BY SEAN GRIFFIN, CEO & EXECUTIVE DIRECTOR.
In his first letter of the new year to members, LSTA CEO & Executive Director Sean Griffin shares his observations on 2024 and his outlook for 2025. This letter originally appeared in the 2024 Winter Edition of Loans Magazine.
Greetings and Happy New Year to all! I hope that everyone enjoyed a restful holiday season to wrap up 2024 and that 2025 has gotten off to a splendid start. And thank you all again for choosing to spend your time with the Winter Edition of Loans Magazine.
Much like many of you, I had some time off at year- end over the holidays. In addition to the traditional year-end and holiday-time activities (spending time with family and friends, cooking, gift wrapping (poorly), catching-up on the holiday classics, etc.), I spent a fair amount of time reflecting on 2024 as well as looking ahead to what 2025 may have in store for us as a market.
OBSERVATIONS ON 2024
Coming into 2024, the markets were focused on a number of events which were to unfold over the course of the year, including the US election, as well as the ongoing battle with inflation and central bank response thereto. Suffice to say, 2024 gifted us all with numerous surprises.
Market Activity – The biggest surprise for me personally in 2024 was the activity in the corporate loan market and CLO markets. My expectations coming into 2024 were for robust markets but not necessarily record setting given some of the potential headwinds (namely questions regarding the economy, rates and election uncertainty). Consider the numbers:
- Leveraged loans saw approximately $1.3 trillion in primary activity and $800 billion in secondary market activity, while the CLO market saw just under $500 billion in issuance (up nearly 250% year-on-year)
- While numbers tell part of the story – dig deeper and you see that 13% of loan volumes were new issue / money, while the rest were repricing and refinancing. Borrowers were able to access the loan capital markets and reduce borrowing costs and/or manage their outstanding debt profiles, but new loan formation through M&A and LBOs continued to be lackluster. On the CLO front, around 40% of issuance was new transaction formation, the remainder being refinancing/extension transactions. As CLOs are the largest single lender to the institutional loan market, it is clear why we saw spread compression and robust demand for loans.
- Additionally, the private credit market continued to utilize CLOs as a viable form of financing, with ~18% of CLO new issue volume being attributable to PCLOs..
- Credit spreads compressed across both markets as well, with the average term loan B refinancings removing approximately 50 bps of credit margin, private credit loans experiencing anywhere from 100 to 125 bps plus of spread compression, and CLO AAA tranches realizing ~45-50 bps of compression over the course of 2024.
- Every market participant spoke with around holiday time was more than ready for a reprieve from the deal-making… but not too much of a reprieve.
There were plenty of potential headwinds in 2024, yet the market proved resilient and remained vibrant, exceeding expectations. It is clear there was healthy appetite for diversified corporate credit risk and that confidence remains strong in the economy and the outlook for corporates.
Economy & Interest Rates – The economy has proven to be resilient (if measured by health of the stock market, up 23% for the year and corporate earnings through Q3 of 2024) even when confronted with an uncertain rates environment. Companies, especially in the sub-IG space, were very resilient to the higher rates environment, and were certainly aided in no small part by the robust capital markets and the ability for borrowers to manage the balance sheets and financing costs, with average spread eductions of syndicated loans at approximately 50 basis points and private credit loans being able to reduce spreads by 100 to 125 basis points or more, in some cases.
Election outcome – in keeping with the ‘surprise’ theme of ’24, the Republican party (barely) completed a sweep of Congress and the presidency. As a keenly interested observer, it was fascinating to witness how fragmented both political parties have become, with the Democratic party now in a very unnatural and uneasy position of wanting for leadership. The sweep does present some interesting potential for our market in 2025, however. It also makes me grateful to be part of a market where we can generate consensus and reasonable meeting of the minds prevails.
WHERE ARE WE HEADED IN 2025?
So where does this lead us for 2025? Disclaimer – I am not, nor have I ever, been in the business of forecasting. I leave that to the professionals. On the rare occasion when I have made predictions on outcomes and events, I have been proven wrong and left woefully disappointed (case in point, I predicted on Nov 30th my Ohio State Buckeyes would put up at least 50 points; ultimately OSU performed an all-time great no-show against TTUN*).
