Debt Capital Markets

Leveraged Finance Markets: As Good As It Gets?

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Daniel Rudnicki Schlumberger: Hi. You're listening to What's The Deal, our investment banking series here on J.P. Morgan's Making Sense podcast. I'm your host, Daniel Rudnicki Schlumberger, Head of Leveraged Finance in EMEA at J.P. Morgan. Today we're here to discuss the key takeaways from the latest European high yield and leveraged finance conference. Conference concluded on September 6th in our London offices, and featured over 1,500 participants, 80 presenting companies, with close to 3,000 organized touch points. I'm joined by Andrew Crook, the Head of Leveraged Finance Sales, and Daniel Lamy, the Head of European Credit Strategy Research. Andrew and Daniel, welcome back to the podcast. It's great to have you both here.

Daniel Lamy: Thanks for having us.

Andrew Crook: Great to be here.

Daniel Rudnicki Schlumberger: Before we dive into this year's conference, I think it would be interesting for our audience to share a little bit more about your roles at J.P. Morgan. Daniel.

Daniel Lamy: So, I run the European credit strategy team in London at J.P. Morgan. It's a publishing role. We produce top-down macro research on the European credit market across investment grades and leveraged finance, I've been in that team for 20 years.

Daniel Rudnicki Schlumberger: Andrew.

Andrew: I am Global Head of Leveraged Finance Sales, which at its core is how your bonds, leveraged loans, and convertible bonds. I have another hat as well, which is co-head of macro credit with Olivier Cajfinger. I've been London-based for 22 years, but the role, I'm excited to say, is taking me to New York. The family moved two weeks ago, so we're raring to go.

Daniel Rudnicki Schlumberger: Excellent. Daniel, let's start with your research. Your team has come out with updated forecasts for spreads, yields, and default. Do you want to summarise those for our audience?

Daniel Lamy: Yes, of course, Daniel. So, we recently made some small changes to our default rate forecast for this year. Previously, we'd been looking for a 2.5% default rate for European high yield. We increased that to 3%, so a small upward revision. We also expect the rate for 2025 to remain at 3%. So just to put that in context, if you look at the decades after the financial crisis, in European high yield, the median default rate was around about 1% over that decade.

So, we're looking for default rates that are higher than they were for a long time over the last decade, but below the mid to high single digits, that would be typically associated with a severe economic downturn. Now, when you look at credit spreads, although credit spreads are not that all-time historical heights. Adjusting for these slightly higher default rates, we think that risk premier are quite compressed. 

We have revised our spread target a bit wider to 425 basis points. And from where we are today, that's equivalent to roughly 75 basis points of widening. So we're looking for some underperformance, but we're not looking for a very large scale repricing, because again, we're looking for moderate, but not very high default rates.

Daniel Rudnicki Schlumberger: Thanks for that. Andrew, how does that tie with what the market and market participants are feeling or telling you?

Andrew: I would say they think, Daniel, is perhaps at the slightly more cautious end of the spectrum. Clients, for the most part, remain reluctantly constructive for a number of reasons. They anticipate low to moderate growth in Europe, benign unemployment, low default rates, and Daniel touched on that, even at 3%. The current spread paradigm is viewed as okay. There are a bit less convicted spreads can tighten, but that doesn't mean that they think they'll widen sustainably. Yields are okay, even if they're not compelling per se.

And interestingly, they all appear to have taken the view that there's been little to no spillover from the early August volatility. The speed of the retracing that manifest itself then demonstrates that there isn't that much overextension in credit. I think we may see from investors some patience rather than the aggressive pursuit of risk addition in secondary. I know we'll come on to talk about this, but my syndicate, and DCM colleagues all guided towards a steady rather than spectacular pipeline.

Primary could be the preferred avenue of risk addition. Perhaps after the initial BB reopening trades, we may see a more varied use of proceeds. And I think investors will view that as an opportunity to source some additional yield. There will be some appetite further down the quality spectrum too, meaning B3 or CCC. But I think that point is very specific to primary. More broadly, the panelist and the participant view was that the technical backdrop remains incredibly strong, and that's much more of a longer-term phenomenon and trend as well.

So there's been an on-going improvement in the appetite for credit that really began in H2 2023. Demand hasn't really faded, despite the rally in spreads. One panelist yesterday put it very succinctly, when they said that it was less about timing and instead it's about time in the market, and I think that's true at the moment. And investor feedback is that inflows can continue through the remainder of this year, and that they're also coming from a variety of sources, for example, fixed maturity mandates.

Daniel Rudnicki Schlumberger: That's very interesting. So what are your main takeaways, Andrew, from the conference from these three days?

Andrew: The lazy answer from me would be for more of the same because it does feel, and it has felt for a while, quite Goldilocks for credit. It's certainly more nuanced than that, and there were a number of themes that jumped out to me. I've talked a bit about technicals already, but we have a buy side that remains frustrated by the lack of supply, specifically net new money. We have a syndicate team that says that the increase in supply is perhaps going to be gradual. 

As well as like amongst the issuer community, or there appears to remain a broad consensus on rate cuts. Issuers remain of the view that there's no rush to print, i.e., wait for a rate cut, wait for a call price step-down, and this is obviously going to ensure that the technical strength persists because there's no rush on the issuer part to print. 

I think away from technicals, the fundamental story, is quite an interesting one. Your PE capital markets panel yesterday, Daniel, I thought was really interesting. And your panelists talked about, and it was a bit of a surprise to me, the cyclical asset recovery that's starting to take hold.

They talked of projections to the upside, reforecasting. I thought that was interesting and a positive for the fundamental story. Direct lending gets discussed at all of these events now. In the past, we've talked about uneasy truces. I think now we've moved forward to a comfortable coexistence. There's a consensus from the buy side and the sell side that more has been made recently of the private to public deal flow in Q1 2024, than is necessarily warranted.

The direct lending product remains omnipresent due to certainty, ability to avoid a rating, and flexibility around coupon e.g., picks, but it does feel like BSLs and high-yield bonds are again, very comfortable within their own skin, which is great news. And there they benefit from the lower cost of capital, the lack of call protection in the loan space, an ability to do size, an ability to access a diversified capital base. I'd say one interesting discussion point around direct lending is the potential discomfort with retail as an emergent investor base.

The final point I'd like to make is around game theory. So we had a panel dedicated to Liability management exercise (LME) and cooperation agreements. Co-ops have been well established in the US. It's an emergent process in Europe. LME is the feeling from investors that they feel very opportunistic and very shareholder driven. Co-ops, on the other hand, seem to be evolving in a way that temporarily stops rather than achieves. And one panellist, made an excellent point, which was that investing in higher-risk corporate credit is as much about game theory now as it is fundamentals. 

However, today, predictions can be removed, and value actually lost to shareholders. And it's clear that this emergent theme is behind a distressed community that still believes the opportunity further down the rating spectrum is a little bit limited. In a related point as well, several made an observation that it has become tougher and tougher to lend to non-sponsors, especially private founders.

So, Daniel, you've moderated two sessions with private equity this week. What were the most insightful points raised, and how do they align with the broader themes discussed at the conference?

Daniel Rudnicki Schlumberger: Indeed, Couple of things I found were quite interesting. First of all, the view on the economy was cautiously optimistic.

Now, it's a bottom-up view based on portfolio performance, but indeed we heard from our capital market panel that we've seen a number of cyclical borrowers turning the corner and now seeing growth. And overall, the feeling was that the risks of a recession seen from the private equity side maybe were not quite as high as those outlined by J.P. Morgan research. Second point I found interesting was around future deal activity. To your point, Andrew, M&A activity, LBO activity. Has been very little so far and very little new money coming from LBO and M&A activity.

We're seeing an improvement. Every quarter is better than the previous one. And the hope is that increased limited partner pressure on private equity general partners, the need to show returns on capital will spur more deal-making activity, in particular, secondary buyout. And our panellists agreed with that, but nobody should be expecting the floodgates to and deal-making activity to go back to 2021 level or even 2018 or 2019. It's gonna take some time. 

