Key Takeaways
- The average bid on loans has come off recent highs with resilient macro-economic data supporting the case for higher-for-longer interest rates.
- Private markets represent a key source of liquidity for issuers, with 65% of loans in the secondary market currently sponsored.
- Bid/ask spreads are marginally tighter this year but tightening in the bid/ask spread for USD first liens has stalled since mid-January.
- Levels of distressed loans have consistently fallen in 2024, remaining a positive indicator for near-term market liquidity.
The interest rate normalization in recent years has dramatically changed credit market dynamics, slowing down the previously red-hot public markets and giving the private markets a chance to take center stage. It has also forced market participants to go back to the basics and focus on fundamentals. With the end of hyper liquid markets distorting the investment process, it is now time more than ever to buckle down, read the fine print, and analyze the risks.
Despite private markets becoming more important and influential, the slowing credit markets have created concerns about the private equity markets. Questions about how the end of the low interest rate era would affect private equity from both the perspective of exiting the high valuation/high leverage investments and the future of mergers and acquisitions (M&A), have slowed fundraising. In this environment, there has been a rise in continuation funds and secondaries to increase hold periods, as well as fund financing vehicles, like NAV facilities, to provide an alternate way of raising capital.
Although sponsored transactions are in both the public and private markets, sponsor-owned companies are structurally different than non-sponsored. At some point, the sponsor will need to exit the investment, and it is unclear how private equity will manage that in the current higher interest rate environment.
Our look at the secondary pricing of leveraged loans this week focuses on sponsored versus not sponsored loans, providing insight into how the market is assessing these two ownership structures.
Chart 1
Sponsored Transactions Carry A Discount
Most loans in this market are sponsor owned, of course. Of the nearly 2,000 tranches in our analysis, about one-third are not sponsored with either public equity or private ownership, and that share has held steady over the past 18 months amid slowing M&A activity.
In 2023, sponsor-owned loans reflected a consistent discount to loans not sponsored. That discount has been as wide as 267 bps and as narrow as 84 bps, declining over the course of 2023 as market participants started adjusting to rates normalizing.
Not sponsored loans started 2023 with an average bid of 96.90 and a bid/ask spread of 105 bps. Conversely, sponsored loans had an average bid of 94.26 and a bid/ask spread of 130 bps, a 264 bps discount on the average bid and 25 bps wider on the bid/ask spread.
As market confidence grew during 2023, the average bid for sponsored and not sponsored loans rose steadily with the discount shrinking. By the end of 2023, not sponsored loans had gained 2.25 points to end at 99.15, just 85 bps off par, and sponsored loans had gained 3.91 points to end at 98.18, 182 bps off par. During 2023, sponsored loans narrowed the discount to not sponsored down to 97 bps.
Bid/ask spreads also tightened during the year, reflecting increased market confidence. By the end of 2023, the bid/ask spread narrowed to 78 bps for not sponsored loans and 93 bps for sponsored loans--26 bps tighter than the start of the year for not sponsored and 37 bps tighter for sponsored.
The market's concern about sponsored loans isn't without basis, as the share of distressed loans that are sponsored is much higher than that of not sponsored. Sponsored loans started out the year with a distress ratio of 32%, falling by one-third to 22% by the end of the year. For not sponsored loans, the distress ratio started 2023 at 20% and fell by a quarter to 14% at year-end.
Despite the different pricing between sponsored and not sponsored loans, they both recovered consistently from large market shocks in 2023. When Silicon Valley Bank (SVB) collapsed in March, our last liquidity analysis noted that EUR denominated tranches took longer to recover than USD. For sponsored versus not sponsored, the impact was less pronounced--in both cases the average bid fell in the first two weeks after the crisis but recovered in about a month.
The resurgence of the Middle East crisis in October 2023 had a longer lasting impact. In September, the average bid for sponsored and not sponsored loans reached 2023 highs--98.11 for sponsored and 99.03 for not sponsored. In the weeks after Oct 6, the average bid fell as low as 97.35 for sponsored loans and to 98.47 for not sponsored--down 77 bps and 57 bps, respectively. The average bids for sponsored and not sponsored loans failed to regain their third-quarter peaks until mid-December, and they ended the year six bps and 11 bps over their third-quarter peaks, respectively.
Loan Markets Cool Heading Into February
Normalization of credit markets began to take hold in January as primary markets reopened. With active primary markets, secondary market pricing started to level out. Recent weeks show that market participants clearly remain cautious, having not fully digested the impact of higher-for-longer. The average bid on all loans remains 133 bps below par, with 79% of loans priced at 98 or higher.
