S&P Global Ratings expects that U.S. finance companies will cope with weakening asset quality, tight funding markets, and a higher level of debt maturities in 2024, but also benefit if a "soft landing" in the economy allows for lower interest rates in the second half.

There were a substantial number of downgrades in 2023, but 81% of our public ratings on finance companies now have a stable outlook, reflecting our expectation that these companies will manage this year's challenges at current rating levels (see chart 1). Another 14% of our public ratings have negative outlooks and 5% have positive outlooks.

Our economists forecast that the U.S. economy will slow but avoid recession, with real GDP growing 1.5% in 2024 and 1.4% in 2025, compared with our forecast of 2.4% growth in 2023. They expect inflation to cool further and approach the Federal Reserve's target by the middle of this year, allowing the Fed to begin cutting rates soon after.

An economic slowdown, a decline in excess household savings, some rise in unemployment, and stresses in areas like commercial real estate are likely to weigh on the asset quality of many finance companies.

We expect many business development companies (BDCs), other commercial lenders, and a variety of consumer lenders--especially those that operate in the riskiest lending areas--to report increases in delinquencies, nonaccruals, defaults, and charge-offs. That said, avoiding a recession should limit that deterioration, helping these companies absorb the earnings pressure associated with an increase in credit loss provisions.

Regardless of economic performance, commercial real estate lenders are likely to face further stress on loans backed by office properties. We expect those companies to focus on maintaining and building liquidity, rather than on growing loans, to meet any margin calls that asset quality problems could trigger.

Interest rates will have widespread impacts. It's likely that high rates, at least through the first half of the year, will continue to limit many finance companies' access to public debt issuances. That will make it more difficult for them to meet debt maturities, which will increase materially this year before rising even further in 2025. At the same time, we expect that finance companies will continue to have good access to secured funding from banks and parts of the securitization market. However, for those companies that are able to refinance imminent debt maturities at high interest rates, debt servicing costs will continue to rise since cheaper debt is being replaced with more expensive funding.

If the Fed cuts rates at around midyear, it's conceivable that finance companies will see improved access to the public debt markets. A rate cut could also help ease pressure on the borrowers of finance companies and spur activity in certain areas. For instance, while we anticipate that earnings of residential mortgage originators will remain limited this year, a drop in rates could help drive greater origination activity.

Lower rates could help finance companies take advantage of business opportunities that have emerged as a result of banks' conservativeness and the regulatory capital requirements they must meet. With regulators proposing to tighten capital standards on large banks, further opportunities could arise.

Lastly, we expect finance companies to face a variety of nonfinancial risks as well, including cyber risk. Cyber attacks hit some finance companies, especially a few residential mortgage originators, in 2023, and we expect this to be an important risk in 2024 and beyond.

BDCs And Leveraged Lending: Origination Volume Will Likely Rise; Asset Quality Strains Will Persist But Are Expected To Remain Manageable

Key credit drivers

The economy's resilience.  While market trends and valuation marks were better than expected in 2023, we anticipate valuations that are more volatile in the near term because of the choppy macro environment. With an expected economic slowdown and higher-for-longer interest rates, BDCs and commercial lenders--which typically focus on lending to highly leveraged middle-market companies--could face borrower stress, falling asset prices, and widening credit spreads. We expect BDCs to maintain adequate cushions to regulatory asset coverage requirements.

The emergence of direct lending as an asset class, which has intensified competition.  The substantial growth in private credit, particularly direct lending, has led to a proliferation of BDCs as several asset managers have launched their own direct lending vehicles (primarily as perpetual, nontraded vehicles). We expect origination volume will rise in 2024 as the pipeline of new originations regains momentum and as companies look to refinance their upcoming investment maturities. We believe that expected tighter banking regulations, direct lenders' ability to write larger checks, and a rise in club deals will continue to allow direct lenders to take market share from broadly syndicated loans. Flush with cash in a still slow lending market, there likely will be an urgency to deploy capital in 2024 that could influence underwriting standards, which in turn drive asset quality.

Access to funding markets.  Financing conditions influence the ability of wholesale-funded nonbank financial institutions to obtain funding for growth and refinance maturing borrowings and credit facilities; financing conditions also influence the cost and terms of funding. In the first half of 2023, macroeconomic uncertainty, higher interest rates, and wider credit spreads led to higher unsecured funding costs for these companies as they pivoted to more secured funding options. As macroeconomic pressures abated and credit spreads tightened in the second half, companies tapped the unsecured market--albeit at higher interest rates relative to their existing debt. Amid the recent rally in interest rates and the continued tightness of credit spreads, a few BDCs have already tapped the unsecured debt market in 2024.

