May 20, 2024 - On May 16th, the LSTA and LMA hosted their joint annual conference in NYC at the conference space of member firm, Hogan Lovells. Addressing a packed room, the LSTA’s new Executive Director, Sean Griffin, noted that a common concern for both the European and US loan markets was whether interest rates would be held higher for longer. Last year, market participants debated whether rates would be cut six times or more. Now, they questioned whether rates would even be cut once this year. He further noted the continued convergence between public markets and private markets and that private credit is indeed front and center with both the press and regulators. The LMA’s Head of Sustainability, Gemma Lawrence-Pardew, then discussed the LMA’s key projects, noting the publication of the LMA’s primary delayed settlement guidelines, whose goal is to improve efficiency.
JPMorgan’s Senior Global Economist, Michael Hanson, then set the scene for the day by giving an overview of the global economy. It seems that US market participants and those in business are less concerned about a recession and instead expect the expansion to continue. Nonetheless, risks exist, and we could still dip into a recession. The Federal Reserve Bank will have to tread carefully and not keep rates high for too long, thereby pushing the economy into a recession. There is significant monetary tightening around the globe and bank lending standards have tightened in the US, Europe, and Japan. China’s domestic economy is trying now to export itself out of its growth slump. Although people are annoyed about high inflation in the US, we continue to spend and governments are spending too. After a one to two year lag, even local governments are hiring teachers and investing in infrastructure which in the short run will support growth. Bottomline, the US economy is not as sensitive to the higher rates as it was in the past. US corporate and household fundamentals are still strong, as are US profit margins in the aggregate. The US is now downshifting to a cruising speed where inflation has come down and wage growth remains acceptable — and that is why, although there has been no recession, a tight labor market remains a risk (immigration has helped a tight labor market not be too inflationary). By contrast, things are looking less favorable in Europe, and we therefore expect the ECB to cut rates faster than the Federal Reserve Bank. Interestingly, China chose to support producers (not consumers) and has, therefore, been experiencing deflation. Ultimately, China is not expected to emerge as a strong source of growth soon – unlike Europe.
Elizabeth Leckie of A&O Shearman then led the European and US Loan Markets: Trends and Deal Terms panel with Lewis Grimm of Jones Day, Jessica Reiss of Covenant Review, Katherine Weinstein of Morgan Lewis and Sanders Witkow of Davis Polk & Wardwell LLP. Nearly 70% of all launched volume in 1Q24 has entailed reducing interest expense with straight mark to market repricings at a seven year high of $161 billion representing nearly half of the total volume in the first quarter. The remainder has come from refinancings / amend to extends and refinancings of the better-performing private credit loans into the BSL market. Many maturities have been pushed out beyond 2028. Despite the relative lack of M&A activity and fundraising challenges, there remains a tremendous amount of “dry powder” in both private equity and direct lending. When compared to the UK, US unrestricted subsidiary investments capacity has grown significantly. Unfortunately, the trajectory of Covenant Review’s composite documentation score continues to slide towards less protection for both European and US loans. In the US, the private credit deals that have been analyzed reveal that the mega deals in excess of $1 billion and BSL deals both have slid with private credit receiving a score of approximately 3.5 and BSL of around four (one being the strongest protection and five being the weakest). Although liability management transactions have migrated to Europe, they play out differently for several reasons, including that European directors may face criminal liability for such transactions and there are documentation structural differences.
First Eagle Investment Management’s General Counsel and LSTA Board Member, Sabrina Rusnak-Carlson, together with Matthew Schernecke and Deborah Staudinger both of Hogan Lovells then presented Private Credit Trends. They noted that the pendulum swings back and forth between the private credit market and BSL market. Because the private debt market is more opaque, it is difficult to work out how much is now going on in the distressed / special situation category and thus its impact on private credit remains to be seen. Default rates have stayed low for private debt, with numerous companies being rescued by sponsors before defaulting – because sponsors have asked lenders for waivers, including the option to PIK interest or for covenant holidays. The panelists cautioned that there is much going on with these companies that may not be visible. Private credit has been known to be illiquid, and typically there was no secondary market; however, with the growth of the market, there has been a growing demand for a secondary market for this asset. The rating agencies are becoming more active here too. One of the other trends highlighted in direct lending was the process of selecting “designated counsel”. Historically, a lender would select their own counsel, but now there is much competition for higher quality loans, and the sponsor will inform lenders they can select their counsel from two or three firms suggested by the sponsor. If you are difficult and fighting for all the points for your client then it is unlikely you will be put on the next grid for counsel selection. This is a challenging and pervasive topic. Although convergence with the BSL market will continue, the panelists noted that private debt is lauded for its practicality and ability to get things done.
