Picture this: cheap but not entirely cheerful

Loan market valuations look attractive, but beware pockets of weakness.

Jan 22, 2024

22 January 2024. Ninety One’s Multi-Asset Credit team explains how loans have lagged the recent rally in credit markets to create compelling valuations but warns investors to take care to limit exposure to an increasingly vulnerable segment of the mark.

The context

Leveraged loans and CLOs (which package up a portfolio of loans) were a great source of return for active credit investors in 2023, given their floating-rate nature against a backdrop of rising rates. Furthermore, loan spreads have lagged the recent rally in credit markets to create compelling valuations. But the backdrop that helped loan investors harmed loan borrowers, which feel the pain of rate rises relatively early. As a result – and despite surprising macroeconomic resilience supporting corporate fundamentals overall – pockets of the loan market appear to be suffering.

Jeff Boswell, Head of Alternative Credit, Ninety One: “Since mid-2022, a fall in interest coverage levels* is a key reason why loan downgrades by rating agencies have consistently outpaced upgrades. In 2023, the overall ratio of upgrades to downgrades was 0.5x in the US loan market – much worse than the 1.3x seen in the US high-yield market. As the chart shows, rating trends were weaker at the lower-rated end of the market.”

The CLO market has also seen these downgrades feed through to riskier tranches, but overall downgrade rates remain low. This is thanks to the in-built structural protection in CLOs, with diversified underlying portfolios helping to limit idiosyncratic risk. Further support comes from favourable deleveraging dynamics in the CLO market, as managers are increasingly returning cash to investors (as discussed here).

The conclusion

While valuations of CLOs and loans look broadly attractive, but Boswell warns that investors need to take care to limit exposure to a deteriorating tail of the market.

Boswell adds: “The less-impacted CLO market remains an appealing route to access leveraged loan exposure; we particularly like short-maturity CLOs, which are benefiting from a deleveraging tailwind. However, investors shouldn’t write off leveraged loans completely; parts of the market remain compelling – here, we think high-quality, short-dated loans continue to offer attractive yields with limited credit risk.”

*JP Morgan recently estimated that 9% of loans borrowers had interest coverage levels (EBITDA/interest expense) below 1x in 3Q 23, and 37% had coverage between 1x and 2x. This compares to 8% and 14% at the end of 2021.

Jeannie Dumas

Communications Director (ex-Africa)

Laura Henderson

Communications Manager

Important Information

This communication is provided for general information only should not be construed as advice.

All the information in is believed to be reliable but may be inaccurate or incomplete. The views are those of the contributor at the time of publication and do not necessary reflect those of Ninety One.

Any opinions stated are honestly held but are not guaranteed and should not be relied upon.

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