With that being said, I firmly believe 2025 will be an interesting and exciting year across the markets. I anticipate capital markets – both leveraged finance and structured finance / CLO – to be busy. I will not go as far as to say ’25 will top tick ’24 in terms of activity (admittedly I did not envision ’24 being what it was), but it will be active nonetheless. When moving into ’24, the focus was on the election and inflation. Now rolling into 2025 we are transitioning to the knock-on and governing effects of the election, how well central banks have achieved their mission of combating inflation and what this means for the leveraged finance capital markets. A few more observations:
Demand for loans – as the single largest lender to the corporate loan market when taken as a group, CLOs have been a key driver of loan market demand. Demand for tranches has been strong and there are no signs of that abating any time soon. Additionally, we have seen new pockets of investors materialize in the form of CLO ETFs. While still a small portion of the market relative to overall market size, ETFs are a new source of investor capital for the space and indicative of the continuing expansion and maturation of the asset class. The key consideration for ongoing new BSL CLO formation will be the health of the CLO arbitrage, i.e. the difference between what loan portfolios pay and what CLO debt costs. Prolonged loan spread compression, without offsetting reductions in CLO debt spreads, or CLO debt spread widening without commensurate softening of loan spreads, can cause the equilibrium in the system to temporarily break down and cause issuance to slow.
Loan market supply – assuming the strong demand trends for corporate loans continues, the market should anticipate seeing more repricing and refinancing activity in 2025. While this keeps the market very busy, the demand- side is seeking signs of new loan formation. In the new year, this may come from a couple of places. Refinancing of some of the larger private credit transactions from 12+ months ago into the syndicated market (the artists formerly known as BSL making their triumphant return) and new M&A and/or LBO activity spurned by the desire for PE firms to deploy new capital, return old capital, lock in returns on existing portfolio companies for their LPs, as well as a presumed more pro-business administration and regulatory environment will all likely contribute an active primary loan market. Perhaps this requires some degree of capitulation, perhaps the (slightly) lower rates environment and better funding costs bridge most of the bid-offer gap that has existed for a couple of years. I believe it will be a combination of the three and the desire for deal makers to do deals that will bring new money paper into the market.
Even more interesting than the market opportunity set is the administrative backdrop that is expected to be present for at least the next couple of years. For the first time in at least four years, and arguably for the first time since the GFC, we expect to be in an environment that is more business and capital formation friendly, with far fewer (but not non-existent) over-reaching regulatory threats to market functioning. This may be a (brief) window of opportunity for the market to be proactive in affecting change, versus the reactive posture we have needed to take for so many years. We need to be diligent and thoughtful while also expeditious in how we approach this unique opportunity in order to capitalize on our ability to make positive changes for the betterment of the market and our industry. The LSTA and its government affairs team will be highly active in the regulatory discussions in Washington that affect our market.
All of the above assumes few, if any, negative surprises that generate headwinds. The economy has been resilient, and while slowing, continues to grow. Rates, and market expectations thereof, will continue to be in focus for 2025, with the Fed having to toe the delicate line of keeping inflation at bay and the labor market robust. One of the biggest question marks, and potential catalysts for unexpected outcomes, will be US fiscal policy – specifically tariffs and deficit spending. How well the new administration messages and manages these critical items will be a major contributing factor to how the economy and our capital markets fare in the new year.
A FESTIVUS MIRACLE?
It would not be the holidays without at least one unexpected and perhaps otherworldly event. And for anyone following the corporate lending market for the past couple of years, there has certainly been a tremendous amount of ‘airing of grievances’ with respect to liability management transactions. While not as personally profound as the events in It’s a Wonderful Life, or Ralphie finally getting his Red Ryder, as a market we were gifted with recent the 5th Circuit Court ruling on Serta, which may have profound and lasting implications for liability management transactions. We are still unwrapping and analyzing this ruling and its impact on the market going forward. Stay tuned, as there will certainly be more to discuss.
A TRUE HOLIDAY MIRACLE
Finally, I would like to extend a special congratulatory note to the LSTA’s own Gina Sloman, who welcomed a healthy baby girl on December 29th. Gina, we are all extremely happy for you and your growing family! Congratulations from all of your colleagues at the LSTA.
Thank you all again for your continuing efforts and support of our market. There is a tremendous opportunity set on our frontier and much that we can accomplish if we work together. Best wishes for 2025.
*The Team Up North
