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1. Bank loans had a great year in 2023, largely due to high base rates,[i] stable fundamentals and strong technical demand from collateralized loan obligations (CLOs). Do you think the loan market has the potential to achieve similar returns in 2024?
We see potential for more tempered returns in 2024, though likely still higher than historical averages due to the current high interest rate environment. What we think is less likely this year is the level of price appreciation we saw in 2023. In our view, loan prices were overly punished in 2022; price increases from the lows of 2022 and high base rates combined for strong performance in 2023. The loan market finished the year on a firm footing with 38%[ii] of the market priced above par at year-end. While we still see a discount in the market, picking up those last few points to reach par will likely be incrementally more difficult, in our view. We are already seeing a more active repricing environment, which we believe will tighten the nominal spread.
2. What are your default expectations?
Given the lack of upcoming maturities and how well corporations have managed their borrowing costs thus far, we have benign default expectations for 2024. Fundamentals remain relatively stable and it’s difficult for us to see defaults rise precipitously. In our view, borrowers have ample liquidity, revolvers and other levers they can use to manage their costs. We think interest expenses are more likely to decrease as the year goes on. Lower-quality loans have the greatest risk of missing interest payments because those companies tend to have higher leverage on their balance sheets, higher interest rates and total nominal interest expenses, and lower levels of free cash flow to address those expenses. We always say loan investing is all about doing your research to evaluate the creditworthiness of each loan.
3. Do you expect supply/demand technicals to continue supporting the loan market in 2024?
We have seen rather limited supply since 2021. We expect that trend will continue, which should help keep prices higher on the technical side as loan demand has yet to significantly decline. 2023 saw a very modest contraction in the loan market, but CLO issuance remained fairly steady and not far off from prior annual heights. We expect that new issue loan supply will be focused on refinancing or extending impending maturities, and that higher-quality companies are unlikely to face many hurdles to issuing new loans. Relative to the past two years, we also expect to see net new money issued in the market given a more accommodative fundamental backdrop.
[i] Put simply, a base rate is the minimum interest rate a commercial bank can offer a borrower.
[ii] Morningstar Pitchbook LCD as of 31 December 2023.
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