News in brief

June 2023 | Issue 255

US loan default rates will peak near record levels, says Deutsche Bank

A new research paper from Deutsche Bank has forecast leveraged loan default rates rising to near all-time highs by the fourth quarter of 2024.

Deutsche Bank’s model has US loan default rates peaking at 11.3% next year after low interest rates encouraged private equity to “produce 2007-type LBO leverage metrics for eight consecutive years”.

Written by analysts Jim Reid, Steve Caprio, Karthik Ngalingam and Cam Keltek, the research found that the US loan market’s rating quality is worse than Europe’s, and its top three sector concentration is the highest on record. “The US loan market is a concentrated bet that one can leverage up non-cyclical sectors and face low default risk,” says the report. “If this assumption fails, the US loan market is exposed.”

While the report found that higher defaults remain expected even if US GDP continues to climb, Deutsche Bank notes that their forecast resembles the return of a boom and bust cycle, rather than a 2008-style shock.

In addition to elevated default rates, recovery rates are also causing headaches for investors. $5.5 billion of loans have defaulted year-to-date, with a recovery rate of just 20%, compared to the historical average of around 70% for leveraged loans. Managers say the low recovery rates display the impact of cov-lite documentation.

Deutsche Bank’s default forecasts are on the higher side of analysts’ expectations. For example, Fitch Ratings is forecasting a default rate of between 2.5% and 4.5% in 2024, according to its latest projections, which were published in May.

Leveraged loan market shrinks as CLO trading grows

A lack of primary issuance has caused the leveraged loan market to shrink this year for the first time since the aftermath of the global financial crisis, according to market sources.

The lack of supply has led to multiple CLO managers chasing the same secondary opportunities, bidding loans higher. This in turn is putting pressure on the equity arbitrage and slowing the pace of new CLO formation.

The lack of primary opportunities has pushed third-party equity investors toward the secondary market, which this year has seen trading volumes exceed $1 billion in some months.

Speaking at Creditflux’s CLO Symposium in May, Pearl Diver Capital partner and head of Europe Matthew Layton said that the secondary market was “extremely liquid”. Adding: “There’s a huge number of ways to execute… and probably more options now than we’ve seen for a long time.”

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Global credit funds & CLO's

June 2023 | Issue 255

Published in London & New York.