I think that's what we are seeing, that's what the market is expecting. Increase the M&A volume, increase new issue volumes, but no sudden spring back to the bountiful years we had seen previously. 

Now, Daniel, I'd like to talk about rates. During the discussion on global rates, there was a focus around potential economic slowdown interest rate expectations. How do you see these trends impacting the market sentiment and capital flow in the European leverage finance market over the next few months?

Daniel Lamy: Thanks, Daniel. I think at the moment, there is universal agreement that central banks will be cutting rates in the coming quarters, but there's a debate about how fast and how far they will be going. And this really comes back to the debate about the soft landing versus the recession. Now, if you go back a few months, there was a strong feeling that the soft landing was almost assured. We'd seen economic data improving in the first half of the year. The US particularly had shown exceptional resilience, and even Europe had seen survey data improving over the first quarter of the year.

Over the summer, there's been a bit of a pullback. Survey data has moderated a bit. Manufacturing, which we and our economists had predicted would turn a corner has not bounced to the degree that we would like to see. And there's been some notable softening in the US labor market, which actually has not been echoed elsewhere, so it's not seen, for example, in the European unemployment rates. And this is really sparking a debate as to whether the US is going to see a more significant downturn. The unemployment rate data came out slightly lower than last month, but still up quite significantly from the middle of last year.

Payroll growth has moderated. It's not convincing enough yet to suggest that we are in a recession, but at the same time there's clearly some kind of slowdown. And if that slowdown continues with markets at very expensive levels, there is scope for a pullback, and that's one of the reasons why we're expecting wider spreads. Now as far as that impacts interest rates, clearly if we're in a weaker growth environment, then central banks are likely to cut even faster and further.

But if that were to happen, high-yield spreads likely would widen as yields don't move lower alongside government bond yields. At the same time, if the soft landing is likely to materialize and this is just a little bit of a soft patch, and rate cuts then spur the economy into a second wind, then we could see some of those easing measures or priced out of the market. And I think in that scenario we actually see very strong demand for leveraged finance, because when you come back to it, all-in yields are still very attractive in the context of where they have been for the last 15 years or so. 

So at the moment, we're really watching the data and waiting for signs one way or the other. I would just maybe at this point should say that although the recession risks have clearly increased in recent months, the house base case doesn't have recession in the forecast. Daniel, if I could just turn it back to you. Andrew, mentioned earlier that clients have been starved of supply, they'd clearly like to see more issuance. What do you see in terms of the outlook for leveraged loan and high-yield supply going forward?

Daniel Rudnicki Schlumberger: More of the same. So a lot of gross supply, but actually very little net supply, little new money. Year-to-date 70% of the supply in Europe are leveraged loan and are on high yield has been related to refinancing and to extend and repricings. With only 15% being M&A linked, you're probably gonna see a little bit more in Q4 of M&A, but not that much more. We are going to continue to see, as long as spreads remain low, good volume of opportunistic issues, doing quick refinancing-based trades.

Maybe a few dividend recapitalization, a little bit more M&A every quarter, but-but not a threat. So, more of the same. Maybe to conclude on the-- after the supply side, I'd like your views on the environment overall and the risk of bounce of volatility in the next few months. Do you think we're going to be in a stable environment? How do you rate the risk of more volatility?

Daniel Lamy: I personally think we could see more volatility in the coming months. There's, of course, the growth debate that I already touched on. You also have an election coming up in the US, which is, at least looking at the moment, very close. So that means that investors don't have a lot of certainty over the medium-term direction of policy, and uncertainty can lead to volatility. There are also some other issues that could, and not necessarily we think that they will, but they could lead to volatility.

For example, euro area sovereigns, and the budget setting process for next year, given that this is the first year that the new fiscal framework will be in force, we are going to see, I think, some debate between national governments and the European Commission over the extent of deficit-reduction. And in some high-deficit countries, that will mean some-- potentially some very painful budget cuts.

We're having some net growth in the market through dividend recaps and a little bit of M&A. And so the technical picture is perhaps a little bit more balanced than it was over the past year or two.

Andrew: I think that given spreads are as tight as they are, we're almost guaranteed some volatility. However, all-in-yields are still fine, and whilst there's gonna be periods that cause us to doubt this view, I still think time in the market, rather than timing, as I referenced to one of our panellists yesterday, ensures that investors won't panic, is my view. And I think end-user demand for credit products, more broadly, is gonna ensure that investors are left with relatively little choice but to look through these periods of volatility.

There are some major looming risk factors. We've got a big election in the US this year. There's Basel III end game. That features prominently with investors, both as a concern as a potential source of opportunity.

The potential impact on bank capital requirements there, on market-making activities of some banks, the impact on liquidity, choice, cost, stability and ultimately, confidence. My view, however, with all of those risk factors, with the exception of the election risk, is that they're gonna remain unresolved beyond 2024, and I'm certainly not smart enough to tell you what their likely impact will be further down the line.

Daniel Rudnicki Schlumberger: That's very interesting. As we wrap up today, we dived into the key takeaways from the 2024 European High Yield and Leveraged Finance Conference. We've discussed lot of things, private equity, macroeconomic factors, rate environment and the sense of unease pervasive and the risks that are out there. Big thanks to Andrew Crook and Daniel Lamy for joining me.

Daniel Lamy: Thank you very much, Daniel.

Andrew: Thank you.

Daniel Rudnicki Schlumberger: Thank you to our listeners for tuning in to another What's The Deal episode We hope you enjoyed this conversation. I'm your host, Daniel Rudnicki Schlumberger, and until next time, goodbye.

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What’s The Deal? | Recession or slowdown? Navigating uncertainty

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Ben Thompson: Hi, you're listening to What's the Deal, our investment banking series here on J.P. Morgan's Making Sense podcast. I'm Ben Thompson, Head of EMEA Leveraged Finance Capital Markets at J.P.Morgan. Today, we'll be discussing the dynamic world of leveraged finance with our guest and friend Jonathan Butler, Head of European Leveraged Finance and Co-Head of Global High Yield Strategy at PGIM Fixed Income. Before we start our conversation, I want to highlight that the annual J.P. Morgan European High Yield and Leveraged Finance Conference is just around the corner, taking place from September 4th to 6th in London. This event is a key gathering for issuers, borrowers, investors, and lenders to discuss the forces and trends affecting the debt capital markets. PGIM is planning to send more than a dozen people this year, emphasizing the importance of this conference in the leveraged finance space. Jonathan, welcome to the podcast. It's great to have you.

Jonathan Butler: Thank you for having me. It's great to be here.

Ben Thompson: JB, it's fascinating to look back at the changes in the leveraged finance market over the years, and we've both been involved in that community for quite some time. Could you share with our listeners a bit about PGIM today, your career path, and how your role in PGIM has evolved in response to the shifting market dynamics?

Jonathan Butler: Yeah. So, unfortunately, I was looking at a presentation today and realised I've been doing 30 years in leveraged finance now. But I've been with PGIM for over 19 years, so coming up for two decades. I set up the London office, which was the start of our European operations in 2005. And obviously, that office has grown through time, and today, we're one of the larger European leveraged finance players. And then for PGIM, we've also grown our leveraged finance platform to be one of the larger global players. We have approximately 100 billion dollars invested across both high yield bonds and leveraged loans in PGIM Fixed Income. So obviously being part of that journey as we've grown the business.  In terms of where we've grown it, we've generally been very much focused on fundamental credit and then what we consider to be relative value, so finding best risk-adjusted returns within the leveraged finance space, obviously here in Europe but also globally.

Ben Thompson: That's terrific. And obviously, with that size platform, you're going to have a very broad-based view of what's going on in the global capital markets and specifically the leveraged finance markets. And one of the things that we are focused on right now is geopolitical risks, which are always on the radar for the buy side. And with the ongoing tensions, particularly the conflicts in Ukraine, in the Middle East, and with what could be a volatile US election process, how are these types of global uncertainties shaping your portfolio strategies at PGIM, and what specific things are you most concerned about or that are keeping you up at night?

