January 12, 2023 - “It’s tough to make predictions, especially about the future.” Yogi Berra’s warning notwithstanding, we combed the papers for 2023 forecasts and recap the conclusions (and occasional conflicts) below.
A year to forget. While we don’t particularly care to discuss 2022, a brief level setting may be in order. First, lending volumes were down. A lot. LCD saw overall leveraged lending fall 46% to $436 billion and institutional lending plummet 63% to $225 billion. Refinitiv tracked $285 billion in institutional lending, off 64%; this was a greater decline than overall leveraged lending (which was buoyed by a 9% increase in pro rata activity, and thus fell a mere 35%), but better than high yield issuance (down 77% year over year). As for the secondary? Loan prices fell more than six points and returns turned negative (but outperformed nearly every other asset class). Loan mutual funds suffered more than $12 billion of outflows, netted between strong inflows through April and massive outflows thereafter, according to Refinitiv’s LLM. This appeared to be counterbalanced by a seemingly robust – yet difficult – $129 billion of CLO issuance. It was no cakewalk for borrowers either, as LCD’s new issue institutional loan yields doubled from 4.08% in 4Q21 to 8.45% in 4Q22.
Will deal flow return in 2023? This year is not expected to be a walk in the park either, with activity remaining muted. To level set, LevFinInsights posted $249 billion of gross leveraged lending (down 70%) and $129 billion of net lending (down 65%) in 2022. Looking forward, LFI adds that Morgan Stanley expects $100-125 billion of net lending, BofA and JPM are a bit higher at $175 billion of net/new money, Wells Fargo sees $200 billion of new lending and Citi expects $300 billion (excluding repricings and extensions). Though there may be some recovery as arrangers work off their (now-smaller) overhang, volumes are expected to remain quite low relative to historical levels.
What of risk? Respondents to LCD’s December market survey expect default rates to end 2023 in the 2-2.49% range from the Morningstar/LSTA Index’s current 0.73% (excluding distressed exchanges). Fitch recently raised its leveraged loan default rate forecast to 2.5-3% for 2023 and 3.25-4.25% for 2024, up from 2022’s 1.6% (including distressed exchanges). Refinitiv and LFI agree that downgrades and CCC exposure will be more consequential than actual defaults, in part because the maturity wall is relatively benign. That said, interest coverage may not be so benign. Bixby Research says that non-public reporters saw median interest coverage after capex fall to 1.3x reported/1.7x adjusted in the third quarter, down from 1.4x/1.9x in second quarter.
What of return? We’re not out of the woods from a volatility perspective, LCD’s respondents warned; 61% said that the worst of the volatility is to come and 70% said that LLLI bids – which bottomed at 91.75 in July – had not yet plumbed their cyclical depths. After soaring in 2022, Refinitiv suggests that reference rates should peak in Spring 2023. On the spread side, attractive credits may price more tightly, but challenging deals may see challenging terms. LFI observes that analysts have wildly divergent total loan return forecasts, ranging from +8% (JPM) to negative 10.8% (DB).
And what of investors? After suffering more than $36 billion of outflows after April, expect to see Loan Mutual Funds outflows to moderate (36% of LCD’s respondents) or possibly even switch to inflows (32%) in 2023, LCD wrote. CLOs are an interesting case. Though 2022 issuance was a near-record $129 billion, according to Refinitiv, any CLO practitioner will tell you it was a very hard slog. 2023 might be a bit softer, with analysts’ forecasts ranging from $90 billion on the low end (BofA) to $115-125 billion on the high end (JPM).
The bottom line: While 2022 was a challenging year, forecasters and the wisdom of crowds suggest that things will not magically turn around in 2023. Fingers crossed for an upside surprise.