What to look for over the next year

Rising payment-in-kind income and nonaccruals.  We remain focused on the potential for a weakening in asset quality through increased nonaccruals and payment-in-kind (PIK) income. S&P Global Ratings forecasts that the U.S. trailing-12-month speculative-grade corporate default rate will rise to 5.0% by September 2024, up from 4.1% as of September 2023. Consistent with this forecast for the corporate default rate, we expect that realized and unrealized credit losses will rise for most BDCs and other commercial finance companies. While asset quality challenges persist for rated BDCs, we see that BDCs with scale have the ability to identify and amend their potentially underperforming investments by temporarily converting cash interest to PIK. While this provides some relief to the borrower in the short run, over time we expect that borrowers' underlying leverage will rise and that interest coverage will remain strained, yielding to potential asset quality deterioration. As a result, while nonaccruals have modestly increased, we have seen rising PIK income (as a percentage of gross investment income) as interest coverage has declined (see chart 2). Our base-case expectation is for PIK income to increase for most BDCs in the next few quarters while borrowers continue to face liquidity pressures.

Delayed impact of higher rates and inflation.  Inflation is easing and the Fed appears set to cut interest rates this year. But given the aggressive interest rate hikes last year and their lagged impact, we anticipate that the interest coverage ratio will decline further as many borrowers have not experienced the rate hikes' full impact. We expect that higher rates and inflationary pressures will, in some sectors, test borrowers that may struggle to pass rising costs to end users, constraining those borrowers' ability to service debt and increasing the probability of default.

Earnings.  BDCs and commercial lenders have limited interest rate risk given that most of their interest-earning assets are based on a floating rate. Moreover, the average EBITDA of the underlying borrowers' BDCs has increased in recent periods, and these borrowers have a greater ability to cope with a potential economic slowdown than their smaller peers (see chart 3). While higher rates will benefit earnings, the BDCs and commercial lenders most likely to experience increasing unrealized losses will have selective borrowers in industries that are unable to pass higher inflationary costs and interest rate pressure to end users.

As of September 2023, the rated BDCs and commercial lenders had about $6.3 billion in investment maturities for 2024--an amount that ramps up to almost $13 billion in 2025 and $19 billion in 2026. Mounting competition will lead to some spread tightening for upper-middle market loans, but we expect overall earnings to grow in 2024 as deal activity picks up and as more investments are underwritten at current spreads (which are still wider than they were before the Fed's rate hikes). Having said that, it could also create vintage and single-name-concentration risk as BDCs and commercial lenders aggressively deploy larger sums of money.

Liquidity.  We expect most rated issuers to maintain adequate liquidity through their ability to draw on revolving credit facilities and relatively liquid loans (Level 2 assets) to meet unfunded commitments, quarterly redemption requests, and upcoming debt maturities. We remain focused on a potential shift in the funding mix to more secured financing since the companies in this sector have meaningful unsecured debt maturities: approximately $5 billion in 2024, rising to $7 billion in 2025 and peaking at $11 billion in 2026 (see chart 4).

Valuations and leverage.  While the underlying investments for BDCs and commercial credit lenders are illiquid, we believe that investments marked 80% or lower of cost have a higher likelihood of defaulting. At rated issuers, 5% of investments, on average, were marked 80% or lower as of September 2023. Macroeconomic uncertainty could lead to further markdowns on valuations (unrealized losses), which can erode the cushions to BDCs' regulatory asset coverage requirements. In our base case, we expect most rated issuers to continue to operate within their targeted leverage ranges and consistent with expectations for the current ratings. We also expect BDCs to maintain adequate cushions to their regulatory asset coverage requirements.

Commercial Real Estate Finance Companies: Continued Pressure In Office Loans Will Drive Further Asset Quality Deterioration

Key credit drivers

The strength of the economy.  Secular changes in the office market are testing CRE finance companies, but the way the economy, inflation, and interest rates behave in 2024 will have important implications for these companies as well, given the cyclical nature of CRE and the impact that rates have on CRE prices and funding conditions. With the Fed expected to cut rates this year, it could ease some of the pressure that higher rates have put on CRE prices and perhaps improve funding conditions for CRE finance companies. Stubborn inflation or a recession would add to the difficulties.

Liquidity needs as asset quality deteriorates.  We expect that asset quality deterioration across CRE lenders' books in 2024 will stem from trouble in the office market as well as headwinds related to higher capitalization rates, lower property valuations, and loan maturities. That deterioration could result in margin calls on the facilities that CRE finance companies often use to finance their loans. Therefore, we expect that these companies will be selective with new originations and focus on preserving and building liquidity to cope with potential margin calls or other liquidity stresses.

What to look for over the next year

Deterioration in the portfolio.  We remain focused on deterioration in the portfolio, particularly for office loans. We continue to see office real estate under intense pressure as hybrid work becomes more entrenched, slowing the recovery from low office utilization. As a result, there continues to be increased risk associated with the transitional office loans of CRE lenders, especially for those that have exposure to highly dense markets such as New York, Washington, and San Francisco. With uncertainty about future office demand and the sector's secular decline, there continues to be price discovery on loans, and we think that further deterioration in CRE finance companies' loan portfolios remains likely (see chart 6).

While most of the transitional CRE loan portfolio is composed of post-COVID-19 originations and is focused in the multifamily sector, these lenders aren't immune to ongoing risks as higher rates have contributed to higher capitalization rates and lower property valuations. In 2024, we expect continued pressure on asset quality as the economic environment tests borrowers in the next few years--likely meaning rising nonaccruals and loan-loss reserves.