Jonathan Butler: Yeah, so we've been concerned about geopolitical risk ever since Russia invaded Ukraine, so over two years ago. That risk obviously is still there today and remains, particularly with Ukraine's incursion into Russia now. But if you then look at how the markets are pricing that in and then also add in the tensions in the Middle East, and obviously the issues there are now approaching a one-year anniversary, again, markets are assuming that this is all going to get worked out, that there are going to be ceasefires, and that we end up in a situation where economically, for market returns, we have a benign outcome. But that does remain concerning to us because there obviously are significant tails there. And again, in sort of wider geopolitical tension, obviously, we still have trade competition between China and the West, and so that is still bubbling along as well, so there are significant tails. We feel that spreads are now at generally pretty close to all-time tights. August had some volatility, but with that backdrop, we're certainly not pricing in where we think tensions could get to in a tail scenario. And then there are obviously other risks going forwards that I think we're probably going to come on to talk about.

Ben Thompson: Yeah, well, you mentioned the August volatility, which was triggered by a number of factors, but top of mind was the reemergence of the concept of an economic slowdown in the US, and that has been a concern for buy-siders for some time, and it certainly came to the fore during the recent August market volatility. This also put the focus again on central bank rate policy. How do you see these forces playing out in the near term, and what implications could those have for the global leveraged finance market, especially from a European perspective?

Jonathan Butler: So, there is obviously risk of recession. We've had interest rate rises both in the US and Europe, which was designed to obviously help slow down the economy, and we're now seeing that come through. So, I guess the million-dollar question is whether central banks have got it right, and avoid recession and go into a soft landing or do we continue to contract and go into a recession? So we don't have the data to know exactly where things will get to yet, but I think that we're likely to see obviously lower growth rates reducing from where they are now. I don't see that rates are gonna go back to where they were before the hiking cycle began. So I think there is obviously change coming. There is risk of recession. Again, sort of how do we look at that? We're keen on basically playing to our strengths. We see ourselves as a strong fundamental credit-picking institution. We earn most of our performance through security selection. So when you look at the index, it's far safer for us to be fairly close to home when it comes to the index. Don't take outsized bets and obviously, through security selection, that's how we're driving our return. So very cognizant of geopolitical and recessionary risks that are on the horizon, but obviously, sticking to our knitting and buying and owning the names that we know well that we think will perform through any periods of volatility.

Ben Thompson: Sounds like a good strategy, given everything that's going on. Changing direction a bit, there's been a lot of buzz around private credit or direct lending lately. How do you see the private credit/direct lending markets evolving, and what impact do you think it will have on the broader leveraged finance market?

Jonathan Butler: So we've actually seen evolution of direct lending for many years. I mean, the first direct lenders were around pre-financial crisis, and as a product, it started growing post the financial crisis. There were many mid-market lenders at that point in time with bank-led syndicates that were being forced towards the direct lending market. But through time, we've seen direct lending morph into what I would describe as private credit, where we have club syndicates of unrated loans going to a number of institutions but not to CLOs and what we've become known as the BSL syndicated institutional loan market, but to an alternative form of lender. I think there are now three products in leveraged finance: high-yield bonds, leveraged loans, and then whether you wanna correlate direct lending or private credit, but a third product type. And they're all tools that are available to borrowers as to what type of debt financing do they want to achieve. So, it's a product that's here to stay. The pendulum probably swung towards private credit in 2022 and '23. I think that that pendulum is swinging back towards the public markets this year. But any borrower's gonna consider all three options, and it's something that we will be able to offer as an institution along with would've been our more core traditional strategies of high-yield and leveraged loans.

Ben Thompson: Thanks for that. As we look ahead to the remainder of 2024 and into next year, what's your outlook overall for the leverage finance market? And given some of the uncertainties we've discussed, what insights would you give to issuers and borrowers trying to navigate this changing environment?

Jonathan Butler: So I think that where we look at spreads today, we're at the tighter end of where we've been for the last 15-plus years, so post the financial crisis and before. If we look at sort of what's created that, we've had a lack of supply in leveraged finance. We've also seen increased demand for fixed income, which includes high-yield bonds and leveraged finance. So that's led to this tight-spread environment. So, if I'm an issuer, I'd be finding now a pretty interesting time to be investing. If we do go into a recession, if any of those geopolitical tails emerge, then spreads will widen. So I think that now is an interesting period for us as an investor. We have to be cautious around those tails, therefore, we're looking to seek returns through relative value. So we're open to new issuance and we'd welcome conversations with borrowers.

Ben Thompson: Fantastic. It's always great discussing these kind of topics with you, and I'm looking forward to continuing that conversation at the European High Yield and Leveraged Finance Conference. It's great that PGIM is sending so many people to the conference. And I guess I'd ask, from your perspective, what makes this conference an essential piece of the leveraged finance market fabric, and what are you hoping to take away from it this year?

Jonathan Butler: Yeah, and I guess there in the first thing is obviously thank you, J.P. Morgan, for putting this conference on. It's a great conference. We send as many people of our team as possible. But having most of the European issuers in the market all available straight after the summer lull, it really means that our analyst team can get to meet with management teams. They can do one-on-ones. They can get an update on how businesses are performing. They can obviously quiz those teams on all of the top-down risks and concerns we have in the market around geopolitics, around recession. How are their order books? How's their current trading? So, it's a fantastic way to get everyone back into gear and back up to speed. So the timing of the conference is perfect, and what you guys lay on in terms of the number of issuers that are there, means it's an essential few days where the team are out of the office and talking to issuers.

Ben Thompson: Thank you very much for joining us at the conference and also joining us here in advance. Just to recap, today we went through a number of key aspects of the leveraged finance market and the effect of a potential US economic slowdown, global geopolitical risks, the evolving role of direct lending, and what's top of mind for market participants. We also got a glimpse into JB's outlook for the remainder of 2024 and into 2025, along with his insights for companies in the space. So Jonathan, thank you for joining me today and sharing your insights, and we look forward to seeing you at the conference.

Jonathan Butler: Oh, thank you, Ben.

Ben Thompson: And thank you to our listeners for tuning to another What's the Deal episode. We hope you enjoyed the conversation. I'm your host, Ben Thompson, and until next time, goodbye.

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What’s The Deal? | Opening with a bang”: An update on the European leveraged finance markets

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Daniel: Hello and welcome to our podcast. I’m Daniel Rudnicki Schlumberger, I’m the head of Leveraged finance for EMEA for J.P. Morgan. And I’m joined today by my partner, Ben Thompson, who heads leverage finance capital markets.

Ben: Hello Daniel.

Daniel: I’d like to start with Natalie Netter, who is our head of syndicate for Leveraged Finance in Europe. So, Natalie, you’re in the thick of it, right? You’re on our trading floor. You hear the flows, you hear what our investors are thinking. How is the mood? How are the secondary markets these days?

Natalie: The markets are strong, but interestingly, the mood is slightly frustrated. So While the markets are in fantastic shape, if you look on the loan side, we actually just yesterday reached a new 52-week high in cash price of loans. And in fact, you need to go back nearly two years to get to these levels. High yield, we have come off a little bit year to date, but marginally only call it 20 basis points. And we're still 150 basis points inside where we were in mid-October. And the index is still sub-7 %. So Relative to where we've been, it's still strong. That said, there's a little bit of frustration, particularly on the high yield side, where I think everyone would have happily shut their books at the end of November, high single-digit returns. But we saw 500 basis points of performance into the last six weeks of the year. And that's frustrated investors because it feels like it'll be a little bit harder this year to make returns work, given just how strong last year ended up in an asset class that tries to pitch itself as a bit less volatile and you know high single-digit returns is perfectly adequate. But where we sit right now from an overall tone, it's positive.

Daniel: And spreads are really low.

Natalie: Yes, certainly. So on the high yield side, we're over 100 basis points inside the 20-year average. We have seen very tight on the spread side on high yield. And then in loans, we've seen a very strong repricing of CLO liabilities, which is allowing that market to buy loans at a tighter spread, versus what we've seen over the last several months, if not a year and a half.

Ben: If you start to pick that apart, and I agree completely that the conditions are strong right now. How much of this rally is down to the technical imbalance versus investors' and lenders' view of the fundamental outlook for the economy and for particular sectors?

