Highlights/recap
At 11.1%,1 year-to-date (YTD) returns for bank loans have outpaced most other fixed income assets. While loan spreads have followed other asset classes in responding to geopolitical and macroeconomic trends, spread movements have been relatively benign, in our view.
Earnings for issuers have been generally healthy, though we continue to see a moderation in growth and margins versus last year and higher rates continue to be a headwind to cash flows. Loan-issuer performance remains highly idiosyncratic, however.
YTD net retail flow was a negative US$17.9 billion,2 but outflows have begun to abate and new collateralized loan obligations (CLOs) continue to be issued, providing demand support to loans. On the supply side, new loan issuance continues to be subdued. With rates staying higher for longer, mergers and acquisition (M&A) activity has been subdued, and we expect that as long as there is low visibility on a US Federal Reserve (Fed) pivot, sponsors will exercise patience in bringing new deals; this is creating supportive technical conditions in the market.
Issuance has been more heavily weighted toward refinancing transactions as issuers try to push out their maturities, after a slow start this year. We have seen nimbleness among issuers in this regard, as they often pursue parallel processes in the high-yield, broadly syndicated loan and private debt markets, finally settling on the one that gives them the best terms. We expect this trend to continue.
Outlook
We expect outflows to moderate as more investors have been drawn to higher loan yields. Persistent fears of loan defaults and increased focus on the timing of future rate cuts will likely constrain retail flows, however. We think M&A transactions should resume once issuers have more clarity on the path of rates (as alluded to earlier), albeit at a slow pace. We expect downgrades to continue outpacing upgrades as growth slows and interest rates remain high.
While loan market maturities for 2024 and 2025 have materially declined through refinancings, in most cases the new deals were done at higher spreads from the original term loans. This is a trend we expect to persist as lower-rated loans with near-term maturities might find limited refinancing opportunities in the broadly syndicated market. A potential outlet for these issuers could continue to come from the private credit market, which has been sitting on substantial dry powder. As refinancing opportunities in the private credit market are likely to continue, lower new issue supply could further shrink the size of the market, providing additional technical support.
Our view on the asset class has not changed. With a more benign macroeconomic outlook and technical tailwinds through low loan issuance amid still healthy demand, loan spreads have support in the near term. In the medium term, say one-to-two years, the interest-rate trajectory will be critical in determining the fortunes of several loan issuers—we believe that a slow default burn may persist for a few years. We maintain our view that stress in the loan market will remain highly idiosyncratic and careful selection of credits is critical.
From a valuation perspective, there is room for spreads to widen in a risk-off environment, in our analysis. However, with rates being where they are and yields close to the highest they have ever been, we think yield pickup should persist if the Fed keeps rates higher for longer.
Endnotes
- Source: Credit Suisse Leveraged Loan Index, as of November 28, 2023.
- Source: JP Morgan, as of November 27, 2023.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
Low-rated, high-yield bonds are subject to greater price volatility, illiquidity and possibility of default.