Resolution on troubled assets.  We're starting to see CRE lenders amend and extend upcoming maturities for some underperforming CRE loans. In 2023, CRE finance companies lowered their internal ratings on a meaningful portion of their loans, including to the lowest "4" and "5" categories, increasing their credit loss reserves in the process. These loans make up a significant percentage of rated CRE lenders' adjusted total equity, and any further deterioration in these loans will only add to the lender's troubles, which would also directly affect leverage owing to increasing reserves. As more loans move toward maturity, they may have to further lower their internal ratings on those loans and potentially deal with margin calls.

CRE finance companies, which typically have expertise in dealing with troubled properties, will also have to decide how to handle stressed or defaulted loans. That could involve extending maturities, seeking partial loan paydowns, foreclosures, or other strategies. As of September 2023, the six CRE lenders we rate have about $9 billion in maturities for 2024 and $7 billion in 2025; that amount ramps up to almost $17 billion in 2026 (see chart 7).

Funding and liquidity needs.  The companies we rate depend on secured financing in the form of repurchase facilities that often have an interest-coverage covenant requirement. Higher interest rates reduced the cushions to interest-coverage covenant requirements, and we see companies prudently working with lenders to amend the threshold by reducing it. In recent years, some have also reduced their dependence on facilities with the highest risk of margin calls. In our view, margin call risk remains meaningful; while some facilities allow for collateral to be marked based on market interest rates and credit spreads, many others only allow for marks based on credit valuation adjustment events.

High rates have also limited these companies' access to debt issuance, particularly in the unsecured market. A drop in rates that supports that access would be a positive for these companies. There's also minor refinancing risk for these companies in 2024-2025 related to their corporate debt before the amount of maturing debt reaches about $2.2 billion in 2026.

Commercial Real Estate Services: Uncertainty Around A Recovery In CRE Activity Will Likely Persist

Key credit drivers

The timing of a recovery in capital markets and leasing activity.  There's an elevated amount of available capital on the sidelines, but interest rates and economic uncertainty have delayed the decision-making of CRE investors. We also saw a decline in transactional volume and a lower average deal size in leasing. A prolonged slowdown of CRE activity could lead to further margin compression and higher leverage for companies that are more reliant on transactional revenue, representing downside risk for existing ratings.

Continued growth for property and facility management businesses.  We expect CRE services companies with substantial earnings from recurring (albeit lower-margin) property and facilities management fees to better withstand the revenue contraction from transactional business lines. Most CRE services companies achieved robust growth in property and facility management in recent years owing to new client wins and portfolio expansion with existing clients, a trend that we expect will continue as companies seek to reduce costs by outsourcing property management. We also have a positive view of the asset management and loan servicing lines of business since these earnings are more resilient in the current CRE downturn and add diversity.

Leverage likely on the higher end of the target range.  Leverage for most CRE services companies increased over the past 12 months because of subdued CRE transactions, which resulted in multiple negative rating actions. While CRE services companies have implemented initiatives to improve operating efficiencies and reduce their cost base, leverage will likely remain elevated until CRE activities meaningfully recover. Positively, most of the higher-rated companies in the sector were able to access debt capital markets to refinance or extend their debt maturities over the past year, which benefits their flexibility in the long term, in our view.

Disciplined capital deployment.  Because of the tighter leverage headroom, we expect CRE services companies to prioritize organic growth and remain disciplined in their shareholder-friendly initiatives. For companies with excess capital, we believe M&A activity will likely be in areas that can generate resilient revenue and broaden their existing service offerings.

A potential rebound in multifamily originations.  Through the first nine-months of 2023, we saw marked declines in origination volumes across the multifamily CRE market amid a higher interest rate environment. That said, we believe that higher refinancing volumes and lower average interest rates should help bolster origination-related revenue for both Greystone Select and Walker & Dunlop in 2024. According to the Mortgage Bankers Assn., there are approximately $130 billion of multifamily mortgages due in both 2024 and 2025, and the association forecasts multifamily origination volume rising to $339 billion in 2024 from $285 billion in 2023.

What to look for over the next year

Earnings volatility from capital markets segments.  We expect transaction activity to remain subdued amid higher financing costs, and as investors stay on the sidelines until there's more clarity on the macroeconomic outlook. That said, there could be a stronger-than-expected capital markets rebound in the second half of the year owing to interest rate stability and seasonal factors (CRE brokers tend to complete transactions by calendar year-end).

A leasing slowdown in both the office and industrial sectors.  In recent quarters, the slowdown in leasing has been across asset types. While a secular decline in space requirements continues to hurt office leasing (something that's partially offset by the post-pandemic back-to-office trend), we're also seeing a decline in transaction volume and lower deal sizes in industrial leasing because of slower demand stemming from macroeconomic uncertainty. That said, CRE servicers' leasing pipeline is robust, though the timing of profit realization will depend on the improvement of macroeconomic factors.