Natalie: I think my point around frustration is such that it is mostly technical. So it's not as though investors are thinking that there's a great opportunity set given where they see the macro, et cetera. What it is simply technical. So on the high yield side, you saw very low net supply last year, coupon clipping, some inflows, and that led for them to have a very high cash balance. And historically, if you sit on too much cash, it's very difficult to outperform the index. And on the loan side, again, very low net new supply. And we just talked about how CLO liabilities are coming in, a very active CLO pipeline leading to demand. We have seven CLOs in market already this year. Most of those deals when they come to market are about half ramped, which means they all have 200 million of buying capacity. And If you take that seven number, and you speak to our CLO team, they see that seven going to the mid-teens in the next month. And again, all of those vehicles will be looking to add at least 200 million of paper. So it's very technically driven, rather than perhaps a fundamental view that things should be going tighter.

Ben: And Daniel, since you're on the front end dealing with the clients, the issuers and and the borrowers, you know, that concern about some of the macro events that could happen and could affect the market and how fragile this rally may or may not be, given that to Nat's point, it's very technical. I mean how-how are the borrowers and issuers and the owners of companies, financial sponsors, corporates, how are they feeling about the outlook? And how do you feel about the outlook from here for the rest of the year economically?

Daniel: I think we're still in a reasonably uncertain situation. It certainly looks better than six months ago. Economists think there is a 50% chance of a soft landing, which means that there's a 50% chance of a recession, either late in '24 or early in '25. That cautious view is probably shared by a lot of the CEOs and CFOs I meet. I have the feeling that risk markets are not taking into account such a high risk of recession. Which in turn means if the data is coming out worse than planned, the market is going to correct.

Ben: Do you feel that's the same way on the buy side, Nat, with the investors and lenders that they're all sort of trading these conditions the same way and that introduces that risk that, to Daniel's point, if some of the data comes out the wrong way, suddenly there's a correction in secondary and primary demand?

Natalie: Certainly. I was going to actually turn the question back to Daniel because one of the points we hear a lot from investors is, why are we not seeing more refinancing now given how strong the conditions are and the fact that they're almost a reluctant buyer. You know, that’s the tone, is reluctant buyers. I think on the market side, there isn't the ability to sit on cash forever, so it needs to be deployed. There's a confusion as to why it hasn't been busier in terms of what you just described, which is the CEOs, CFOs seeing all of this uncertainty. I guess to turn it back to you, why has it been so limited in terms of the actual out-of-the-box activity we're seeing on that front?

Daniel: It is getting busier.

Ben: Yeah it is. I'd agree with that. I think as we think back and we like to benchmark ourselves at the start of your conversations to where we were a year ago with some of the major factors that would affect company confidence to go out and do a transaction or sponsor confidence to buy a company. If you think about at the time a year ago, the direction of interest rate trajectory was clearly higher. Inflation was still not at all under control. Rates were going up. The forward curve was looking like rates were going to go up even further. That chance of recession that Daniel referred to, a 50%, at least from our economists, was a much higher percentage chance of a recession. So I think what we've got now and the difference to this year is the trajectory of rates, whether it's straight from the mouth of the central banks or the way the markets are trading on the forward curve. Trajectory of interest rates is definitely downward over the course of the year. We can argue and people will about the speed and the pace at which those rate cuts will come and how the market will trade those. But Also now we have this sense that consensus is building around. If it is a recession, it's going to be fairly mild and there's a good chance that we avoid recession, particularly in the US. Those are two big psychological barriers I think to transactions getting done. We still have a residual issue in terms of the difference in opinion on multiples, buyers and sellers, and we've seen that certainly over the course of 2022 and 2023. I'll turn it to Daniel in a second for his views on the sponsor activity. This could be the year where we finally see people meeting in the middle. So bridging that gap on valuations now that there's a little more confidence amongst the buyers that the economy could be okay and rates could come down, and the seller is now seeing that we're just not going to go back quickly to where we were two or three years ago. And I don't know if you're getting that sense, Daniel, from the sponsor community in particular that there's more pressure to do transactions during 2024. It would be interesting to hear your views on that.

Daniel: I think we're going to see a lot more M&A-related transactions in 2024 after a pretty lackluster 2023. If you look at the two sources of primary transactions that leverage loan and high-yield market, you've got M&A-related transactions that should get gradually better, but it takes time for auctions to mature. Then there's the refinancing. We've already started seeing in the refinancing space a flurry of transactions hitting the market. I think we should talk about that for our audience because in the US, in New York, it has been a flood of new transactions.

Ben: Yes, no, I agree. I think what's changed very rapidly and, frankly, has surprised us and the lenders is the pace at which we've gotten into a repricing market. So the bulk of last year's volume in Europe, anyway, on the loan side over 70% and on the bond side over 50%. The volumes that we saw, gross volumes in the region last year, those were refinancing trades. The bulk of those on the loan side being just amends to extend transactions where you push out the tenor of your loan by two to three years, and on the high-yield side more pound for pound, euro for euro refinancings of existing bonds, whether by exchanges or ultimately through just cash in, cash out. So that was the bulk of the volume last year. What we didn't see until this year outside of a couple of exceptions in early Q4 last year, were repricings. Which are more of a loan flavour, but those where you've got a loan at E plus 550. You come back to the lenders and say, you know "Bad news today, that loan is now going to have a 450 margin, do you want to hold on to your position or not? That started as you say in size in the US right out of the gates at the start of the year. Europe was a little slower to get started but we've had you know half a dozen of those transactions now launched just in the span of the last several days. We're trying to catch up to what's going on in North America. That I think has surprised us a little bit in terms of how quickly that's come and how aggressively that's come. But I do think for the course of the year now, we would expect to continue to see that base load of extension transactions, refinancing transactions, but now also this latest wrinkle of repricing transactions. Back to you, Nat, as we've got a couple in market and others away from us, what are you seeing and how are the lenders reacting to that new phenomenon?

Natalie: Sure. I mean, Obviously, the lenders prefer a nice new money transaction with a nice juicy spread rather than having margin taken away from them. Although I'd say generally the response has been fairly mature in terms of the fact that a lot of these loans were put in place at a time when market conditions were a bit weaker and the reality is there might be a little bit of whinging around the edges. They want to hold on to the paper and while they in one breath say, "We really wish you guys weren't launching repricings." On the other breath they say, "Do you think there'll be any new money for me to add?" So It feels like the European market environment is very healthy for the names that do have that little bit of excess spread in them. Talking about the refinancing theme, I think the loan market's done a more proactive job than the bond market in terms of pushing maturities out, as you said, last year. We saw huge volumes there. I think it's the high yield market where we're seeing investors questioning why we haven't seen more of that call refinancing activity, which of course if you look at the increase in costs given the interest rate moves, it's obvious issuers would want to wait. But Daniel, are you seeing that mentality shift now that we're into '24 and then also just given the dramatic moves we've seen in terms of where issuers can access? Are we feeling more traction on that side now?

Daniel: Yes. I think we're going to have a very busy year in terms of refinancing in many different guises. From the most simple maturity extension, we've got a lot of debt maturing in the next three years, €280 billion in Europe of leveraged loan and high-yield bonds are maturing in 2024, 2025 and 2026. That's a lot. That's 40% more than on the 1st of January, 2023. Straight refinancing, we're going to see more complicated transactions, potentially dividend recapitalization, debt issuance, funding dividend recapitalization, distribution to shareholders, a fund-to-fund transfer or continuation vehicles. Potentially we're going to see transaction looking to lower the cost of debt, for example, by refinancing second lien into cheaper or lower spread first lien debt if leverage is modest enough. Or why not even refinance a direct lending loan into the syndicated loan market? All these transactions are being considered. We've got quite a pipeline ahead of us. Now, the real question as for a borrower or an issuer of debt is, should I go now or should I go later? Are we at the beginning of a continuous improvement in the cost of debt or are we just in a good window? I would be interested in both your views.

