Conference Presentation, Panel
Credit Is a Cycle: Global Market Outlook
Milken InstituteMichael Milken, Ilfryn Carstairs, Josh Friedman, Sir Michael Hintze, David Miller, Jim Zelter
- Short periods of opportunity are anticipated in easy access credit markets later in the economic cycle, driven by the expectation that yields will remain near zero globally, forcing institutions into illiquid securities and creating contests for yield.
- The firm plans to deploy capital into markets with positive risk-reward profiles, including Asia, which is expected to offer higher returns for the same risk level as developed markets, and India, where joint ventures will focus on distressed assets stemming from the NBFC shadow banking sector.
- A conservative stance has been adopted compared to the previous year, with a strategy to provide liquidity when others cannot, targeting dislocations in stressed assets, leveraged loans, and commercial mortgage-backed securities (CMBX) that have fallen 10 to 12 points.
- Specific market dislocations are identified in CMBX, where weakening underwriting standards, a rise in interest-only loans from 35% to 76%, and loan-to-value ratios exceeding 120% in 41% of securities create opportunities to short bonds with positive potential returns.
- The firm expects default rates to fall below 1% as 1-heart exposures roll off, with debt service coverage ratios remaining three times better than the 2007 to 2018 period, while leveraged loans are projected to stay cheap with credit spreads significantly higher than the prior six quarters.
- European markets face structural challenges including regulatory constraints like Basel III/IV and a lack of capital market transition, yet this environment is expected to generate risk transfer opportunities due to mismatches and the potential for banks to hold lower inventory while maintaining higher market caps.
- Global demographic shifts, such as birth rates falling below replacement levels and a 70% drop in the U.S. birth rate since 1950, along with technical innovation, are expected to keep interest rates lower for a prolonged period, driving demand for strategies yielding 6% to 8%.
- Private equity dry powder of $1.3 trillion is expected to be invested over the next five to seven years, potentially creating $3.25 trillion in purchasing power for company acquisitions, with the firm expecting to place two trillion dollars into originating, distributing, and trading activities during this timeframe.
- The firm intends to double or triple its real estate lending capacity and potentially absorb five billion dollars in its hedge fund business immediately, with plans to deploy 30 billion dollars over the next six to 12 months in loan and convertible markets.
- Overall capacity is expected to double over the next five years, with the firm anticipating the ability to put billions to work annually while growing its CLO business in a measured way constrained by liability issuance timing and asset spreads.
- Significant risks are identified in the commercial mortgage sector, where a 7% drop in collateral value could trigger losses in the BBB layer, and in the broader market where a "tremendous spike" could occur if investors realize mutual funds may decline, causing forced selling among crowds in ETFs.
- The firm expects the consensus view that interest rates will not rise soon to support fixed-rate products, while predicting outflows in the leveraged loan market and inflows into the high-yield bond market as bond issuances shift toward first and second lien structures.
- The firm believes it can solve demand and supply mismatches by the next year's panel, capitalizing on the search for yield by Japanese pension systems and the inability of QSIPs to handle the needs of great credit investors, necessitating the creation of origination platforms.