Pressure on multifamily properties from a difficult financing environment.  For CRE services companies with meaningful multifamily lending operations, higher interest rates and moderating rent growth could stress credit metrics and the liquidity of the underlying properties. While delinquency rates remain low, we could see gradual asset quality deterioration and increased refinancing risk if the CRE financing conditions don't improve.

Residential Mortgage: Elevated Rates Will Continue To Limit Originations

Key credit drivers

Elevated interest rates, which have significantly reduced originations.  Mortgage origination volume declined for rated nonbank residential mortgage companies in 2023 because of higher interest rates (see chart 9). We expect originations will remain challenged in 2024, particularly compared with the robust levels of 2020 and 2021. High mortgage rates, buoyant home prices, and reduced purchasing power have continued to compound the difficulties for residential mortgage companies. In particular, the sharp decline in refinancing volume led to lower gain-on-sale margins and weaker profitability. The Mortgage Bankers Assn. expects the industry's 2024 origination volume to increase by about 22% year over year, to $2.0 trillion, after it declined by approximately 27% in 2023, to $1.6 trillion.

Mortgage rates have come down since they peaked in October 2023, and S&P Global Ratings forecasts a steady decline in 30-year mortgage rates going forward, with the baseline expectation of rates dropping to an average of 6.8% in 2024 and 5.5% in 2025. Still, we believe the low inventory of homes for sale and affordability challenges will limit origination volume.

Mortgage companies with large MSR portfolios, which are poised to benefit.  The value of MSRs, which rated lenders have accumulated on their balance sheets, has moved in the same direction as interest rates. Although mortgage rates recently declined, a large portion of mortgages has rates that are significantly lower than the prevailing rate, which limits the likelihood of refinancing. As rates remain elevated, the speed of mortgage prepayments remains low, which extends the duration of the underlying cash flows and supports MSR valuations. In addition, MSRs have bolstered the liquidity positions of rated mortgage companies since they may be used as collateral or sold on the secondary market.

What to look for over the next year

Marginal improvement in profitability.  Any improvement in profitability in 2024 would follow a year of cost savings. We expect residential mortgage origination volume to be up slightly in 2024, but low inventory and high home prices will continue to pressure purchase volume. We believe the recent drop in the 30-year mortgage rate is also unlikely to spur a surge in refinancing volume because many existing borrowers have already taken advantage of lower rates. While some mortgage companies will pursue growth opportunistically as the industry consolidates, we expect most companies to keep focusing on expense management in 2024.

Leverage, which will likely stay elevated.  As mortgage companies continue to adapt to an environment with low origination volume, they have been announcing cost-cutting measures, ranging from mortgage operation closures to staff reductions. Nevertheless, we expect that leverage, as measured by debt to EBITDA, will likely remain elevated in 2024. Positively, many of the residential mortgage companies we rate have low ratios of debt to tangible equity and relatively strong balance sheets, which should help them navigate a difficult macroeconomic environment and EBITDA volatility.

Continued growth of MSR portfolios at companies with strong servicing platforms.  As some mortgage companies curtail or exit certain lending channels, we expect them to continue seeking MSR purchases, subservicing agreements, and special servicing opportunities. As interest rates remain high, we expect mortgage servicing assets to hold their value because of low prepayment speeds and refinancing activity. Companies that have deployed tighter MSR hedging programs have protected themselves from the potential decline in MSR valuations.

Delinquencies remain low, so far.  We expect mortgage companies' exposure to credit risk to remain relatively low and manageable. Low unemployment rates and high home prices have kept charge-offs and delinquencies at low levels. A possible deterioration in asset quality in 2024--even though it's unlikely to be severe--would raise servicers' advance liquidity requirements and reduce MSR valuations. An increase in the unemployment rate could also result in higher delinquencies.

Increased cyber security costs.  Cyber security presents an immediate challenge for residential mortgage companies because they store a significant amount of sensitive personally identifiable information. A data breach at Mr. Cooper Group in October 2023 and at Loan Depot earlier this month triggered company-initiated response protocols, including shutting down certain systems to contain the threats. While the possible total costs associated with these incidents are hard to estimate, we expect residential mortgage companies to continue making cyber security investments to counter potential threats.

Consumer Lending: Asset Quality Could Falter From A Weaker Macroeconomy

Key credit drivers

The state of consumer finances.  Despite the macroeconomic uncertainty in 2023, credit losses among consumer lenders have remained manageable as a result of low unemployment levels and lenders tightening underwriting standards. We expect that a slowing economy, rising unemployment, and the lingering impact of higher inflation will reduce subprime consumers' purchasing power and weaken consumer credit quality. Student loan payments also resumed in October 2023, which will add to the debt burden of consumers going forward. These factors will likely have an exacerbated effect on lower-income workers, who are more likely to use consumer lending products.

Funding mix.  High interest rates will keep limiting most lenders' ability to access the unsecured debt markets, prolonging their reliance on secured funding with potentially restrictive maintenance covenants. While our economists expect Fed rate cuts to begin in mid-2024, we don't think they will materially impact the funding mix of consumer lenders this year.