Natalie: Well, one thing I would say on that front is, if you look at what the market's pricing and you talked about how robust the view of where rates cuts are going and how that could end up being a disappointment. If you just look at the Euro five-year swap rate-- So If you look at six-month, which is what it's off of, that's still close to 4%, and five-year swaps are 265. So they're pricing in 135 there. You can capture that when you go to market today if you're doing a five-year deal. So It does feel like right now you have very low spreads. Interest rates have come down. I know there's the expectation that they come down further. On the loan side, if you look at where we're pricing new transactions on a spread basis, it's very attractive, and OID has come down massively. And We're all learning in real time that, you know what, if things get even better with your loan, you can come back later and reprice it at par. Why not go today, especially when you look at where OID has gotten to? I don't know, Ben, if you agree or disagree with that.

Ben: Yes, no, I do. I think the trickier question because again, if you're doing a loan transaction today, you can capture the falling rate either by just waiting for your base rate to fall out from under you if the forward curve is correct, or to your point, you can do a derivative trade right now to capture that forward reduction that the curve is showing. To me, the bigger question is on this high-yield side, because if you look at that component, Daniel mentioned the 40% higher level, which gets you to 280 billion of refinancing required across Europe, across loans and bonds in the next three years forward from here. 175 of that plus or minus is bonds, and the other 100-odd is loans. A lot of that loan bit is about 60% of that 100 billion in loans is 2026 maturity. So the loan market per se doesn't really have an extension need. The high-yield side, on the other hand, that 175, that's a big number that's got to get taken care of. And to your point before, Nat, the bias on the part of the issuers in some cases is, well, I'm going to two-handle, three-handle a piece of paper now, and I'm going to come out now much better than I would have a couple of months ago, but maybe that doubles in terms of my cost-cost of financing. That's really a reason to stop and think and say, "Well, do I really want to go now." Particularly if base rates do come down and I could issue safely in 12 months and capture that lower base rate. But the risk you take to your point exactly is spreads are really tight levels now across the asset classes, and if those start to move wider just because more volume comes or because we do start to hit some of these economic issues.

Natalie: The scenario where your-your rates go down the most is one where your spreads widen.

Ben: Correct. Correct.

Natalie: It should be relatively offsetting from that perspective.

Daniel: Actually, our credit stretches are expecting by the end of the year high-yield spreads to increase more than the five-year bond would decrease.

Ben: Yeah. Absolutely. So our view is bankers being typically fairly cautious by their nature. I think your advice to clients is whether you're capturing the falling rates by issuing a loan. If you're wrong on spread to your point, Natt, then you can come back in 6 to 12 months and reprice tighter if that option exists. You can capture the falling rate curve by staying floating, or you lock in fixed now, and most of the deals that we were doing up to this point have been five non-call too in the high-yield format, so you're locked in for two years. Do you really think things are going to get so much better in the capital markets in the next two years that you're really going to look at yourself and regret locking in now versus taking the chance that whether it spreads going higher, as Daniel was saying, the economy getting worse or just a lot more issuance, which is by its very nature going to drive things wider? Question why you would hesitate to do that now. I think some of that hesitancy though, as we've talked about, is the composition of the high-yield bond market in Europe tends to skew much higher rated in terms of credit quality, and as a result, I think those types of issuers are more inclined to think no matter how bad the markets get, they'll have access, it just could be more or less expensive. That allows them, I think, to take a slightly more complacent view about waiting as long as possible on their existing tightly priced debt.

Natalie: We have seen an increase in partial refinancings to your point around that gives you multiple entry points into the market. We're working on a number of those transactions where the issuer or borrower doesn't want to put all their eggs in this basket. That's, I think, another theme that we'll likely see given that the market's far more attractive than it was over the last 18 months, but rates, you're still looking at doubling, tripling your coupon on the high-yield side.

Ben: Yeah

Daniel: I guess the conclusion is don't be complacent. It's a great market. Let's enjoy it while it lasts. It is probably still a market of windows. So thank you very much. If you've got any question, comment, suggestion for the podcast, don't hesitate to give us feedback through your J.P. Morgan contacts.

Natalie: Thanks, Daniel.

Ben: Thanks, Daniel.

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What’s The Deal? | 2024 Outlook: Windows of opportunity, bouts of volatility 

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Kathleen Darling: Hello, and welcome to What's the Deal, our investment banking series here on JP Morgan's Making Sense podcast channel. I'm your host today, Kathleen Darling, a member of JP Morgan's debt capital markets team. Today, we're diving into the dynamic world of capital markets with Achintya Mangla, global head of equity capital markets, and Kevin Foley, global head of debt capital markets. Achintya, Kevin, great to have you both on the podcast.

Kevin Foley: Thanks so much for having us, Kathleen.

Achintya Mangla: Kathleen, thank you for having us here.

Kathleen Darling: It's certainly been an interesting and dynamic year for capital markets. Let's first start with a quick year in review. Can you both name one or two major highlights for capital markets in 2023, Achintya, let's start with you.

Achintya Mangla: Sure, Kathleen. I would say the key word is resilience. And I would put it in two buckets. I would start with technology. I think going into and transitioning from a very low rate environment to the current rate environment, there were a lot of question marks on what happens to the tech sector. And I think resilience is the key word when we look at the entire global tech landscape. Away from the performance of the big seven, which is significant and driving a large part of the market gains. I think we have seen companies starting to successfully navigate the journey in profitability while maintaining some element of growth. And I think that balance of growth and profitability is something that we got to give both shareholders and management of these tech companies a lot of credit for achieving in a very credible way. They're reducing cash burns and achieving a business model that can sustain these rates. And at the same time, we continue to see meaningful innovation in the tech space. Clearly, the last 12 months or more have been inspired by AI and large language models, but it is more than just one or two companies. It is the entire ecosystem of innovation. And some of it, the evidence we will only see a few years later, because while the private capital markets in later stage companies have been slow, the reality is we have seen a very meaningful pickup in early-stage venture financing for the tech companies, which really points to greater innovation. So that's on the tech side. I would also say on the secondary markets, and I was wrong once again. When I started the year, I don't think I would have predicted the S&P and NASDAQ to be where they are. But I think the markets have been incredibly resilient, really driven by optimistic data on the inflation side and good earnings data. What's interesting, though, is the primary activity on the equity capital market side hasn't really caught up with the secondary markets, and I think that's unusual to have such a low correlation between a very strong secondary market, but rather muted primary activity. So resilience, Kathleen, is what I would say is the key highlight.

Kathleen Darling: Great. Kevin, can you pick up on that?

Kevin Foley: Sure. I'll play right off the term of resilience, 'cause it's definitely been the factor in the credit markets as well, right? We've had an economy that's been more resilient. We had an employment picture that's been more robust. The conviction around the end of fed hikes has set off a rally here along with the optimistic view of inflation being under control and with the consumer spending remaining robust, all of that has driven a rally here in the last six plus weeks in the credit markets. It's also been helped by the fact that there has just been a lack of supply in terms of primary market, so you have an environment right now where the need to come to the market for refinancing, is limited. You have a muted M&A picture. And you have limited Capex investment or balance sheets that are well-funded already for those investments. And that's keeping new supply limited in an environment where cash is still abundant and there's a lot of liquidity looking to be put to work. And that's creating a very positive technical for our markets, across investment grade, leverage loans, high yield bonds. All of them have had the benefit of having demand outstripping supply, along with a more optimistic view of the economy and where we are in the rate cycle. That has driven a nice rally here at the end of the year. That has definitely been the biggest surprise of the year, and obviously the delay or potentially avoiding of a recession has been one of the biggest surprises of the year.

Kathleen Darling: There's a lot of uncertainty in the year ahead, from geopolitical concerns, the macro backdrop, both in regards to rate movement and a potential recession, as well as an upcoming presidential election in the US. We recently had Jay Horine, head of North American investment banking, on the podcast, and he's approaching 2024 with cautious optimism. Kevin, we've heard you stress the word caution before, so let’s dig into that.

