Speakers at BNP Paribas’ 20th Annual High Yield and Leveraged Finance Conference found that 2023 was characterised by challenging macro dynamics. Primary issuance took a plunge, having been impacted by the slowdown in M&A, with A&E and refis being the core drivers.
Nonetheless, the outlook for this year is positive with High Yield investors sitting on healthy cash balances and CLO issuance improving, together with stronger conviction around M&A activity and capital markets outlook. Despite the limited supply last year, CLO activities kept momentum throughout Europe and the US and as we start 2024, a healthy pipeline of new issue deals is providing both market access and investment opportunities.
Credit outlook 2024
Three key takeaways:
- Market expectations are high.
- The market is positioned for a soft landing.
- Three key themes will dominate in 2024: Duration, decompression and deleveraging.
❝ There are high expectations for 2024 and risk appetite has picked up. We are likely to see easier credit conditions providing the backdrop for a dovish but sluggish time for markets. ❞
According to Viktor Hjort, Global Head of Credit Strategy & Desk Analysts, BNP Paribas, the outlook for the credit market is sluggish but dovish: economic growth is not a given but Central Banks are likely to turn increasingly dovish. Total returns for high yield are expected to be positive while defaults are unlikely to rise substantially but should remain sticky.
The soft-landing narrative has been fuelled by:
- Inflation which is expected to fall back to target levels and stay there.
- A Fed that is expected to cut rates through the course of 2024.
- GDP growth which, despite slowing down, is likely to remain positive.
Winners and losers
Looking ahead, markets that should benefit the most from dovish central banks are those most rate sensitive, such as financials, highly leveraged and poorly liquid businesses. In particular, distressed sectors such as Real Estate are now more likely to survive. Lower rates create a higher cushion for potential slower earnings, while also making it easier for businesses to refinance their maturity walls. Supply over the last few years has been relatively muted, but with lower rates supply should increase especially across High Yield.
Key themes
Three themes will dominate the year ahead, according to speakers at the conference.
- Decompression: BB’s should outperform and there is also scope for deleveraging to become a broader investment theme.
- Duration: High Yield should continue to outperform loans.
- Deleveraging: Many companies, particularly in the TMT sector, will be reviewing and right sizing their capital structures in line with the current environment, and there may be an increasing amount of corporate restructuring, such as asset sales. This will remain a feature of the market in 2024 and TMT is likely to outperform as it deleverages.
The private equity perspective
❝ The M&A outlook is optimistic, and the valuation gap is narrowing. Private equity is very focused on the momentum and the financing markets are ready to support. ❞
The financing markets have opened very strongly with the view from private equity that terms are back to ‘normal’ 2021 levels. The combination of the broadly syndicated market, plus private debt, provides private equity with financing options and confidence that financing is not the issue to getting deals done.
Private equity portfolios remain in generally good shape, and the positive response to the wave of A&Es in 2023, managed the maturity wall such that it attracted little commentary from conference participants. The financing markets have shown themselves able to adapt and cope with volatility demonstrating their maturity.
M&A outlook
Following a disappointing 2023, the M&A outlook is more optimistic. The valuation gap is narrowing, and the private equity market is very aware of the need to re-establish the cycle of equity investment and exit, but opportunities will remain stringently reviewed by Investment Committees. Although there has been a dearth of larger deals, there have been opportunities in the mid-market which are predicted to continue. P2Ps will remain in focus for 2024. However, the difficulties of managing shareholder dynamics and confidentiality, plus valuation, will challenge the ability to secure successful execution.
It is widely believed that a number of meaningful executions are under evaluation, and the competitive advantage has shifted towards Private Equity and is currently less geared towards strategics. With the cost of debt reducing, finding the optimum window of opportunity in a big election year will be a key area of focus in 2024.