Conference Presentation, Panel
Credit Markets: What's Next?
- High-yield market volume is projected to reach double pre-crisis levels with a trajectory exceeding historical norms, while dealer inventories sit at all-time lows, lower than in previous cycles.
- Regulatory frameworks including the Volcker Rule, Basel capital requirements, and Dodd-Frank are driving disintermediation in middle-market lending, real estate credit, and proprietary desks, accelerating a migration of business from banks to hedge funds and alternative capital providers.
- The shift of capital origination and complex credit from banks to institutional investors is accelerating in Europe with anticipated expansion into Asia Pacific, creating a multi-decade opportunity for investors to assume roles previously held by banks.
- Banking balance sheets are expected to continue shrinking, with the middle-market loan share dropping from 70% in 2002/2003 to 12% in the first half of 2014, representing a $50 billion annual gap that alternative lenders are positioned to fill.
- Commercial real maturity walls are forecast to total $45 billion in the current year, rising to $104 billion next year and $113 billion in 2017, creating supply conditions where lenders expect to dictate terms on short-tenor loans of one to 18 months.
- Default rates are anticipated to rise from current lows, with the lowest market segments expected to underperform, while a $200 billion expansion in "distrust" assets with spreads over 1,000 basis points is projected to grow from a base of $50 billion to $250 billion.
- The technology sector faces vulnerability marked by a doubling of triple-C issuances and leverage increasing from mid-five times to over seven times, while European banks face a market correction within an 18 to 24-month horizon regarding credit spreads and solvency.
- Two-thirds of the bank loan market is expected to remain covenant-light, though private credit firms anticipate dictating terms on new issues, with Providence Benefit Street Partners expecting to expand opportunities in Europe where banks are shrinking.
- Structured finance issuance is expected to trade cheaply due to reduced market attention, with opportunities identified in purchasing legacy mezzanine MBS at 50 to 60 cents on the dollar and anticipating recoveries of 75 to 85 cents, while a distressed market for new issue subordinated bonds is forecast for a few years out.
- Institutional investors are expected to move globally into markets like Asia Pacific and Europe to access higher spreads and relative value, with private credit offering premiums for its lower liquidity and operation in smaller markets.
- Technology and financial structures from the US are expected to replicate in Europe, Asia, and Latin America to support middle-sized companies, while government bonds are projected to continue trading at negative yields, creating duration challenges.
- Five-year forward-looking returns are conservatively estimated at 4% to 5% for high-yield, with pension funds expected to accept that 5% is the new 10% target, unable to achieve 7% assumptions through traditional credit instruments or index-based strategies at scale.
- To achieve returns, pension funds and investors are expected to shift toward specific, idiosyncratic strategies with risk transparency, as flexible capital is needed to provide rescue financing and equity throughout a company's entire life cycle.
- Specific capital deployment targets include growing DW Partners from 10 to 55 professionals and from $1 billion to $6 billion in capital, while equity in companies like Ally is expected to generate double-digit returns on equity.
- Corporate balance sheets are expected to grow significantly with increased cash reserves in Japan, China, and the UK, while the market anticipates a move toward bespoke alpha models to achieve returns like 5% and opportunities in trading and long-short equity strategies in Europe.