Kevin Foley: I think cautious optimism is the right way to term the year. Yes, there is a reason for optimism given what we've seen and the resilience of the economy what looks like a conclusion of fed hikes, because the inflation data has been encouraging. But to declare we're out of the woods, it feels like it's a bit premature. We definitely have the impact of higher rates still working its way through the system. The consumer has been resilient, but that's because the jobs picture has held up. But what is going to be the impact on higher rates on businesses, individuals, as a lot of that still works its way through the system, regardless if inflation is under control or not. Higher for longer feels like it's the mantra. There's a lot of optimism out there about cuts coming from the fed as early as the second quarter of next year. That feels like it might be premature, to be drawing those conclusions. So a lot to be played out. Reasons to be optimistic, but there's also a lot of reasons to be cautious too. So I think we go into it hoping for the best but preparing for the worst. What we're telling our issuers and borrowers right now is there is a good environment. We are coming off the highs that we've seen over the past year. It's a good environment to go out and try to take advantage of the market technicals. When you look at spreads in the high yield market as well as in the high-grade market, neither one is indicating a recession. Or even the possibility of a recession. We're well inside the recessionary averages on a spread basis. We're inside the non-recessionary averages as well. So this is a good backdrop to take advantage of it. You mentioned the geopolitical concerns. Those are still hanging in the balance. We've got a presidential election. We've got the uncertainty around the economy. And there's always the known unknowns that could be a factor. When you look at QE and QT, these are unchartered waters that we're navigating through. And the side effects of that are to be determined.

Kathleen Darling: Achintya, what are your thoughts?

Achintya Mangla: Look, I agree with Kevin, but I would divide the world into I'm cautious on certain elements, and I'm optimistic on some others. And I'm really cautious on the secondary markets. Kind of a reversal of the highlights that we saw in 2023. I think geopolitics, we've talked about it, but an interesting data point that I heard and this might not be entirely accurate to the number, but there are, I think, elections in about 40 plus countries, which represent approximately 40% of the world's population, and 40% of the world's GDP. That is a lot of overhang, and probably unprecedented in recent history. I agree, I think the investors, both [inaudible 00:10:00] equity and credit, are probably being a tad too optimistic on the rate cuts. And I think the other two reasons to be cautious are we are yet to see the impact of lower inflation in corporate earnings. And I think that will drive equity markets to some extent, because the multiples are reflecting the expectation of lower yields, lower inflation, but the earnings are not yet reflecting an impact of lower inflation. So cautious on the secondary markets. I am a little bit more optimistic in terms of primary activity on the equity capital market side. This includes IPOs, follow on offerings, private capital. And it's really driven by various issues, including some companies will need to provide liquidity to shareholders. Others would have made a significant journey towards a business model which combines growth with profitability. And hence, are ready to go public. Yet others would have gone through a phase where they have reduced the cash burn, and haven't needed capital yet to grow further, but the time has now come in 2024 to take advantage and capitalize on the developments that they have needed. And of course, I think we might also see some equitization of balance sheets as corporates around the world start to prepare themselves as they should, for a higher rate environment and a higher rate for longer. So I think cautious optimism is the right way to look at it. Perhaps with a slight reversal of the trend we saw in 2023.

Kathleen Darling: Achintya, in an earlier episode, Lorenzo Soler, head of global equity syndicate, talked about the IPO markets, and he was really focused on quality, that being high quality names, the quality of engagement from the buy side, and the quality of cornerstone investors. How are you thinking about quality as we approach 2024?

Achintya Mangla: Look, I think that's exactly right. IPOs have had a tough time, right? We looked at 2021, 2022, and that class of IPOs has clearly end up [inaudible 00:12:35] as we look at the IPO class of 2023 to 2026 the next cycle of IPOs, I am confident and hopeful that they will give investors the performance expected from the IPO class as well as shareholders and employees the returns they expect as well. That's largely anchored in the quality of the companies going public. There is a lot of liquidity with investors, and investors are absolutely willing and have the risk appetite to invest in IPOs, but the bar has gone high in terms of growth, profitability, quality of management, corporate governance, and scale, to some extent. And yet I do believe that the muted activity of IPOs in 2023 was driven as much by supply as by demand. I think the market is there, the liquidity is there. In fact, we've seen a lot of investors become cornerstones, which is a relatively new trend in North America which shows their keen desire to participate and get a fair allocation in IPOs. But yet, it is also driven by the fact that, as we talked earlier, some of the shareholders and companies are not ready to go public yet. They are on a journey to change their business models, reduce the cash burns, position for a very different market environment than we have seen since 2008. And I think as that journey gets closer to completion, you will start seeing a lot more IPOs in the next couple of years. I don't foresee a first quarter of '24 or the first half to suddenly go back to pre-COVID IPO levels, but I think over the next few quarters, we will gradually go back to an environment where IPOs are a very viable and important aspect of the capital markets. An important tool for private equity venture capitalists and other corporates, and investors start seeing the returns, though I would say that one of the things... And you know, we're working with a lot of investors and corporates, is we go to divert the attention from just the day one performance of an IPO to really the midterm and the long-term performance. And I'm really hopeful that as we keep tracking the delivery of a company versus what it's promised at time of the IPO, three months, six months, 12 months from the IPO, that could align well with shareholder returns. So I think a lot more to happen in the next few years. Interestingly, I think there are a few geographical trends as well. Clearly North America will continue to be the largest and the broadest market for IPOs. And I think we'll continue to attract a host of international companies including European companies.

Kathleen Darling: Can you talk a bit about which specific markets you're keeping an eye on?

Achintya Mangla: The two markets that I think we will see increased activity, particularly relative to pre-COVID is going to be the Middle East and India. I think those are two markets where we're seeing a lot of momentum in terms of domestic liquidity, in terms of local economic growth, private company formation and hence, IPO activity. And the last one is eventually we will see Hong Kong market activity pick up as well. So I think we're really focused on IPO as an asset class, but less so quarter by quarter, more so in making sure that the next class of IPOs over the next two, three years really delivers everything that IPOs are expected to, both from an investor as well as a shareholder perspective, with quality being absolutely the cornerstone and the foundation of a healthy IPO market.

Kathleen Darling: Kevin, switching over to you. Talk to us about your expectations for the debt capital markets in 2024, specifically what are you anticipating across investment grade, high yield, and leverage loan markets? And what do you anticipate the key drivers to be for market activity?

Kevin Foley: So from an investment grade standpoint, we expect issuance volumes in the bond market to be flattish to slightly up in 2024. From a high yield perspective, we're forecasting up around 25%, and from a leveraged loan perspective, up 10%. Probably expect to see similar volumes that we've been seeing in the fourth quarter of 2023 continuing into the first six months of the year and are hopeful that we can see a pickup in activity in the back half of the year, kind of even out to those numbers that I cited. M&A, M&A, and M&A is going to be the three keys in terms of what next year's going to look like. In order to get volumes up or to even hit those levels certainly in the high yield market and leveraged loan market or to exceed them, it is going to be tied M&A. As we were hopeful that if we're getting more clarity on the economic picture, more confidence out there, that we're going to see a pickup in M&A activity. There has been a lot of activity in the fourth quarter in terms of behind the scenes, not necessarily announced in financing commitments being put on the tape, but activity is picking up, and it feels like that is tied to the increased confidence, where we are on the economic cycle, where we are on the rate cycle. And belief that valuations are finding their level, right? We've spent a lot of 2023 of buyers and sellers trying to work through matching up on where are clearing levels? What I often like to say as I'm working through the stages of grief that everyone is past denial that the world has changed and we've gone through a correction, but we've been working our way to that final stages of acceptance. So that is going to be the key for next year in achieving that forecast, particularly in the leveraged finance market. We will benefit from the fact that we start to see the maturities pick up in the back half of '24 into '25 and '26, and a lot of issuers and borrowers are going to choose 2024 as an opportunity to start to address those. There's been a little bit of hesitancy on that because of the fact that everyone has locked in low rates or low spreads. So it's been a very good environment. We've gone through the greatest refinancing wave, no one's been in a rush to go out and take that paper out, but they're gonna have to start to address that as time marches on. So we expect as the year progresses, we're gonna see it pickup in the refinancing activity, but again, the key is going to come back to that M&A picture, what the volume's going to be like and what's that going to drive demand for new financings.

Kathleen Darling: Across each of your businesses, are there certain trends you're closely watching? And Kevin, let's start with the debt capital markets.

