Key Takeaways
- The average bid on all loans remains below its January high, with pricing in the secondary market leveling out amid higher-for-longer interest rates and increased activity in the primary market.
- Price improvement has paused across the spectrum, with the proportion of all loans priced 98 or higher dropping to 78.4%, from a near-term high of 80.1% in January.
- Levels of distressed loans have crept higher in February, so far, despite distressed ratios having fallen sharply in 2023.
- Sponsored loans account for 70% of the bids that improved to 98.00 or higher in 2023.
As the Federal Reserve Bank signals that we might be at the end of the process towards normalizing rates, the market has breathed a sigh of relief. Primary loan issuance has been strong, and demand from collateralized loan obligations (CLO) has kept up pace.
However, it is still too early to let down our guard. Even if we are at the end of the rate hiking cycle, the impact of the new rate environment has yet to be absorbed by borrowers' financials, and we have yet to see how the higher cost of borrowing will affect new mergers and acquisitions (M&A), the refinancing of the looming maturity wall, and the need for sponsors to exit high valuation investments.
The behavior of secondary pricing over the past few weeks, after the Fed announced its intention to leave rates unchanged, and Jerome Powell's' observation that "inflation is still too high," seems to reflect that more cautionary tone.
Over the past few weeks, the average bid has been largely unchanged. After reaching 98.76 in mid-January--a peak since the onset of higher-for-longer--the average bid is still currently at 98.68. Loan market participants clearly remain cautious, with the price action in February a reminder that the path of rates, and the impact of high rates on credit, remains unknown.
Meanwhile, the share of loans priced at 98.00 or higher remains just below 80%. The share of loans priced at 98.00 or higher steadily gained ground in 2023, rising from 26.4% at the end of 2022, and more than doubling by the end of 2023 to 75.7%.
Of the loans priced 98.00 or higher today, 63% were in our sample of loans at the beginning of 2023. In examining the performance of these loans since the start of 2023, most were pulled to 98.00 or higher from 95.00-97.99 (40.1%) and 90.00-94.99 (24.7%). The proportion of all loans currently priced 95.00-97.99 (13.8%) has fallen more than 21.2 points, and the proportion of all loans priced 90.00-94.99 (6.5%) has fallen more than 23.7 points since the beginning of 2023, respectively.
Of the nearly 2,000 tranches in our dataset, 65% are sponsored. Sponsor-owned companies are structurally different than non-sponsored, because at some point, the sponsor will need to exit its investment.
Sponsored loans account for 70% of the bids that improved to 98.00 or higher in 2023, and have come a long way to be within shouting distance of par. The price action seen in 2023 indicates that market participants have grown increasingly comfortable with rising risks despite persistent credit headwinds. Now, whether private equity can exit high valuation and leverage positions in the context of tighter and more complicated credit conditions remains in question.
In this installment of our bi-weekly research on the secondary pricing of leveraged loans, we examine the averages, grouping tranches by bid price to provide insight into how the market is assessing credit risk across the spectrum.
Chart 1
Loan Secondary Markets Cool In February
Against the backdrop of this new normal in credit markets, primary market activity surged in January and the bid in secondary markets leveled out.
Following January's Federal Open Market Committee communications and ensuing strong macro-economic data, the average bid on all loans dipped 11 basis points (bps) to 98.63, while the average bid on USD first liens fell 15 bps to 98.69.
Loan market participants have held the line. The average bid on all loans remains just 132 bps below par, and 78% of loans are priced 98 or higher.
However, high rates have contributed to broad deterioration in credit quality for well over a year now. While defaults remain historically low, minimal credit losses can largely be attributed to low refinancing needs seen since 2022.
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 on all loans 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. USD first liens have led the drop, falling 17 bps to 98.74 from 98.91 in mid-January.
Our analysis this week raises questions about the balance of risks in loan markets as we navigate 2024. Questions about how high rates will affect private equity, from both the perspective of exiting high valuation/high leverage investments and the future of M&A, remain.
However, the rise of sponsored loans (and private markets more generally) hasn't appeared out of nowhere; this growth has materialized over a period of more than 40 years. Private markets are also well established serving an essential cohort of regional economies, and small and medium-sized business. We will be closely watching how market participants navigate challenging conditions and respond to liquidity risks this year.
The response to the current balance of risk may not change overnight, and established markets may lead the way. This could sound a lot like Toto's 1978 hit song: "Hold the line."
Chart 2
EUR and USD First Liens Remain Near Parity
The average bid on EUR first liens edged out USD and regained a premium over USD first lien loans briefly 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. The average bid on EUR first liens has slipped 8 bps since to 98.69 but remains near parity with USD first liens at 98.74.
Chart 3
Chart 4
Chart 5
Secondary market liquidity continued its 2023 rebound with bid/ask spreads continuing to grind tighter in February. The bid/ask spread for USD first liens stalled in mid-January, and is currently nine 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 6
Distressed Levels Creep Up
Levels of distressed loans have crept up in February, despite their strong rebound last year. As high levels of distress reflect tightening credit conditions for weaker-rated issuers, current levels are well off recent highs and remain a positive indicator for near-term market liquidity.
Chart 7
The drop in distressed levels this year has been led by sponsored loans, with the distress ratio for all sponsored loans at 19.4, nearly 275 basis points tighter than its level at the start of the year.
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 | |
| Molly Mintz, New York; Molly.Mintz@spglobal.com |
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