anticipated to rise into the mid-single digits over the next year.
• The loan market is expected to record a higher default rate than the high yield bond market during this cycle due to an overweight to lower-rated securities, higher borrowing costs, \& greater exposure to the software/technology sector.
• Recovery rates in the loan market are expected to be lower than the 65% long-term average due to the covenant-lite nature of most loans.
• U.S. High Yield Bonds returned 3.7% in the first quarter of 2023 with a trailing-12-month default rate of 1.3%.
• European High Yield Bonds returned 3.4% in the first quarter of 2023 with a trailing-12-month default rate of 0.1%.
• Approximately 55% of U.S. high yield bonds had yields above 7% at the end of the quarter.
• U.S. Senior Loans returned 3.1% in the first quarter of 2023 with a trailing-12-month default rate of 1.7%.