News

Casual observers of the US broadly syndicated loan market may be forgiven for feeling a little confused at the moment. Despite rising default rates and growing stress, loan prices continue to rally, and the primary pipeline is busy.

That view is echoed by another CLO portfolio manager, who reports increasing chatter from bankers pitching M&A deals, with expectations that the LBO market should be busy towards the end of the year and busier in the first quarter of next year. The same manager added that they have a warehouse open and have been putting only primary issuance into it recently.

Not everyone is as sold on the loan pipeline, with another manager pointing out that while anything is better than nothing, current deal flows would not be enough to support a full return of the CLO pricing engine.

Despite these positive trends on the supply-side, concern is growing in many quarters about loan performance. Although market participants are increasingly looking at a soft landing for the US economy, the damage done to company cashflows from high interest rates remains.

Oaktree addressed this topic in its latest Insights research: “We believe the incidence of distress is likely to be most acute among US leveraged loans and private debt, asset classes that typically feature floating rates. We estimate that the interest rate risk of roughly two-thirds of the US loan market was unhedged as of YE2021. Since then, three-month Sofr (the most common reference rate today) has increased by more than five percentage points. Importantly, changes in loans’ reference rates aren’t immediately reflected in companies’ interest expenses, so firms that failed to hedge have only recently had to start contending with dramatically higher borrowing costs.”

That stress is already filtering through into company performance, but mainly through rating downgrades. The actual default rate for US loans has risen, but only a little. S&P’s figure for August 2023 was 1.9%, but it is forecasting that could increase to 2.75% by June 2024. Fitch is more pessimistic, expecting the default rate to reach 4.0% to 4.5% by the end of this year.