Podcast Summary
This podcast features Armen Panossian, head of Oaktree Capital Management performing credit platform, discussing the current state of the credit market. The conversation covers a range of topics, including the decrease in the average debt to EBIT ratio for US leverage credit, the potential risks in the leveraged credit markets, and the impact of rising interest rates on companies with unsustainable capital structures. The podcast also delves into the differences between high yield bonds and leverage loans, the expected increase in downgrades for weaker single-B rated loans, and the opportunities for distressed debt investors and skilled performing credit managers.
Key Takeaways
Debt to EBIT Ratio and Interest Coverage Ratios
- Decrease in Debt to EBIT Ratio: The average debt to EBIT ratio for US leverage credit has decreased from a high of 6.5x in 4Q 2020 to around 4x at the end of the second quarter of 2023. This indicates a reduction in the level of debt relative to earnings before interest and taxes.
- Stable Interest Coverage Ratios: Interest coverage ratios for US high yield bonds and US leverage loans are currently at 5.3x and 4.5x respectively, which is not causing concern. These ratios measure a company’s ability to meet its interest payments and a higher ratio indicates better financial health.
Risks in the Leveraged Credit Markets
- Focus on Tail Risk: There is a focus on tail risk in the leveraged credit markets, particularly for the weakest cohort of borrowers. Many companies borrowed excessively when interest rates were low, creating unsustainable capital structures now that rates have risen by over 500 basis points.
- Increased Defaults and Volatility: If tail risk becomes a reality, there is a higher risk of increased defaults, lower recovery rates, and temporary volatility for both performing and distressed credit investors.
High Yield Bonds vs. Leverage Loans
- Difference in Quality: There is a significant difference in quality between high yield bonds and leverage loans, with a higher proportion of double B rated debt in the high yield bond market. Single B rated debt accounts for approximately 65% of the leveraged loan market.
- Expected Increase in Downgrades: Downgrades are expected to increase for weaker single-B rated loans if borrowers’ earnings continue to weaken.
Opportunities for Distressed Debt Investors
- Quadrupled Potential Dislocated Debt: The global universe of potential dislocated debt has quadrupled since the Global Financial Crisis, providing opportunities for distressed debt investors and skilled performing credit managers.
- Smart Credit Risks: Credit investors should limit duration and take smart credit risks, as short-duration debt with some credit risk has outperformed in 2023.
Technical Factors Benefiting the High Yield Bond Market
- Support from Issuer Fundamentals: Technical factors, such as issuer fundamentals, have supported prices in the leverage loan market and now a similar trend is seen in the high yield bond market.
- Negative Impact of Interest Rate Spike: Demand for high yield bonds has been negatively impacted by the spike in interest rates, while supply has also been declining.
Sentiment Analysis
- Bullish: The podcast expresses a bullish sentiment towards the credit market, highlighting the decrease in the average debt to EBIT ratio for US leverage credit and the stable interest coverage ratios. The discussion also points out the opportunities for distressed debt investors and skilled performing credit managers, indicating a positive outlook for these market participants.
- Bearish: However, there is a bearish sentiment towards the leveraged credit markets, particularly for the weakest cohort of borrowers. The podcast discusses the potential risks associated with tail risk and the impact of rising interest rates on companies with unsustainable capital structures. The expected increase in downgrades for weaker single-B rated loans also contributes to this bearish sentiment.
- Neutral: The podcast maintains a neutral sentiment when discussing the differences between high yield bonds and leverage loans. While it acknowledges the difference in quality between the two, it does not express a clear preference for one over the other.