Liquidity, which may be affected by weaker asset quality.  Deteriorating asset quality could translate into weaker earnings and credit metrics for consumer lenders. For lower-rated lenders (rated 'B+' or lower), we expect weaker asset quality to squeeze liquidity and cushions to maintenance covenants. If maintenance covenants for secured financing facilities are breached, lenders could lose access to the facilities and be forced to repay all borrowings under the facilities. Lower liquidity levels among lower-rated lenders could also increase the likelihood of distressed debt exchanges, something Curo Group Holdings went through in 2023. Positively, we expect refinancing risk to be manageable among the six rated consumer lenders over the next 12 months.

What to look for over the next year

Possible strains on asset quality.  Net charge-offs have normalized from their pandemic lows as the end of government stimulus, high inflation, and rising interest rates have changed consumer repayment behavior (see chart 11). We expect that consumer loan charge-offs and delinquencies will continue to rise in 2024 as the macroeconomy slows, as unemployment climbs, and as student loan payments continue. We remain focused on trends in delinquency ratios because higher delinquencies could lead to higher net charge-offs. Deteriorating asset quality could also weaken consumer lenders' leverage, liquidity, and funding access.

Regulatory environment.  Consumer lenders are exposed to ongoing regulatory risks, which can swing depending on the administration in power. While federal risk in the U.S. has abated over the past few years, we've seen state governments in the U.S. continue to make regulatory changes that affect the lending strategies of consumer financing companies, specifically payday lenders that charge high annual percentage rates (APRs). In 2023, Minnesota joined many other states in passing a regulation that capped personal loan interest rates, at 36% APR plus fees. And the trend extends beyond the United States: In March 2023, the Canadian government announced its plan to reduce the maximum allowable rate of interest to 35%, which could have an earnings impact for lenders with Canadian operations. Further regulatory changes to rate caps pose significant risks to consumer lenders.

New products and a shift of portfolio mixes.  In recent years, many consumer lenders have diversified their products and expanded their customer bases by offering new financing options in the form of credit cards, retail points of sale, auto loans, and lower-risk longer-duration installment loans. To combat the uncertain regulatory environment and the weaker macroeconomy, these lenders have shifted their portfolio mixes toward either less risky customers or more secured lending.

Origination volumes.  TransUnion, a consumer credit reporting agency, reported total unsecured personal loan balances of $241 billion in the third quarter of 2023, up from $210 billion a year before. While originations and loan balances grew in 2023, we also saw lenders tighten their underwriting standards to manage credit quality. In 2024, we expect that lenders will remain selective in originations and continue their focus on either less risky customers or more secured lending.

Auto Lending: The Expected Decline In Used Car Prices And Macroeconomic Headwinds Will Strain Asset Quality

Key credit drivers

Worsening credit quality, especially for subprime lenders.  The recent rise in auto loan delinquencies and losses--even amid relatively low unemployment--has been, in part, a result of weakening borrower performance, higher interest rates, and declining recovery rates. We anticipate that a slowing economy, an expected rise in unemployment, higher-for-longer interest rates, and a decline in used car prices will hamper these lenders' asset quality and profitability.

Challenging financing conditions.  Accessing funding to support new originations is crucial to auto finance company operations, and it can be more difficult during economic downturns. For most of 2023, because of higher interest rates and wider credit spreads, we saw that the high-yield bond market was inaccessible for rated issuers. As a result, they relied on more secured financing for funding needs, and we expect this trend to continue in 2024.

What to look for over the next year

Delinquencies, as a leading indicator for credit quality.  We remain focused on trends in the delinquency ratio since a prolonged rise in that ratio in the first half could foreshadow climbing net charge-offs in the second half, with more risk for subprime lenders than captives (see chart 12 for historical delinquency ratio data). Additionally, we expect the net charge-off ratio to rise in 2024 as used-car prices taper off and higher-for-longer interest rates squeeze the repayment ability of lower- and middle-income consumers.

Used car prices.  Supply chain constraints have subsided, which will help boost vehicle sales and help further normalize used car prices. We expect U.S. used car prices to decline by about 10% over the next 24 months (after a 4%-5% decline in 2023), which will lower recovery rates and increase the loss given default for lenders.

Among the auto lenders we rate, we believe the captive auto finance companies have the greatest exposure to leasing, which is subject to residual risk from falling used car prices. While subprime lenders have no operating lease exposure, they aren't immune to the expected decline in used car prices since they depend on recoveries through auction sales on repossessed vehicles.

Origination volume and credit costs, which drive profitability.  Even though companies have tightened their credit underwriting standards, we expect origination volume to rise in 2024 as consumer demand remains robust. However, we think profitability metrics could be squeezed because of a rise in credit loss reserves and a higher cost of funds to support growth. As subprime lenders continue to access the securitization markets at more attractive pricing than that offered by the unsecured debt market, it will continue to encumber their assets, which could limit their balance sheet flexibility in a stress scenario. We will also monitor covenant cushions since potential breaches could limit a company's ability to fund future growth while stressing its liquidity requirements.