Kevin Foley: I think what everyone is watching, what's happening with the treasury market. We're running deficits with no end in sight. You've had an environment where banks, foreign governments have been big buyers. The fed has been a big buyer of the treasury market. The regional banks. All of those have pulled back their appetite for treasure issuance at a time when the need for issuance is going to pick up because of funding of deficits. You have treasuries that have been sitting on fed balance sheet that are gonna start to come out without a natural buyer. We watch each auction. We're trying to assess demand and the pickup in supply and how that's going to play itself out. That is going to have an impact on rates, regardless of what the fed is doing. So even in an environment where the fed may be done cutting rates, the fact that you have a anticipated pickup in treasury supply at a time where demand may be pulling back from entities that have been making up the lion's share of the buyer base over the past five years, shifting, that can have a significant impact on rates. So we'll be watching each auction closely starting today.

Kathleen Darling: Achintya, what are you closely watching in regards to the equity capital markets?

Achintya Mangla: I think first, all the points Kevin mentioned are actually gonna impact the broader markets with current equity, so I think treasury markets and the rate trajectory is absolutely critical like it has been in '23. The two additional things I would say are corporate earnings, going back to my earlier point, if inflation does come down, how do corporate earnings fare? And consumer spending. I think we have all benefited from pretty robust consumer spending post-COVID, and I think it'll be interesting to see how consumer spending, business confidence approaches and what the trends are in that direction in 2024. That combined with the treasury aspects Kevin mentioned I think will define, to a large extent, the broader market sentiments.

Kathleen Darling: As we close out the year and this podcast, what is the one take away you want to leave clients with today?

Achintya Mangla: I think the one take away we would leave our clients with, and we'll continue to work with our clients with is really prepare for a higher rate environment, and we alluded to earlier in this podcast, hope for the best, but prepare for what might be less than ideal market conditions, especially when it comes to rates. And I think the thing that we're going to start working with a lot of companies and our clients is the conversation on what the right capital structure is how a capital structure should look like in a higher for longer rate environment is the one that we want all our companies and clients to focus on. And the conversation will go beyond absolute leverage levels. The conversation will include modeling in what could be the higher cost of financings as the debt maturity wall comes closer. The impact on interest costs, debt servicing costs, and therefore, the implied strategy for capital structure. And I think that'll be an interesting conversation and we will work with our clients to anticipate those changes, anticipate the refinancing as they come along and ensure that they're ready for all environments, including rate cuts. Or if indeed the market has or sees less rate cuts, then anticipate it. That would be our best advice, and as always, be nimble as the markets present different opportunities.

Kathleen Darling: And with that, Kevin, we'll round it out with your takeaway for clients.

Kevin Foley: So being a credit person versus the equity person, I'll stick with the hope for the best prepare for the worst, glass half empty folks. But it is don't be complacent. It is take advantage of the environment while it's there. There are reasons to be optimistic. There are reasons to be cautious. Our expectation is at the very least we will see some volatility in these markets, so try to take advantage of the backdrop while it's there and take the money while it's available. We're going to anticipate volatility. At what point, what's the trigger? Hard to say. But there will be plenty of windows of opportunity. There'll be bouts of volatility and that's going to be 2024 in a nutshell.

Kathleen Darling: Achintya, Kevin, it has been a pleasure having you both with us on What's the Deal to provide your insights on both the equity and debt capital markets. We'll definitely stay tuned for the new year to see how markets unfold, so thank you again for joining us.

Achintya Mangla: Kathleen, Kevin, great to speak to you both. And for all our listeners, thank you for listening and have a great holiday season.

Kevin Foley: Kathleen, thank you for having us, and to all our clients out there, thank you for all the trust you've placed in us in 2023, and we look forward to working together in the future, and happy holidays, happy New Year to everyone.

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What’s The Deal? | Ready to navigate market windows?  

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Kathleen Darling: Hello, and welcome back to What's the Deal? I'm your host today, Kathleen Darling, a member of J.P. Morgan's Debt Capital Markets team. I'm excited to welcome back Todd Rothman, a managing director with our Leverage Finance Capital Markets group, to discuss the sentiment and activity in both the leverage loan and high yield markets. Todd, welcome back to the podcast. 

Todd Rothman: Thanks, Kathleen. Great to be back.

Kathleen Darling: We have really seen a pendulum swing in markets over, call it a week's timeframe, so I think it's important to first set the stage for our audience in term of October performance and drivers thereof. When we last spoke with Brian Tramontozzi towards the end of September, he discussed how lenders in the leveraged loan market and investors in the high yield market were showing a constructive bias and a willingness to take on more risk post Labor Day, with supporting market backdrops as evidenced by 58% of loans trading above 99, and the J.P. Morgan Global Dollar High Yield Index sitting at roughly 8.8%, which was 100 basis points inside the high for the year at the time. However, sentiment quickly changed with conflicts arising in the Middle East, the 10 year Treasury crossing the 5% threshold for the first time since 2007, and key economic data coming in hotter than expected, further emphasizing this notion that rates may need to remain higher for longer. Let’s start off by contextualizing for our audience what we saw in both the leverage loan and high yield markets in October?

Todd Rothman: Sure, I'm happy to. I think it's important that we start with the precipitous move that we saw in treasuries. If we go back to the end of September, we had a 10 year that was sitting at 4.6%. If you roll the clock forward to the end of October, we were just north of 5%. That was the first time, as you said, since 2007 that we hit that level. So not only was it a large move in terms of numbers, but also psychologically had a lot of impact on market sentiment. To give you a little bit more context there, if you go back to July, the 10 year was actually just below 4%. So we're looking at 100 basis point move in base rates in just over four months. The ramp that we saw in the 10 year can likely be attributed to really a few things. First and foremost, I think was the economic data that we saw, which pointed to a much more resilient economy than the market was really expecting. And that took both the risk and some of the fear of a recession off the table. The other couple things were around the shear volume of treasuries that need to be issued and some of the supply/demand concerns that the market had there. And finally, what the market's experiencing is a bit of a shift in the buyer base for treasuries. A lot of the typical players, sovereigns and the like that were traditional buyers of treasures are steeping back, and so that's created even further supply/demand imbalance, which has helped pushed rates a bit higher. Away from rates, the other dynamic that we saw play out over the course of September and October was around VIX, or the Volatility Index. In September, we were sitting at multi-year lows of 13 to 14. We saw that climb over 75% to 20 by the end of October. So if you combine the run-up in treasuries, the overall market volatility, the end result was seeing markets trade off fairly meaningfully and fairly quickly. So with that market backdrop, maybe I'll start on the bond market and then we'll move over to the leverage loan market after that. So the bond market, in particular for tight spread BB rated credits, that market is a lot more sensitive to the move that we see in base rates. So if you take that, the market volatility, the way that manifested itself was over an eight-week period, we saw high-yield mutual funds experience outflows of over 12 billion dollars. So you take that, you take the macro backdrop, and the end result was a big move in both the High Yield Index and a slowdown in new issuance. So case in point, the first week of October, we actually didn't see a single high yield bond yield print, you'd have to go back to the regional bank crisis at the end of March for the last time that we saw a regular market week without any issuance. The rest of October, nearly half the deals that did come, they came at the wide end of price talk or wide of price talk, another sign that the market was shifting away from issuers. And then the High Yield Index in secondary, we saw a pretty meaningful move there. We started out at just over 9% in September and we widened out nearly 65 basis points to 9.7% at the bottom on October. Spreads, on the other hand, did offer a bit of solace to issuers. So, at the end of October, we were sitting in around a 475 basis point spread level. If you compare that to historical periods, the average non-recessionary average high yield spread is around 550 basis points. And for recessionary periods, it's 980 basis points. So from a spread perspective, it did look  quite attractive for issuers to enter the market and to raise capital, but we did see a bit of sticker shock set in and a number of issuers saying, "I don't wanna take those higher coupons in this environment. I'm going to wait." The other thing that that told us was, with spreads that tight, the market's probably not pricing in that material or that near term a recession or other geopolitical events that could upset the market. So now, if we turn to the leverage loan market, very similar to what I described on the high yield bond side, September was a really robust for leverage loans. So, a couple things to note that were going on. One, we had very strong CLO formation, one of the strongest months that we've seen of the year. We had north of 26% of the loan market trading above par in secondary, so a really strong sign for the robustness of the market there. And the end result of all that, between new CLO formation, a strong secondary market, we actually saw two things happen. One, we had one of our highest volume months of the year in terms of new facilities. We had roughly 59 billion dollars come through the market. That compares to a monthly average this year of just about 25 billion dollars. The other thing going on was 40% of that volume was actually related to term loan repricing, to where we took the margin down from existing levels for borrowers. Roll the clock forward to October, and similar to what I talked about tin the high yield bond market, a lot of the same outcomes happened here. So, we went from 26% of the loan market trading above par all the way down to 4%. We went from 40% of deals being repricing related down to no repricing deals at all. And the other thing that we saw, very similar to the bond market, 50% of the loans that did price in October came at the wide end or wide of price talk.

