Over the past decade, the hunt for yield has generated significant liquidity in the credit markets. It has also distorted the relationships between spreads and risk. Debt leverage remains high (particularly in M&A transactions, which continue to spur market issuance), while spreads, which have widened recently, remain at historic lows.
While default rates currently remain innocuous, the combined pressures of inflation and rising interest rates indicate rising headwinds for credit markets. On a global scale, 2022 will likely be characterized by more limited access to, and a higher cost of, credit. We expect credit quality deterioration and default pressures among low-rated or unrated borrowers as financing conditions tighten.
The increasing risk of defaults raises the specter of declining recovery rates. The position of senior secured lenders in the capital structure has steadily weakened over the past decade. A lifetime ago, senior secured meant that recovery loan investors could expect 90% or better ultimate recoveries. Senior secured was senior and secured. The erosion of lender protections in loan documentation has muddied those waters.
We have already seen how the deterioration in lender protections has hindered investors during restructurings—J. Crew, Neiman Marcus, Serta, and Diamond Sports are all examples. An orderly restructuring process is likely to become the exception, not the rule. Today, not unlike Roger Maris’ home run record, the senior secured ranking has an asterisk after it. And what that asterisk will do to recoveries remains to be seen, but there’s significant risk that it will erode the status and the related recovery of senior secured lenders.
This Global Leverage Finance handbook digs into these various issues, asking challenging questions and providing data insights.
Ruth Yang
Managing Director
Global Head of Thought Leadership