Regulatory scrutiny of subprime auto lenders.  We expect that regulation will continue to hang over subprime lenders, though to what extent will depend on the administration in power. State attorneys general and the U.S. Consumer Financial Protection Bureau will keep scrutinizing subprime auto lenders' origination and collection practices. Affordability is an area that regulators could focus on, particularly as inflation and higher interest rates weigh on consumers' purchasing power. Any legal action by states or the federal government against subprime lenders could heighten the risk that certain companies' operations will be limited.

Fleet Management And Leasing: Strong Demand And Fewer Supply Chain Delays Generate Steady Earnings While Interest Rates Pressure EBIT Coverage

Key credit drivers

Strong demand despite economic volatility.  Fleet management companies had good revenue growth over the past several years despite macroeconomic stress, supported by healthy origination volumes and high used car prices. Although we expect used car prices to stabilize in 2024 off their recent peak, we believe the industry will remain resilient, particularly as it benefits from lower interest rates in the second half. We also expect demand to remain high as more U.S. businesses look to outsource vehicle management operations.

Access to nonrecourse asset-backed securities (ABS) markets.  Issuance activity in the commercial fleet leasing ABS market has been favorable. The industry continued to report negligible credit losses on leased vehicles because of high used car prices, strong underwriting standards, and open-ended lease structures (which shift residual value risk to customers).

What to look for over the next year

Origination volume remaining healthy while backlogs persist.  Original equipment manufacturer (OEM) supply chain disruptions have eased, decreasing the delivery cycle for new vehicles. As supply constraints fade away, we expect higher origination volumes and revenue. That said, there are still meaningful vehicle backlogs, which may slow revenue growth. While the backlog delays revenue generation, we view positively the committed future origination volumes.

Reduced pressure on EBIT coverage as interest rates decline.  Strong revenue growth was offset by higher interest rates in 2023, lowering EBIT coverage metrics (see chart 14). As interest rates fall through 2024 and 2025, we expect these metrics to improve.

Electric vehicles will comprise a larger portion of the fleet.  Several states have banned the sale of new gas-powered cars after 2035, and we believe that other states will pass similar rules. We expect fleet management companies to add electric vehicles and complementary services to meet client demand, which may require some operational changes.

Money Transfer And Payment Services: Resilient In Light Of Macroeconomic Headwinds

Key credit drivers

Exposure to fluctuating macroeconomic conditions.  Despite difficult macroeconomic conditions, most money transfer and payment services companies achieved modest top- and bottom-line growth in 2023 (see chart 15). That said, some payment processors are still sensitive to fuel price declines, while money transfer companies remain exposed to persistent inflation and exchange rate volatility despite benefiting from a resilient labor market.

Investments in growth initiatives and shareholder-friendly actions continue to weigh on net debt.  For most companies in the sector, investments in working capital, acquisitions, and share repurchases are still a burden on net debt levels. During the first nine months of 2023, both FleetCor and Wex were involved in M&A activity, while most of the sector's other incumbents continued to deploy capital through opportunistic share repurchases and dividends. Larger acquisitions and opportunistic share repurchases could weigh on net debt in 2024 and prevent these companies from reducing leverage.

What to look for over the next year

Likely strains on top-line growth from macroeconomic pressures.  Global inflation has limited the rebound of discretionary travel. Despite the easing of pandemic restrictions, international tourism hasn't reached pre-pandemic levels, but it has improved over the last few years. As a result, money transfer and payment services companies with exposure to the travel and tourism industry may continue to see revenue growth, albeit at a slower pace, as persistent inflation limits discretionary travel. Further, while fleet fuel card companies benefited from rising fuel prices in 2022, declines in fuel prices in 2023 were a drag on revenue growth for FleetCor and Wex. Our economists expect the price of West Texas Intermediate crude oil to decline to $80 per barrel in 2024, which will likely dampen top-line growth for these businesses.

Global remittance growth losing momentum.  While retail money transfers have decelerated, we've seen strong growth in money transfer services over digital platforms. The World Bank estimates that remittances to low- and middle-income countries increased by 3.8% (to $669 billion) in 2023, compared with 7.7% growth in 2022. In 2024, we expect slower growth in global remittances and pressure on revenue growth in the sector from exchange rates, inflation, and a slowing economy overall.

Fintech innovation, which is a longer-term threat to money transfer companies.  Money transfer and payment services companies have continued to introduce adjacent financial service products into their expanding ecosystems. Despite potential competition from crypto platforms, we don't view this as an immediate risk since the scalability of these platforms is limited and since the underlying asset prices are volatile. Additionally, most of the money transfer companies we rate have bolstered their digital platforms in recent years. The World Bank estimates that 30% of the global remittances they track were sent via digital platforms in 2023.

Capital deployment.  We expect well-positioned companies to opportunistically deploy excess capital through acquisitions and shareholder-friendly returns. We believe the sector's better-positioned incumbents will continue to make opportunistic acquisitions, and we will monitor how companies manage their net debt as excess cash is depleted through buybacks and M&A.