Kathleen Darling: Great. Now, taking us to present day, the 10 year Treasury
rallied roughly 30 basis points since October, 27th, closing out the week of October 30th at around 4.5%. This rally was largely driven by the Fed choosing to hold rates steady at their November 1st meeting, overall softer labor data, and a smaller than anticipated treasury refunding size. Can you talk about how markets have responded to this?

Todd Rothman: Sure. So, I think the Fed holding rates steady was really already priced in by the market. Some of the comments by Chairman Powell, however, did point towards a move dovish tone as he mentioned that their efforts to bring down inflation had made meaningful progress and that they'd continue to monitor the data to see their path forward. With that sentiment, traders are now pricing in a virtual certainty that the Fed is going to hold rates steady in December. That's only picked up in recent weeks as we've seen more data, seen more Fed speak. And this view is also in line with J.P. Morgan economic forecast that the Fed is likely to hold steady on rates for the remainder of this year and then start to take action late in 2024 with their first-rate cut. In conjunction with the Fed meetings last week, we've seen payroll data, jobs data that continues to point towards a message that the market is believing is saying the Fed is likely done, and if they're not done, they're close to done in terms of rate hikes. And it's also provided more comfort to the market that a recession is not a near term event, and that if there is one, it is more likely than not to be a soft landing than a hard landing. So the result of the economic data and treasury tightening has been that we've seen a big rally in secondary markets, both in the high yield bond and the leverage loan side over the course of the past week. The hope here is that that is going to start moving some issuers on the bond side to come of the sideline to address their refinancing needs. And we've already started to see that a fair bit this with a big pickup in volume versus last week. The High Yield Index, from a secondary standpoint, has also proved this out, so we've seen a meaningful 60 basis point move down to inside of nine and a quarter percent on the J.P. Morgan High Yield Index. And then on a similar note, we saw high yield spreads tighten roughly 35 basis points last week as well, so those now sit around 450 basis points. Back to my comment earlier, that's still sitting well below recessionary and non-recessionary levels. And then on the loan side, we've seen the exact same thing. So after having 11 consecutive sessions of secondary loan levels trade downwards, we saw secondaries start to trade up towards the end of last week, and that's continued into this week. Case in point, back to my stat around loans trading above par again, so if we bottomed out at 4% in October, we're now back up to 10% of loans trading above par, not quite at the 26% that we hit in September, but potentially signaling the beginning of September part two for the loan market as well.

Kathleen Darling: If we think about it, there're really two market windows before year-end for companies to transact, roughly two weeks before Thanksgiving, and then call it three weeks before the December holidays. What is your message to companies now in terms of executing on these windows of opportunity?

Todd Rothman: So, the first message is that markets are completely open right now. What we're talking about is optimization on pricing and terms, and what we constantly remind our borrower and issuer clients is that volatility can rear its head at any time, and if you need the money, go take it when it's there. So some of the themes that we talked about last time, Kathleen, you and I spoke, and throughout the year, on the loan side, we still talk about roughly 40% of CLOs reaching the end of their reinvestment period at the end of this year. That'll grow to slightly more than half at the end of next year. The good news is, as I mentioned before, September and the end of the summer were really good new CLO formation windows. Slowed down a bit in October, starting to pick up again in November. But the question for the loan market remains: will new CLO formation be able to completely make up for the amount that is going out of reinvestment period? And as a reminder, CLOs make up about two thirds of the buyer base for leverage loans. So on the loan side, we continue to encourage our borrower clients that there is a first mover advantage to taking care of your refinancing needs or any capital raising needs that you have today when you know what the market looks like. Similarly, on the bond side, for several quarters we've been talking about above average cash balances that high yield mutual funds were sitting on. When we got to the end of Q3, for the first time in a couple of years, we actually dipped below the longterm average, and we're kind of sitting around three and three quarter percent cash balances right now, still very good, but not as lofty as it was before. What is helpful for the technical and the high yield bond market is that we've had a number of repayments, and then you've also had a number of large rising stars that exited the high yield market as they migrated up to the investment grade market. So as I said before, markets are open, there is cash out there. The buy side is waiting for new deals to come through. The final point to take into consideration there is that we have a really, really light M&A pipeline of underwritten deals that are due to come to market. If you look at that across both loans and bonds, in the US, it's only roughly 11 billion dollars. If you add Europe in, it's only another couple billion euros. Compare that to the post-COVID peak in 2022, we hit 110 billion dollars then. So, the pipeline here is really, really small, which means that the cash is looking for a home and does create good conditions for borrowers to access the loan market and issuers to access the high yield bond market.

Kathleen Darling: As we wrap up this episode, there's approximately 740 billion of 2025 and 2026 maturities across leverage loans and high yield bonds. As companies move towards year-end and start planning for calendar year 2024, do you have any thoughts on how companies with either a 2025 or 2026 maturity should be thinking about addressing these?

Todd Rothman: So, it's really interesting. Obviously, we've dealt largely with 2023 and 2024. I don't think most people realize that we've already addressed a third of the 2025 maturities with refinancing activity that we've done over the course of this year. What surprises a number of people is the shear number of companies that are already proactively looking at 2026 as well. Close to half of what we've done this year has not only addressed '24 and '25 maturities, but actually started going after 2026 maturities as well. So, we continue to encourage our borrower and our issuer clients to think along those lines. We talked about the CLO reinvestment period fall off. So in terms of addressing the remaining 2025 and 2026 maturities, and by the way, I think by the time we get into next year, we may start talking about 2027 maturities as well, the themes remain the same. So, we just talked about the CLO reinvestment period and the importance for borrowers in that market to take advantage of the first mover advantage that's out there. On the high yield bond side, one of the trickiest things we've had to manage as treasuries have continued to gap out, even though spreads have remained relatively tight, we've had to get a number of high yield issuers comfortable with the concept that a 6% and change coupon that was available a year ago had become 7% and change this year, and now, in some instances, may be as high as 8% or higher. October was the first month that we saw the BB High Yield Index close above 8% since 2009. And so, one of the things that we remind people of is that we are in a higher rate environment, and even if one does believe in the concept that rates are going to start getting cut towards the backend of next year, the shear volume of treasury issuance that needs to take place means that base rates are likely to remain higher for longer, and therefore this is a new normal in terms of pricing dynamic for issuers in the high yield market. And finally, windows are going to come and go. I think one of the key lessons that we've learned here post Labor Day, September was a great borrower and issuer friendly month to access the loan and the bond market. October was really volatile and became a less hospitable environment for people to raise capital. Markets were open, it was just more expensive. And so, encourage everyone to remember that volatility isn't going away, get ready to go to market, and look to hit a window as soon as they open. The risk feels asymmetric in terms of cost of capital going wider a lot more than it gets tighter.

Kathleen Darling: Todd, thank you for the thorough read on the markets. Although we do not know what is to come of tomorrow, the current backdrop and supporting technicals seem to support a promising pathway to end the year for both the leverage loan and high yield markets. We will very much be looking forward to activities ahead. Todd, thanks so much for joining the podcast today.

Todd Rothman: Kathleen, thanks for the discussion. As always, enjoyed it.

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