Current loan yields and spreads remain attractive with average loan coupons at close to record highs (~9.25%) and surpassing high yield bonds (~6.15%)1
Shifts in expectations to a slower Fed cutting cycle will likely strengthen the case for direct lending yields remaining in an historically attractive 11-12% context.
Healthy companies challenged by higher rates are seeking capital solutions which present attractive investment opportunities particularly in the small company space.
Slowing economic growth across regions at the beginning of 2024 have created a continued focus on sustained higher interest rates as the year progresses. Macroeconomic uncertainty and geopolitical events have driven capital across various segments characterizing positive and negative implications we continue to monitor.
Against this cautious outlook, we asked the experts from Invesco’s bank loan, direct lending and distressed credit teams to share their views as the second quarter of 2024 wraps up.
As we continue in 2024, there has been a significant focus on the uncertainty of the US macroeconomic backdrop and its potential implications for the senior secured bank loan market. We continue to believe there are still several compelling reasons to consider investing in senior secured loans:
We feel current loan yields and spreads look very attractive both on a historical and a relative basis. The average coupon for loans has been around 9.25%, outpacing the average high yield coupon of 6.15%1. After averaging around 245 bps less than high yield bonds over the past fifteen years, this is the first time in history the average loan coupon has surpassed that of high yield bonds. It was only around two years ago when loans were yielding ~4.80%; loans recently have been yielding over 400 basis points more than that1.
So far in 2024, inflation has appeared to break its downward trend, causing market participants to rethink their outlook for interest rates. Investors now expect a slower and shallower rate cutting cycle as potentially stickier inflation complicates the Federal Reserve’s path to exiting a higher rates regime.
For example, SOFR (the base interest rate for our loan coupons) is now projected to average ~5.20 for 2024 – in-line with 2023 and higher than the ~4.90% projected earlier in the year. While we may see spreads and OID compress to some extent, we still believe all-in, direct lending yields will remain in the 11-12% context on an unlevered basis. We believe these represent incredibly attractive levels from a risk/return perspective and are meaningfully higher than those leading up to the Fed’s tightening cycle.
Further, we believe the current backdrop is supportive of a favourable transaction environment given better visibility into the macro landscape, a more stable inflationary picture relative to prior years, and heightened pressure from LPs for private equity firms to generate realizations and invest in new platform companies. Combined with continued discipline in terms of credit quality as well as relatively stable and attractive yields, we continue to believe this is a compelling environment to deploy capital in the direct lending asset class.
For most major central banks, the primary objective for 2023 was fighting inflation while simultaneously maintaining financial stability. They appear to have done this with some degree of success so far, despite challenges earlier in the year when Silicon Valley Bank and Credit Suisse triggered temporary concerns.
Indeed, price rises have slowed sufficiently to allow the Fed, the European Central Bank and the Bank of England to pause rate hikes in recent months. Furthermore, growth in all three regions proved more resilient than expected over the course of the year.
That said, it remains clear that underlying pressures persist. With this in mind, markets are adjusting to the realisation that interest rates are likely to remain higher for a longer period than initially anticipated. Furthermore, we are likely to see slowing economic growth across regions in 2024, as the impact of higher interest rates starts to bite.
Against this backdrop, we sat down with experts from Invesco’s bank loans, direct lending and distressed credit teams. They shared their views on what we can expect from 2024.
It is important to start by acknowledging today’s unstable geopolitical landscape. The troubling conflict in the Middle East has added an additional degree of uncertainty to the investment backdrop.
Our outlook is based on the assumption that the conflict will remain relatively contained, rather than spilling over and significantly altering the operating environment for loan issuers. However, we continue to watch this closely.
Overall, we believe 2024 will be another strong year for loan returns. Coupon levels are near all-time highs and will remain at these levels until central banks pivot aggressively towards lowering rates.
While an aggressive easing cycle is possible based on historical experience, it is not our base case. Furthermore, even if this environment were to materialise, it would not materially diminish loan coupons until late 2024.
Private credit is an asset class that can generally be defined as non-bank lending. In other words, it includes privately negotiated loans and debt financing. The private credit market typically serves borrowers that are too small to access public debt markets, or that have unique circumstances requiring a private lender.
Broadly syndicated loans are privately arranged debt instruments comprised of below investment grade borrowers. They are made to large cap companies and syndicated by intermediary commercial and investment banks. These loans are then distributed to multiple institutional investors.
CLOs, or collaterialised loan obligations, are securitised versions of broadly syndicated loans. CLOs create portfolios of hundreds of loans and structure them into different tranches with different risk/return profiles. This allows investors to choose their preferred balance of risk and return, which benefit from a collateralised structure.
Typically, CLO notes offer a premium to other securitised vehicles because of the complexity of understanding the underlying private loans and the uniqueness of each CLO structure. CLO notes are registered securities and trade and settle like bonds.
Direct lending means providing capital to companies or businesses without the benefit of an intermediary. In other words, you’re directly lending to a company.
Distressed credit involves investing in the senior debt of companies at significant discounts to par, usually due to perceived fundamental weakness.
Returns are generated by investing in companies where, over the longer-term and through various actions, meaningful upside potential can be unlocked.
1 Source: Credit Suisse as of 31 March 2024.
The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.
Alternative investment products may involve a higher degree of risk, may engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, may not be required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual portfolios, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager.
Information is provided as at 30 May 2024, sourced from Invesco unless otherwise stated.
This is marketing material and not financial advice. It is not intended as a recommendation to buy or sell any particular asset class, security or strategy. Regulatory requirements that require impartiality of investment/investment strategy recommendations are therefore not applicable nor are any prohibitions to trade before publication. Views and opinions are based on current market conditions and are subject to change.
Israel: This document may not be reproduced or used for any other purpose, nor be furnished to any other person other than those to whom copies have been sent. Nothing in this document should be considered investment advice or investment marketing as defined in the Regulation of Investment Advice, Investment Marketing and Portfolio Management Law, 1995 (“Investment Advice Law”). Neither Invesco Ltd. nor its subsidiaries are licensed under the Investment Advice Law, nor does it carry the insurance as required of a licensee thereunder.
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