Higher-for-longer rates have contributed to credit quality broadly deteriorating for well over a year now, but defaults remain historically low. These minimal credit losses can largely be contributed to low refinancing needs since 2022. But, as the lagged effects of high policy rates take hold, one eventuality will be at the capital structure. With bond and loan maturities rising more than four-fold between 2024 and 2028, and 'B' rated bonds now at yield north of 9%, the resilience of leveraged loans could be tested as the year wears on.
Loans began 2024 on the tail of a drawn-out rally that pushed the average bid up 79 basis points from 97.75 in October 2023, to 98.53 at the end of the year. The uptrend for loans continued during the first few weeks of 2024, but has stalled since Jan. 19, with the average bid slumping nine basis points to 98.67 in February.
Not sponsored loans have led the drop, falling 12 basis points, to 99.13 from 99.24 in mid-January. Meanwhile, the average bid on all sponsored loans fell seven basis points over the same period, to 98.42.
The broad shift in market tone arrived alongside macro-economic data pointing to resilient aggregate demand, with higher-than-expected inflation readings and a strong labor market supporting the case that rates will be high for longer. In times like these, it's good to remember a keen observation from the lyrics of an old song by Memphis Minnie and Kansas Joe McCoy (popularized in Led Zeppelin's 1971 cover): "If it keeps on rainin', levees goin' to break."
EUR First Liens Regain Premium Over USD
The average bid on EUR first liens edged out USD and regained a premium over USD first lien loans in February. This came as EUR first liens continued to regain ground against par in January, with the average bid rising 72 bps to 98.76, from 98.03 when the year began. Meanwhile, USD first liens began February at 98.73--five basis points below the level at the start of the year--after shedding 19 basis points since Jan. 19.
Chart 2
Chart 3
Bid/ask spreads tightened in January as secondary market liquidity continued its 2023 rebound. Notably, the bid/ask spread for USD first liens stalled at 0.71 in mid-January, and is now just six basis points tighter than its level at the start of the year. Meanwhile, the bid/ask spread for EUR first liens has tightened 18 basis points, to 0.9 from 1.08 when the year began.
Chart 4
Distressed Levels Continue To Fall
Levels of distressed loans have continued to fall, and this remains a positive indicator for near-term market liquidity. High levels of distress reflect tightening credit conditions for weaker-rated issuers.
Chart 5
The drop in distressed levels this year has been led by sponsored loans, with the distress ratio for all sponsored loans falling more than 300 basis points to 19.1.
Chart 6
Sponsored loans will be interesting to watch in 2024 as they generally provide issuers with a closer relationship to the lender. This, in turn, can help facilitate credit amendments if an issuer becomes distressed. The willingness of sponsors to amend and extend loans has the potential to buffer capital constraints from tight primary markets over the next 18 months.
Secondary market liquidity has improved should sponsors choose to move on from portfolio companies as well. The average bid depth for all sponsored loans has risen to 6.1 from 5.1, while the average bid/ask spread has tightened to 0.81 from 1.3 since the start of 2023, respectively.
Chart 7
Chart 8
Our Surveillance Of Loan Secondary Market Liquidity
S&P Global Ratings' Credit Research & Insights has established a proprietary analysis of secondary market data for leveraged loans and is publishing bi-weekly research on secondary market pricing to provide transparency on evolving market dynamics. For this bi-weekly research, we aggregate weekly datasets from S&P Global Market Intelligence Loan Pricing Data, combining features from S&P Global Market Intelligence Loan Reference Data.
To create the various aggregates included in our analysis (e.g., USD first liens, second liens, distressed, etc.), we screen leveraged loan tranches in the dataset on several criteria, including market depth, facility currency, lien type, and spread, among others.
Our liquidity research enables bespoke risk assessment within the leveraged finance markets. By tracking secondary market pricing metrics--such as the bid/ask spread, bid depth, and distressed ratios--in various cuts of the data we get a clearer signal on overall market health and current market liquidity. Our myriad approach to aggregating the data provides a multi-faceted perspective on liquidity risk in the market.
For the purposes of our research, we define distressed loans as those with spreads greater than 1,000 basis points.
All loans in our dataset are defined as all USD/EUR first lien/second lien loans meeting the sampling criteria.
To view these exhibits and related research, visit spglobal.com/ratings/PrivateMarkets.
This report does not constitute a rating action.
| Credit Research & Insights: | Jon Palmer, CFA, Austin 212 438 1989; jon.palmer@spglobal.com |
| Ruth Yang, New York (1) 212-438-2722; ruth.yang2@spglobal.com |
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