2024 Credit Markets, Banking and Bankruptcy Outlook, Part II

Credit Markets and BankingThe Fed spent most of 2023 trying to tamp down inflation by raising interest rates a path it embarked on starting in March 2022 which subsequently pushed up Treasury yields across all maturities As interest rates increased the market concurrently experienced an increase in credit downgradesNevertheless credit markets showed some signs of life in the second half of the year as inflation fears began to easeFor 2023 JP Morgan forecasted new issuances of leveraged loans and highyield bonds at 300 billion and 200 billion respectively At the current run rate highyield bonds will come in slightly below and leveraged loans slightly above this forecastNew issuances of leveraged loans in 2023 remained subdued and likely ended the year below the new issuance levels of 2022 which were also way off from the record highs achieved in 2021 Additionally approximately 35 of the leveraged loan index is rated CCC which means these loans are susceptible to nonpayment if business conditions are unfavorableMoving down the capital stack highyield bond issuance was up to 118 billion through the first three quarters of 2023 well below the longterm average but still significantly higher than the record low of 953 billion seen in 2022 However highyield bond issuances in September 2023 started to show some signs of resilience as levels returned to that experienced in 2021 indicating that companies may finally be getting more comfortable accessing the capital markets in an elevated interest rate environmentAdditionally new Collateralized Loan Obligation CLO volume is expected to be about 115 billion for 2023 well above 2022 volumes but still below 2021 levels an important fact given that CLOs continue to dominate the nonbank leveraged loan issuance marketFinally the absence of refinancing activity in 2023 led to the second largest yearoveryear decline in the marketamp8217s average number of years to maturity a record low of 55 years Going forward though many companies may still be wary of issuing debt in this market the potential for lower borrowing costs in 2024 coupled with increased investor appetite to take on risk will likely help corporate borrowers amp8220kickthecanamp8221 down the road Highyield bond and leveraged loan maturities should be manageable through 2024 but will rise to 830 billion in 2025 and 2026 adding uncertainty to the future and increasing the likelihood of a new amp8220maturity wallamp8221On a related note the banking sector is experiencing a complete reversal of the amp8220easy moneyamp8221 conditions it enjoyed between 20092021 Recent 40year inflation highs although inflation is trending downwards rising risk aversion and scarce financing are expected to continue in 2024Three bank failures destabilized the banking sector in 2023 causing an estimated 30 billion loss to the Federal Deposit Insurance Corporation FDIC The response by regulators was to substantially raise regulatory requirements to minimize risk of defaults Regional banks those between 80 billion and 120 billion in assets will likely be hardest hit when it comes to meeting these new regulatory requirementsAbout 50 of commercial banks tightened lending standards in 2023 adding to the challenge of increasing interest rates Even if best case scenarios appear in 2024 commercial bank credit could remain subduedThe question is whether the adverse situation in some of these banking bailouts will show up in excess tightening in the future The potential of such behavior has introduced risk to the sectoramp8217s outlook The bottom line is that liquidity may tighten in the neartomedium term across the board from secured and highyield debt to credit provided by regional banks Regardless of the form of credit the cost of capital is expected to continue to be elevated over the next few years as compared to the prior decade which will have ongoing economic implicationsDefaults and BankruptciesThe ripple effect of all these challenges will show up in bankruptcy courts in 2024Challenging conditions are currently evidenced in debt default rates which rose consistently this past year but have fallen in recent months Historically the default cycle has peaked roughly one to two years after the Fed Funds rate has peaked which means this lagging effect should happen soonThe US speculativegrade corporate default rate was 19 in August 2023 but could more than double by June 2024 if the economy stumbles or consumers finally begin to pull back on spendingJP Morgan forecasted highyield bond and leveraged loan default rates to rise to 30 and 35 respectively in 2023 and extend higher in 2024 The good news is that this is below SampampPamp8217s pessimistic scenario of 475 for highyield bondsTotal 2023 expected defaults amp8211 combining defaults and distressed exchanges amp8211 already ranks as the marketamp8217s third largest annual default total led by media and entertainment consumer products healthcare and retail sectors in the US Bloomberg reportsCorporate funded debt continued its meteoric rise to almost two times higher than just prior to the great recession Signs of the evergrowing debt load of typical US companies can be seen in the extremely low levels of operating income especially in key sectors such as retail and media and entertainmentThe number of bankruptcies filed by public and private companies with over 100 million in assets increased during the first half of 2023 to 72 filings according to SampampP Global Market Intelligence These bankruptcies will more than double 2022amp8217s total and if the pace continues it will mark the first time since 2020 that bankruptcies have surpassed 100 over 100 million in assets Healthcare and retail continue to lead all other sectors in terms of filing for bankruptcyExpect defaults to continue to rise as higher interest rates linger amp8220Higher for longeramp8221 could be the mantra over the next two to three years Core Personal Consumption Expenditure PCE prices continued to slow to 32 in November which is at the Fedamp8217s target on both a three and sixmonth annualized percent change basis However the Federal Open Market Committeeamp8217s FOMC central estimate for inflation doesnamp8217t have core PCE reaching the 2 target until 2026 which would require a trend shift in inflation slowing soon according to CitigroupHistorically tight credit conditions tend to precede increases in defaults Look for a further uptick in bankruptcies led by retail Charles Schwab predicts bankruptcies peaking by the end of the first quarter or into the second potentially leading the US into recessionWhat this Means for Credit Market WatchersCurrent economic and financial metrics indicate that bankruptcies tight credit and defaults will likely continue into the new yearTightening credit perhaps rising unemployment inflation and interest rates are factors that will continue to distress retail and consumerfacing companies Whether a correction in the economy comes or not at some point factors must reset The question is not if but how and when Will the Fedamp8217s potential interest rate cuts move the needle for consumers and creditors Can inflationamp8217s continued decline buoy consumer sentiment Have regulators done enough soon enough to stabilize the banking sectorAnswers to all these questions will inform whether the economy will be faced with a recession in the near futureAbout the authors This article was written by four credit markets experts from Alvarez ampamp Marsalamp160 Andrea Gonzalez Managing Director UCC Practice Mark Greenberg Managing Director UCC Practice CoChair Rich Newman Managing Director UCC Practice CoChair and Seth Waschitz Senior Director UCC PracticePosted at MediaVillage through the Thought Leadership selfpublishing platformClick the social buttons to share this story with colleagues and friendsThe opinions expressed here are the author39s views and do not necessarily represent the views of MediaVillageorgMyersBizNet

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