The event’s keynote speaker, Geopolitical Strategist, David Chmiel, Managing Director of Global Torchlight, then took the stage. Forty percent of the world’s population lives in countries holding elections this year This is taking place in a global economy with much flux and uncertainty. When asked whether their country was headed in the right direction, a minority of Americans believe it is (though more than last year). By contrast, there was much optimism in Indonesia, Mexico, and in India where the vast majority of their populations believes their countries are headed in the right direction. The Open Society Foundation, a think-tank that examines public approaches to democracy, found that when asked if they would support a leader who ignored elections and parliaments, those above 55 generally did not. We should not forget that democracies free people up to advance themselves economically. We likely will see a rise in Europe for anti-establishment parties and an unwinding of political consensus there. The challenge will be whether this desire to turn away goes beyond economics and becomes more systemic. Ideally, we would see an improvement in the level of trust in institutions. With the exception of China, business is now trusted more than government; however, even trust in business hovers only around 50%. Around the world people want their governments to do more with less. People want more spending on infrastructure, healthcare, and defense. This will have an impact on the debate about the US’s role in NATO. Chmiel thinks we are moving towards a world where companies must assume a role in strategic industries. Citing a recent statement by US Secretary of the Navy, companies must be prepared to make the “needed , fundamental investments in the industrial base and your own companies at a time when our nation needs us to be all ahead of the flank.”
LSTA’s EVP and DGC and Head of Policy, Tess Virmani, as well as LMA’s Gemma Lawrence-Pardew, were joined by Fanny Charrier of Credit Agricole and Maria Dikeos of LSEG on the Sustainable Finance panel. Sustainable finance has enjoyed remarkable growth since 2015 totaling $1. 3 trillion in 2023. We have seen a lot of innovation of the product into 2021. However, there has been a dip in volumes, driven by some reticence on the part of borrowers who are concerned about increased regulation. Certain borrowers are also concerned that sustainability-linked loans (SLLs) carry more risk for them, and the compliance architecture is a challenge for some of them (the cost to the borrower of the product too has become the subject of discussion). There has been a lot of interplay and growth in both bonds and loans (in fact, the use of proceeds structure came from bonds to loans). The trade associations have tried to support that growth. By 2022 much work had already been done and the slowdown is probably less a reflection of how the market views sustainable lending and more the result of what was going on in the economy. They have become more complex and drawn more regulatory pressure. There are many headwinds in the US on SLLs, and this may indeed cool the tide on SLLs.
Monique Mulcare of Mayer Brown and the team from Fitch Ratings, Judah Gross and Elizabeth Han, then shed light on default and recoveries. The cumulative default rate in the US from 2023-2025 is forecasted to be 10% for leveraged loans and in Europe 11%. Healthcare and pharmaceuticals are two industries that are facing challenges after the pandemic, yet they exhibited markedly better recoveries than the 53% cross sector weighted average at 68%. Those issuers who emerged in 2023 have exhibited low ultimate recoveries in line with past stress years of 2016 and 2020. The overall 2023 recovery rates are dragged down by technology, media, and telecoms, and retail. Issuers with first lien loan only capital structures observed lower recoveries for first lien debt relative to issuers with multitiered capital structure. Par-weighted average first lien recoveries for first lien loan only structure’s averaged 45.7% for those companies that emerged in 2023. Interestingly, those issuers which executed liability management transactions prior to bankruptcy experienced weighted average aggregate recoveries of 47% on their original first lien claims in 2023, trailing behind those without LMTs. No issuers with LMTs recovered more than 70% on their first lien claims in 2023 on a weighted average basis.
Thank you to all those who spoke and joined us for another incredibly successful Joint LSTA and LMA Conference. Click here for the slides.
