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5 min read
The loan market has undergone significant structural shifts in 2023. Economic uncertainties and rising interest rates have changed borrower needs, lender priorities, and approaches to constructing deals. Private lending has had the most significant impact by capturing market share from traditional commercial banks and broadly syndicated lending. These private loans grow more flexible and customized with each passing year.
Private lending is also affecting downstream activity. For example, collateralized loan obligations (CLOs) bundle privately originated assets rather than broadly syndicated ones. Banks now participate in loans arranged by private firms and make further inroads trading on secondary markets.
As a result, participants across the market must adapt to new complexities or risk falling behind rivals. Macroeconomic changes are likely to continue into 2024. Loan stakeholders must stand ready to adapt. Needs and expectations for services delivered by providers such as agents and trustees will continue to change throughout 2024.
Unfinished Business
Central banks have by no means finished their efforts to tamp down inflation. Although inflation has cooled and consensus around future rate cuts has emerged, other data, such as continued labor market strength or the risk of energy cost spikes, make the timing of rate cuts hard to pin down precisely. Per Wilmington Trust’s 2024 Capital Markets Forecast, “Looking out over the next three to five years, a number of factors will coalesce to keep average inflation at or slightly above the Fed’s target.”
At the same time, expectations for recessions in the U.S., Europe, or the UK lingered throughout 2023. While pessimism has generally softened, it has not reversed into full-blown optimism for 2024. Caution prevails.
Other major 2023 factors still loom over the coming year. Geopolitical flare-ups from Eastern Europe to the Middle East to the U.S. presidential election contribute to unease. Some economists expect housing and labor markets to suffer pronounced impacts. Wilmington Trust sees a roughly 60% probability of a soft landing.
Overall, these macroeconomic uncertainties cast a shadow on loan market outlooks. If recessionary tremors continue, corporate borrowers will face heavier debt burdens due to higher-cost loans. Prospects for upticks in distress scenarios and defaults persist.
However, the situation differs from 2008 in several critical ways. Liquidity remains ample. Private credit adds flex to the market with more opportunity to extend amend, or restructure deals than in past cycles. Structural shifts make room for creative solutions, provided stakeholders remain agile and adaptable to what emerges in the coming year.
Structures and Players in Transition
In “Leveraged Loans: A Market in Transformation,” we explored whether private lenders would put more pressure on banks in primary deals. Hybrid financing has also continued to restructure the loan market with seemingly infinite combinations of private and bank participation. Our team is seeing recent efforts from some banks to partner with private credit originators rather than lose the upside in debt capital markets altogether,
Whereas syndicated loans once centered on standardized terms, private transactions involve bespoke structures. Lenders have the flexibility to tailor terms to individual borrowers. Because Basel III regulations require banks to meet higher capital reserve and liquidity coverage ratio requirements, they must limit the loan assets on their balance sheets relative to deposits and equity capital. Therefore, they are unable to match private lenders.
Conditions for 2024 resemble periods of Earth’s history where rapid evolution and diversification created massive numbers of new species. As private lenders capture market share from traditional banks, they change the DNA of loan construction. Deals grow more complex and customized—the coming year will be no exception.
Transition Tradeoffs
Deal customization brings flexibility, but it also brings complexity to the loan market. Handling one-off deals with intricate, unique stipulations may strain operations built for efficient, consistent processing at a global level. The resulting rigidity can make it more challenging to manage portfolio exposures and risks. Some players will still rely partially on manual reviews because they cannot innovate as quickly as the market evolves.
However, we firmly believe innovation and automation will set the loan servicing agenda for 2024. It is now a necessity rather than an option. Service providers must lean aggressively into technology and process transformation efforts.
Reporting is a compelling case in point. Managers and investors need visibility into deals, while high levels of customization risk becoming opaque. Many also need aggregated data across entire portfolios rather than siloed reports. Custom deals make “apples-to-apples” analysis more challenging. In addition to transparency, accuracy, timeliness, and accessibility in loan data and reporting, they need new ways to analyze risks and returns.
In this context, embedding data into static reports strains resources and makes extracting data for new insights harder. One intriguing prospect for 2024 will be a potential shift in emphasis toward efficiency—easily and seamlessly ingestible data that enables flexible, self-service insights. Recipients can thereby tailor and refine dynamic data views rather than wading through static reports. This possibility changes the role of a service provider from report creation to data delivery.
A CLO Snapshot
We hear several common themes in conversations related to the CLO market and 2024 expectations. Clients and market analysts at recent industry events have told us they believe CLO issuance will remain broadly consistent with 2023 levels. Given the structural transformation of loan supply, growth is more likely with middle market collateralized loan obligations (CLOs) over their broadly syndicated counterparts. Managers are already creating CLOs holding privately originated assets rather than traditional syndicated loans.
However, smaller CLO managers may continue to face consolidation pressure. Permanent capital vehicles have an advantage in giving CLO managers access to reliable equity to issue multiple CLOs. However, those managers who rely on deal-by-deal equity financing may tend to struggle to launch CLOs as consistently over time. The steep corporate debt maturity wall could also further jeopardize managers’ ability to redeploy principal paydowns into new collateral. These factors, along with market uncertainties, threaten the reinvestment engine driving most CLO returns.
Moving Forward
As we enter 2024, we will continue to track the evolving macro and structural dynamics reshaping corporate lending. From macroeconomic uncertainties to the rise of private credit to demands for sharper transparency, we expect an active year ahead.
As such, we remain committed to helping clients navigate risks, capitalize on opportunities, and transform operations as needed. Please reach out to discuss how we can support you with transactions in 2024’s shifting loan landscape.
Wilmington Trust’s domestic and international affiliates provide trust and agency services associated with restructurings and supporting companies through distressed situations.
Not all services are available through every domestic and international affiliate or in all jurisdictions. Services are available only to institutional clients, (i.e. Eligible Counterparties or Professional Clients as defined by applicable regulations), and not for Retail clients.
This article is intended to provide general information only and is not intended to provide specific investment, legal, tax, or accounting advice for any individual. Before acting on any information included in this article you should consult with your professional adviser or attorney. Facts and views presented in this report have not been reviewed by, and may not reflect information known to, or the opinions of professionals in other business areas of Wilmington Trust or M&T Bank. M&T Bank and Wilmington Trust have established information barriers between their various business groups.
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