Current loan yields and spreads are attractive with average loan coupons at close to record highs (~9.5%) and surpassing high yield bonds (6.1%)
Monitoring the movement of capital across segments where competitive pressures may be impacting returns within a modest outlook of rising rates
A continued focus on the increasing size of the distressed credit opportunity set, creating attractive opportunities for experienced managers within challenging economic headwinds
Signals of slowing economic growth across regions at the beginning of 2024 have created a continued focus on sustained higher interest rates as the year progresses so far. 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 loans, direct lending and distressed credit teams to share their views as the first quarter of 2024 wraps up.
2023 was an exceptional year for loan returns (second highest on record) on both a relative and absolute basis, driven primarily by robust coupon that is near all-time highs. Looking forward in 2024, we continue to expect loans to provide high income in a higher for longer interest rate environment. Despite two consecutive years of exceptionally strong relative performance, we believe there are still several compelling reasons to consider investing in senior secured loans:
We feel that current loan yields and spreads are attractive with the average loan coupon surpassing high yield bonds. We believe bank loans currently offer higher relative value both from an absolute and risk-adjusted basis.
We would characterize 2023 as a year in which uncertainty related to macroeconomic conditions, geopolitical events, and the US Federal Reserve’s (Fed) aggressive tightening stance created a challenging environment for merger and acquisition (M&A) activity. As a result, transaction volumes were down, driving fewer opportunities to deploy capital across the direct lending asset class.
While the transaction activity was slow, the quality of the deals that were executed was among the most compelling we’ve seen in direct lending. Only the strongest credits with conservative capital structures and tight documentation were able to cross the finish line. Further, given the floating rate nature of the asset class, direct lending offered yields of 12-13%, unlevered – a very attractive level when compared to historical yields of 7.5-8.0%.
In 2024, it appears the Fed is headed towards more accommodative monetary policy. While the timing and magnitude of their actions remain to be seen, we expect the impact on direct lending yields to be fairly muted. If we assume the Fed cuts three times in 2024, which is currently the consensus view, along with potentially modestly tighter spreads and original issue discounts, we believe direct lending yields should only decline 50-100 bps. Under this scenario, we believe direct lending yields should settle in the 11-12% area, unlevered – still incredibly attractive from a risk/return perspective and meaningfully higher than levels exhibited leading up to the Fed’s tightening cycle.
Further, we feel that the backdrop supporting a more favourable transaction environment is firmly in place, including better visibility into the macro environment, softening inflationary pressures, potential rate reductions 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 and a relatively stable yield environment, we believe 2024 is shaping up to be a compelling opportunity to deploy capital in the direct lending asset class.
In short, we have never been busier. Our small capitalization focus and investment pipeline is not only the largest it has ever been, but it also represents some of the highest quality opportunities we have seen in our careers. 2024 is likely going to be a difficult year for many small capitalization companies, and in particular, over-levered corporate issuers. Within this space, approximately one-third of the companies with fixed charge coverage ratios below 1.0x – meaning a significant percentage of our investable universe cannot service its interest expense.
Higher rates over the last year have also impacted liquidity in many leveraged capital structures, and even with the potential for central banks to modestly cut rates in 2024, liquidity and refinancings of overleveraged balance sheets are likely to be challenged. These factors lead us to believe the next two-to-three years will represent an unparalleled opportunity to generate compelling risk-adjusted returns for three specific reasons:
Invesco is one of the world’s largest and most experienced private credit managers, catering to a wide range of client objectives and risk tolerances.
We follow a consistent credit process centred on due diligence, conservative underwriting, and risk mitigation. The idea is to preserve capital while targeting attractive risk-adjusted returns.
Contact us to learn more about our capabilities in:
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.
Alternative opportunities: What’s the outlook for private credit, private equity and real assets?
In each new edition, we look at the outlook for private market assets. In particular, we focus on private credit, private equity, real estate, infrastructure and commodities.
Private credit: A case for senior loans
The uncertain US macroeconomic backdrop with inflation pressures, interest rate hikes, and a potential recession was a significant focus throughout 2023. Despite these challenges, we see three compelling reasons to consider investing in senior secured loans now.
Senior secured loans: investing in a “higher for longer” interest rate environment
Discover the key features of senior secured loans and how they can help in a “higher for longer” interest rate environment. Download the full whitepaper for case studies, scenario analysis, and a Q&A with one of our bank loans experts.
1 Source: Credit Suisse as of December 31, 2023.
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 22 February 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.
