Credit Market Outlook

Market volatility is on the rise, and credit manager selection is more important than ever.

Market Volatility on the Rise

2018 saw an increase in market volatility, driven by the growing possibility of trade wars, uncertain and opaque U.S. government / public policies, increasing interest rate & inflation, and European political instability.

Weakening Credit Metrics

Covenant lite (“cov-lite”) loans are loans that are typically issued with fewer restrictions on the borrow and fewer protections for the lender. Cov-lite loans continue to dominate the U.S. leveraged loan market (currently representing more than ~85% of all institutional loans are cov-lite).

Corporate leverage has increased to higher than pre-crisis levels, along with debt to EBITDA levels increasing a full turn (4.0x to 5.2x) from 2009.1 As a result, cov-lite underwriting and overall weakening credit metrics could limit recoveries when cycle shifts.

Liquidity Currently Ample and Cheap

Liquidity is currently near all-time highs as more investors have rushed into leverage lending markets in the search for yield, which has caused increased issuance and tightening yields.

Ample and cheap liquidity has allowed many weak entities to refinance.

Borrower friendly credit-agreements and refinancings could potentially prolong the survival of distressed companies, delaying defaults.

This is reflected by the current low default rate during times of heightened corporate debt; potential for defaults will increase when cycle turns as these companies become vulnerable.

Interest Rates Continue to Increase

“Over the past year the economy has been growing, the unemployment rate has been near record lows…it is likely that the economy will grow in a way that will call for two interest rate increases next year.” - Federal Reserve (Fed) Chairman Jerome Powell
(December 19th, 2018)

The Fed lifted its benchmark rate in December for the 9th time, to a range of 2.25% to 2.50%.

Spreads Have Compressed

In recent years, spreads have compressed across U.S. Middle Market Lending and virtually all fixed income markets, continuing a long trend. The risk free-rate however, as noted above continues to increase.

What Does This Mean?

We believe key drivers in determining the success of a credit investment portfolio are thoughtful opportunistic investment strategies and differentiated credit selection capabilities

In our view, it’s imperative to invest with a Manager that has:

  • Invested Through Past Cycles
  • Differentiated Credit Selection Capabilities
  • Offers Opportunistic Investment Strategies
  • Global Platform
  • Flexibility to Change Investment Approach Based on Market Dynamic

How OFI Carlyle Private Credit Fund Seeks to Take Advantage?

Stressed Opportunities: 
Secondary purchases of mispriced, stressed liquid credits in periods of market volatility or dislocation. May include loans, bonds, Collateralized Loan Obligations (CLOs) tranches and other liquid credit instruments

Distressed Non-Control Opportunities:
Opportunistic secondary purchases of distressed non-control debt investments at a deep discount to intrinsic value where there is a low likelihood of gaining a control position. May include failed bank syndications where credit securities can be purchased at discounts to intrinsic value due to technical issues

Special Situations:
Provider of credit financing to borrowers undergoing some type of idiosyncratic distress and/or dislocation. May include situations involving over-levered balance sheets, closed capital markets or company-specific issues

Key Takeaways – We Believe

  1. Volatility Creates Opportunity
  2. Manager Selection is Incredibly Important
  3. Carlyle Credit is Well Positioned in All Cycles
  1. ^ LCD Quarterly Review, Q4 2018

It is important for investors to consider the risks specific to investing in private credit. These include but are not limited to certain credit risks and risk from other factors such as perceived liquidity, quality of the borrower, credit risk of counterparties and subordination of debt. Credit instruments that are rated below investment grade (commonly referred to as “high yield” securities or “junk bonds”) are regarded as having predominantly speculative characteristics with respect to the issuer's capacity to pay interest and repay principal. Some credit instruments will have no credit rating at all. A private credit fund's liquidity is limited regardless of how the fund performs and may decline unpredictably in response to overall economic conditions or credit tightening. Debt or equity securities held by a private credit fund may be subordinated to substantial amounts of senior indebtedness, a significant portion of which may be unsecured. During periods of financial distress or following an insolvency, an issuer's ability to influence affairs is likely to be substantially less than that of senior creditors. Accordingly, private credit funds may not be able to take the steps necessary to protect fund investments in a timely manner or at all. Private credit funds may be non-diversified investments which may be more susceptible to an adverse event affecting a portfolio than diversified investments and a decline in the value of that non-diversified investment would cause a fund's overall value to decline to a greater degree.

S&P/LSTA Leveraged Loan Index (Bank Loans): This is a market value-weighted index designed to measure the performance of the U.S. leveraged loan market based upon market weightings, spreads and interest payments. New issues are added to the index if they qualify according to the following criteria: loan facilities must be senior secured; minimum initial term of one year; US dollar denominated; minimum initial spread of LIBOR + 125 basis points; $50M initially funded loans.

Bloomberg Barclays U.S. High Yield Corporate Index (High Yield): Barclays US Corporate High Yield Index represents the universe of fixed rate, non-investment grade debt. Eurobonds and debt issues from countries designated as emerging markets (e.g., Argentina, Brazil, Venezuela, etc.) are excluded but, Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. Original issue zeroes, step-up coupon structures, 144-As and pay-in-kind bonds (PIKs, as of October 1, 2009) are also included. The index includes corporate sectors. The corporate sectors are Industrial, Utility, and Finance, encompassing both US and non-US Corporations. An investment cannot be made directly in a market index.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately USD 3.4 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

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