Appendix: Rating Factor Assessment

Table 1

NBFI finance companies
Company	Preliminary anchor	Entity-specific adjustment	Anchor	Business position	Capital and earnings	Risk position	Funding/Liquidity	Comparable ratings adjustment	SACP	Group/ GRE support	ICR	Outlook
Auto lending
Cobra Equity Holdco LLC	bb+	0	bb+	Moderate	Constrained	Constrained	Moderate/Adequate	1	b-	0	B-	Stable
Credit Acceptance Corp.	bb+	0	bb+	Moderate	Strong	Moderate	Adequate/Adequate	0	bb	0	BB	Stable
Commercial lending
Jefferies Finance LLC	bb+	0	bb+	Moderate	Adequate	Moderate	Adequate/Moderate	0	b+	1	BB-	Negative
KKR Financial Holdings LLC	bb+	0	bb+	Moderate	Very strong	Constrained	Adequate/Adequate	0	bb-	4	BBB	Stable
MidCap Financial Issuer Trust	bb+	0	bb+	Moderate	Adequate	Moderate	Adequate/Adequate	0	bb-	0	BB-	Stable
Oxford Finance LLC	bb+	0	bb+	Moderate	Adequate	Moderate	Moderate/Adequate	1	bb-	0	BB-	Stable
Commercial real estate
Apollo Commercial Real Estate Finance Inc.	bb+	0	bb+	Moderate	Adequate	Moderate	Moderate/Adequate	0	b+	0	B+	Stable
Blackstone Mortgage Trust Inc.	bb+	0	bb+	Moderate	Adequate	Moderate	Moderate/Adequate	1	bb-	0	BB-	Negative
Claros Mortgage Trust Inc.	bb+	0	bb+	Moderate	Strong	Moderate	Moderate/Moderate	-1	b	0	B	Stable
KKR Real Estate Finance Trust Inc.	bb+	0	bb+	Moderate	Moderate	Moderate	Moderate/Adequate	1	b+	0	B+	Stable
Ladder Capital Finance Holdings LLLP	bb+	0	bb+	Moderate	Adequate	Moderate	Adequate/Adequate	0	bb-	0	BB-	Positive
Starwood Property Trust Inc.	bb+	0	bb+	Adequate	Adequate	Moderate	Moderate/Adequate	1	bb	0	BB	Stable
Consumer finance
Curo Group Holdings Corp.	--	--	--	--	--	--	--	--	--	--	CCC+	Negative
Enova International Inc.	bb+	0	bb+	Moderate	Adequate	Constrained	Moderate/Adequate	0	b	0	B	Stable
Goeasy Ltd.	bbb-	0	bbb-	Moderate	Adequate	Constrained	Moderate/Adequate	1	bb-	0	BB-	Stable
OneMain Holdings Inc.	bb+	0	bb+	Adequate	Moderate	Moderate	Adequate/Adequate	1	bb	0	BB	Stable
World Acceptance Corp.	bb+	0	bb+	Moderate	Strong	Constrained	Moderate/Moderate	-1	b-	0	B-	Negative
Other
Burford Capital Ltd.	bb+	0	bb+	Moderate	Very strong	Constrained	Adequate/Moderate	0	bb-	0	BB-	Positive
Hannon Armstrong Sustainable Infrastructure Capital Inc.	bb+	0	bb+	Moderate	Strong	Adequate	Adequate/Adequate	0	bb+	0	BB+	Stable
Massachusetts Development Finance Agency	bb+	1	bbb-	Strong	Very strong	Adequate	Strong/Strong	0	a	1	A+	Stable
National Rural Utilities Cooperative Finance Corp.	bb+	1	bbb-	Very strong	Adequate	Adequate	Adequate/Adequate	1	a-	0	A-	Stable
Navient Corp.	bb+	0	bb+	Moderate	Adequate	Moderate	Adequate/Adequate	0	bb-	0	BB-	Stable
Rithm Capital Corp.	bb+	0	bb+	Moderate	Moderate	Moderate	Weak/Adequate	1	b	0	B	Stable
NBFI--Nonbank financial institution. SACP--Stand-alone credit profile. GRE--Government-related entity. ICR--Issuer credit rating.

Table 2

Business development companies
Company	Preliminary anchor	Entity-specific adjustment	Anchor	Business position	Capital and earnings	Risk position	Funding/Liquidity	Comparable ratings adjustment	ICR	Outlook
Ares Capital Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Blackstone Private Credit Fund	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Blackstone Secured Lending Fund	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Blue Owl Capital Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Blue Owl Capital Corp. II	bb+	1	bbb-	Adequate	Very strong	Moderate	Moderate/Adequate	0	BBB-	Stable
Blue Owl Credit Income Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Blue Owl Technology Finance Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Golub Capital BDC Inc.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
HPS Corporate Lending Fund	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Main Street Capital Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Prospect Capital Corp.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
Sixth Street Specialty Lending Inc.	bb+	0	bb+	Adequate	Very strong	Moderate	Adequate/Adequate	0	BBB-	Stable
ICR--Issuer credit rating.

