Real estate Can remarkable US industrial revenues continue?
Historical increases in US industrial rents have out-performed past trends. Can that run continue? We look at e-commerce and interest rates for an answer.
Current loan yields and spreads remained attractive with average loan coupons at close to record highs (~9.25%) and surpassing high yield bonds (~6.15%)1
Easing inflation, improving M&A volumes, and a moderated yet elevated yield should all be tailwinds for direct lending for the rest of 2024.
Healthy companies challenged by higher rates are seeking capital solutions which present attractive investment opportunities particularly in the small company space.
Significant focus on the uncertainty of the US macroeconomic backdrop and its potential implications on the market remain top of mind for investment opportunities. 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 third quarter of 2024 wraps up.
Kevin Egan, Senior Portfolio Manager, Senior Secured Bank Loan Group
As we approach the end of the third quarter, 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 9.19%, outpacing the average high yield coupon of 6.24%1. After averaging around ~170 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 three years ago when loans were yielding ~4.80%; loans recently have been yielding over 400 basis points more than that1.
For more information about bank loans, read our quarterly update of “Private Credit: A case for senior loans.”
Ron Kantowitz, Head of Direct Lending
During the first half of 2024, the economy demonstrated resilience despite the persistence of higher-than-desired inflation, and the Federal Reserve maintained its "higher for longer" stance on interest rates. As a result, private equity-related mergers and acquisitions (M&A) volume, typically a significant driver of direct lending opportunities, saw a further decline of 34% when compared to the already-low levels exhibited during the first half of 2023. It’s worth noting however that the direct lending deals that were completed over the period continued to be fundamentally strong, especially when supported by a disciplined approach to structuring and documentation. Importantly, all-in yields on an unlevered basis remained attractive and well above historical levels.
For the remainder of the year, inflation is expected to abate and the Federal Reserve may shift to a more accommodative policy. It is also anticipated that M&A volumes will improve as pressures mount for private equity firms to return capital to investors. Should new direct lending opportunities increase in number, ample dry powder remains available – although a continued emphasis on maintaining discipline in leverage capacity and credit terms will be key.
Importantly, the quality of direct lending deals we are seeing remains very compelling. We remained focused on underwriting conservative capital structures with moderate leverage and tight documentation. We believe the current environment should allow for a continuance of historically attractive yields. Given the potential for a more accommodative Fed, SOFR is now projected to average around 5% for 2024. While we may see some compression in spreads and original issue discounts (OID), we still believe that all-in direct lending yields will remain in the 11-12% range, unlevered. These levels represent incredibly attractive opportunities from a risk/return perspective.
Paul Triggiani, Head of Distressed Credit and Special Situations
Within distressed credit and special situations, many themes from earlier this year continue to persist. Global economies remain strong overall, with some exceptions in Europe, particularly the United Kingdom and Germany. The US Federal Reserve still has the opportunity to engineer a “soft landing” once monetary policy loosens, but this seems less likely for the U.K. and Germany.
Year-to-date, our pipeline of special situations opportunities, particularly capital solutions transactions, has grown exponentially. We are evaluating new investments in private equity-owned businesses almost daily. These businesses have healthy operations, but with leverage profiles that were set up between 2018 and 2022 which have now resulted in untenable cash interest expense levels. These private equity sponsors face a dilemma: they own performing businesses capitalized in a near-zero base rate environment, and now much of their free cash flow is spent on cash interest expenses. They have owned these companies for several years without the ability to reinvest in operations, expand into new products or geographies, or pursue accretive M&A strategies, resulting in minimal equity value creation.
That’s where we are able to step in and structure attractive capital solution transactions that may help significantly reduce interest expense, sometimes possibly eliminating it, with appropriate downside risk mitigation through security and governance. These are healthy companies that do not need to restructure, which means they can offer significantly reduced risk and offer historically compelling risk/return asymmetry.
Source: Credit Suisse as of June 30, 2024
Source: Pitchbook LCD as of June 30, 2024. Base rate reflects the average during the quarter. Uses three-month LIBOR (prior to 2023) or SOFR (2023 or later) plus the weighted average institutional spread.
Credit Suisse Leveraged Loan Index data through December 31, 2023, updated annually. *Denotes returns in excess of the axis. 2008 returns were –28.75%, 2009 returns were 44.87%.
CS LLI and CS WELLI as of June 30, 2024. Morningstar correlation data from June 2003 to June 2024. Updated quarterly. Past performance does not predict future returns.
Sources: PitchBook Data, Inc.; Bank of America Merrill Lynch; Bloomberg as of June 30, 2024. The Morningstar LSTA US Leveraged Loan Index represents US Loans, the ICE BofA US High Yield Index represents US High Yield, the ICE BofA US Corporate Index represents US Investment Grade, the ICE BofA Current 10-Year US Treasury Index-TR represents Treasury. An investment cannot be made directly in an index.
Historical increases in US industrial rents have out-performed past trends. Can that run continue? We look at e-commerce and interest rates for an answer.
The Invesco Solutions team shares its views on a range of private market asset classes.
Alternative Opportunities is a quarterly report from Invesco Solutions. Each edition looks at the asset outlook for private credit, private equity, real estate, and real assets.
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Important information
Information is provided as at June 30, 2024 sourced from Invesco Private Credit and Credit Suisse 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.
Investment risk
For complete information on risks, refer to the legal documents.
Many senior loans are illiquid, meaning that the investors may not be able to sell them quickly at a fair price and/or that the redemptions may be delayed due to illiquidity of the senior loans. The market for illiquid securities is more volatile than the market for liquid securities.
The market for senior loans could be disrupted in the event of an economic downturn or a substantial increase or decrease in interest rates. Senior loans, like most other debt obligations, are subject to the risk of default. The market for senior loans remains less developed in Europe than in the U.S. Accordingly, and despite the development of this market in Europe, the European Senior Loans secondary market is usually not considered as liquid as in the U.S.
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.
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