Conference Presentation, Panel, Fireside Chat
Credit Markets Forging Ahead | Milken Institute Global Conference 2024
- The Federal Reserve and other central banks are expected to shift from restrictive to neutral or accommodative policy soon, potentially removing rate headwinds and creating credit return tailwinds over the next 12 months.
- High yield spreads at 300 basis points over treasuries represent the year's tightest levels, with expectations for benign conditions in the short to medium term and a favorable setup for credit broadly over the next three to five years.
- Higher rates and volatility are anticipated to generate tailwinds for private equity as the market recovers from the zero-interest rate era, with private credit's share of total leverage finance projected to normalize to the high single digits from a 24% peak in 2022.
- M&A volumes, which dropped 38% in 2021-2022 and 36% in 2022-2023, are expected to recover, allowing private credit to capture a normal market share.
- Private credit growth of 16% CAGR over the last decade is viewed as stable compared to private equity's 18% CAGR, suggesting the market is not in a bubble.
- Significant refinancing needs are expected as portfolio companies and properties approach maturity, creating opportunities to deploy capital for general partners lacking exit markets.
- Strong demand is predicted for credit-oriented real estate construction loans, offering equity-like returns with full downside protection under current market conditions.
- A "blend of worlds" is forecast where private and public credit managers compete for deal flow, potentially resulting in tighter loan documentation, compressed spreads, and excess capital.
- Further pressure on loan spreads is expected in the short term as increased bank involvement in CLO liability and continued CLO equity returns drive additional tightening.
- Manager performance is expected to show greater dispersion as the private credit market evolves into distinct vintage categories similar to real estate strategies.
- Loan recoveries on the broadly syndicated side are projected to decline from historical $0.70 to $1.00 to approximately $0.40 to $1.00, even if headline default rates do not rise materially.
- A long, drawn-out process with continuous defaults is anticipated resulting from over-leveraging of challenged businesses during the prior decade of low rates.
- If a recession occurs, current distress levels of 2.5% to 3% are viewed as the beginning, as rising interest coverage ratios and economic costs will force more borrowers into difficulty.
- Over 70% of LBOs in current portfolios held zero interest rate hedging, representing significant risk exposure if rates remain high or rise further.
- Liability management exchanges ending in bankruptcy with worse recovery rates could trigger an industry backlash reversing trust and capital flows.
- Sponsors engaging in coercive exchanges and non-pro rata up-tiering may face reputational damage leading to higher spreads or financing costs in primary markets.
- Covenants are expected to tighten significantly following the current round of distress and liability management exercises as the buy side becomes more stringent in negotiations.
- Lawyers will likely continue to find arguments within loan documents to allow for opportunistic behavior, necessitating stricter documentation from the buy side in the future.