Table 3

Financial service finance companies
Company	Business risk profile	Financial risk profile	Anchor	Capital structure	Financial policy	Liquidity	Management and governance	Peer adjustment	SACP	ICR	Outlook
Commercial real estate services
Avison Young (Canada) Inc.	--	--	--	--	--	--	--	--	--	CCC	Negative
CBRE Group Inc.	Satisfactory	Modest	bbb+	Neutral	Neutral	Exceptional	Neutral	Neutral	bbb+	BBB+	Stable
Cushman & Wakefield	Fair	Aggressive	bb-	Neutral	Neutral	Adequate	Neutral	Neutral	bb-	BB-	Negative
Greystar Real Estate Partners LLC	Fair	Significant	bb	Neutral	Negative	Adequate	Neutral	Neutral	bb-	BB-	Positive
GreyStone Select Financial LLC	Weak	Significant	bb-	Negative	Neutral	Adequate	Moderately negative	Negative	b	B	Stable
Jones Lang LaSalle Inc.	Satisfactory	Modest	bbb+	Neutral	Neutral	Exceptional	Neutral	Neutral	bbb+	BBB+	Negative
Newmark Group Inc.	Fair	Intermediate	bb+	Neutral	Neutral	Strong	Moderately negative	Neutral	bb+	BB+	Stable
Walker & Dunlop Inc.	Fair	Modest	bbb-	Negative	Neutral	Strong	Neutral	Negative	bb	BB	Stable
Fleet leasing
Element Fleet Management Corp.	Satisfactory	Intermediate	bbb	Neutral	Neutral	Adequate	Neutral	Neutral	bbb	BBB	Stable
Enterprise Fleet Management Inc.	Satisfactory	Intermediate	bbb	Neutral	Neutral	Adequate	Neutral	Positive	bbb+	BBB+	Negative
Residential mortgage
Altisource Portfolio Solutions S.A.	--	--	--	--	--	--	--	--	--	CCC+	Stable
Freedom Mortgage Holdings LLC	Weak	Aggressive	b+	Negative	Neutral	Adequate	Moderately negative	Neutral	b	B	Stable
LD Holdings Group LLC	Weak	Highly leveraged	b	Negative	Neutral	Adequate	Moderately negative	Neutral	b-	B-	Negative
Mr. Cooper Group Inc.	Weak	Aggressive	b+	Negative	Neutral	Adequate	Neutral	Neutral	b	B	Stable
Ocwen Financial Corp.	Vulnerable	Highly leveraged	b-	Negative	Neutral	Adequate	Moderately negative	Neutral	b-	B-	Stable
PennyMac Financial Services Inc.	Weak	Significant	bb-	Negative	Neutral	Adequate	Neutral	Neutral	b+	B+	Stable
Rocket Mortgage LLC	Fair	Aggressive	bb-	Negative	Neutral	Strong	Moderately negative	Positive	bb	BB	Stable
Consumer lending and payday
FirstCash Holdings Inc.	Weak	Intermediate	bb	Neutral	Neutral	Strong	Neutral	Neutral	bb	BB	Stable
Money/Payment services
Block Inc.	Fair	Modest	bbb-	Neutral	Negative	Strong	Moderately negative	Neutral	bb+	BB+	Stable
Euronet Worldwide Inc.	Satisfactory	Modest	bbb+	Neutral	Neutral	Strong	Neutral	Negative	bbb	BBB	Stable
FleetCor Technologies Inc.	Satisfactory	Intermediate	bbb-	Neutral	Negative	Adequate	Neutral	Neutral	bb+	BB+	Stable
MoneyGram International	Fair	Highly leveraged	b	Neutral	FS-6	Adequate	Moderately negative	Neutral	b	B	Stable
The Western Union Co.	Satisfactory	Intermediate	bbb	Neutral	Neutral	Exceptional	Neutral	Neutral	bbb	BBB	Stable
Wex Inc.	Satisfactory	Aggressive	bb	Neutral	Neutral	Adequate	Neutral	Negative	bb-	BB-	Stable
Distressed debt purchasers
PRA Group Inc.	Satisfactory	Aggressive	bb	Neutral	Neutral	Adequate	Neutral	Neutral	bb	BB	Stable
SACP--Stand-alone credit profile. ICR--Issuer credit rating.

Primary Credit Analysts:	Gaurav A Parikh, CFA, New York + 1 (212) 438 1131; gaurav.parikh@spglobal.com
	Igor Koyfman, New York + 1 (212) 438 5068; igor.koyfman@spglobal.com
	Brendan Browne, CFA, New York + 1 (212) 438 7399; brendan.browne@spglobal.com
Secondary Contacts:	Xintong Tian, New York + 1 (212) 438 8215; Xintong.Tian@spglobal.com
	Pablo Mendez, New York +1 212 438 0331; pablo.mendez@spglobal.com