Good Times Ahead (for some)! by Gary Lembo

Looking Ahead
  • Massive cash infusion during pandemic drove inflation to historic levels, outpacing wage gains
  • Consumer debt rose during pandemic back to pre-2008 heights, but debt is now twice as expensive with central banks raising interest rates
  • Sensing increased credit risk, banks are beginning to tighten lending standards
  • Liquidity in the market is now both more expensive AND shrinking
      • Leveraged loan mutual funds seeing net outflows
      • CLO issuances drying up

 Let's dig deeper………………

Pandemic stimulus may have averted a disaster, but left us with runaway inflation
  • During the pandemic credit tightened briefly, but the Fed’s unprecedented stimulus provided much needed liquidity to the market
  • Since March 2020, the Fed has printed more money than at any time in history and increased the U.S. money supply by more than 40% (20% annual growth over 3 years) Over the past 130 years, the money supply has grown by less than 7% per year on average.

”It takes about a year for Big Money Supply increases to start making their way into the economy.” - Milton Friedman:

  • That same stimulus created the inflation we are experiencing today
  • Unlikely the Fed can step in again as prices of goods and services will soar even higher
  • Consumers will continue to get poorer and poorer as their money gets devalued

Consumers have taken on more debt than before the Great Recession, and it’s now twice as expensive
  • U.S. household debt is a record $16 trillion today. Over the past 20 years, consumer debt has more than doubled, while Americans' real incomes have barely budged.
  • This debt amounts to an average of $123,000 for every household, an increase of 100% over the past 20 years.
  • Real wages have only increased 10% over that span.
  • The pressure on prices is eroding consumers savings

Sensing risk, banks are tightening lending standards, at least as abruptly as during the Great Recession
  • Starting to see the effects of banks tightening credit standards show up in the primary and secondary markets
  • Alternative asset managers will follow as they perform price discovery on both primary and secondary loans and all other securities

Pandemic stimulus has set us up for an intense correction; loan issuance has already stalled
  • Long overdue for a recession
  • Would have happened in 2020 but for the stimulus
  • This is a normal part of the credit cycle as good times lead to loosening credit standards/easy credit and the credit pool expands and lenders run out of good borrowers to lend to and chase borrowers with lower credit standards
  • Eventually the lower quality borrowers will default, and lenders will start to tighten their lending standards, and this will also slow the economy even further

Credit markets are beginning to react to upward pressure on bond spreads
  • For a long time, the Bond market and the Leveraged Loan market remained resilient, and prices did not move
  • All things considered the Leverage Loan market and the High Yield market have traded down but are still fairly calm
      • The two rates below are critical for corporate-bond prices
      • As they rise, bond yields also go up
      • As that happens, bond prices fall
  • Rising interest rates are yet another dark cloud on the credit-market horizon.
  • Inflation, an over-leveraged consumer and rising rates mean restructuring firms should start to see a pickup in business

And yet, as much as spreads have widened, liquidity is still draining out of the credit market

Restructuring work will most likely increase
  • With credit markets priced for recession:
      • Borrowers with floating rates are already in trouble because interest expense has ballooned
      • Borrowers with maturing loans will have trouble refinancing because new issuances will carry bigger discounts
  • With liquidity draining out of the credit markets:
      • Borrowers will have no choice but to address their fundamental business challenges
      • Lenders and bondholders will have fewer opportunities to trade out, creating “accidental owners”
Loan Market Update
  • Last week was very quiet in the PRIMARY market with only one new issue…..typically 4/5 plus new issues
      • Entain (Ba1/BB) launched a $750 million TLB to support its acquisition of SuperSport. Initial price talk is S+350-375 at an OID of 97 with commitments due October 18th.
      • Latam Airlines (B2/B-) is still in market with a $750 million term loan to support its exit financing. Banks have widened price talk to a 15% yield in order to attract investors
  • The forward calendar (backlog) has decreased to $25.9 billion from $28.0 billion the previous week, as some volume fell off the pipeline.
  • Renewed focus on the forward calendar as Elon Musk announced his intention to proceed with the Twitter transaction as originally structured. The Morgan Stanley-led $12.5 billion financing package currently consists of a $6.5 billion leveraged loan, $3 billion of secured bonds and $3 billion unsecured bonds
  • The secondary loan market started Q4 on a strong note, reversing the plunge that was seen in late September.
  • Leveraged loan retail funds posted a $1.5 billion outflow last week which pushed year to date funds flow for leveraged loans negative. This is the first time since 2020 annual funds flow for leveraged loans are negative.

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