European Loans
Strong technical and healthy fundamentals to continue supporting robust returns
Following another strong year for the European Loan market, underpinned by record-breaking demand and low, declining defaults, we remain bullish on the outlook for 2025. Looking forward, we expect a continuation of the supportive trends we saw in 2024. Demand for the asset should remain strong, with a healthy pipeline of Collateralised Loan Obligations (CLOs) expected to come to the market. Supply will continue on a similar trend, with potential for a pick-up in H2 as M&A volumes increase.
Exhibit 1: Below long-term average default outlook
Source: S&P ELLI report & CS-WELLI ex-USD, as of 31 December 2024.
We expect defaults to remain low and well below long-term averages in 2025, given the stable macro backdrop, comparatively low levels of stress, as well as robust issuer fundamentals. The latter will be further supported by our expectation that the European Central Bank (ECB) will continue to gradually reduce interest rates. Spreads and yields remain at attractive levels and with low levels of market stress, make for a very compelling entry point to the European Loan market as we enter 2025.
Global High Yield
Supportive fundamentals and default outlook should bolster coupon-like returns
Global Developed High Yields (HY) recorded a solid 2024, driven by supportive corporate fundamentals (low defaults and robust supply/demand dynamics). European HY returns slightly edged out US HY, helped by stronger spread compression across European credit quality.
Exhibit 2: Subdued defaults likely to continue into 2025
Source: JPM US Leveraged Loan and & European HY Issuer Par-Weighted Default Rate including distressed exchanges. Nov 08 – Dec 24.
In 2025, we anticipate a positive year with coupon-like returns. Developed market defaults should remain comfortably below long-term averages given firm fundamentals and a supportive macro-economic environment in the United States and likely supportive ECB policies. We anticipate benefits from renewed capital market activity (increased M&A issuance). The developed
markets’ underlying credit quality and composition continues to remain firm, evident by elevated exposure in higher-rated and secured debt.
European Direct Lending
Significant fresh Direct Lending dry powder needed to finance P/E requirements
In 2024, the European Direct Lending sector adeptly navigated higher interest rates and economic uncertainty. Borrowers and managers adjusted by shifting towards more conservative structures, favouring senior secured cash pay debt with some use of junior instruments, deeply subordinated and capitalising interest.
For 2025, direct lending, with properly set financial covenants, may continue to offer strong risk-adjusted returns relative to other traditional asset classes.
An increase in European deal volume is anticipated due to private equity dry powder at a record €351 billion, which boosts opportunities for leveraged lending as sponsors seek financing for buyouts. Fresh direct lending dry powder is required to stay in line with loan to value market norms.
Exhibit 3: Private Equity dry powder – strong demand for Direct Lending
Source: Preqin, European as of March 2024. Private Equity includes Balanced, Buyout, Co-investment, Co-investment Multi-Managers, Fund of Funds, Hybrid, Hybrid Fund of Funds, and PIPE strategies. Direct Lending includes Senior, Unitranche, Blended/Opportunistic, Junior/Subordinated.
Expected significant rate cuts and a narrowing of buyer/seller valuation expectations will likely spur new buyout activity.
European Special Situations
Macro headwinds driving continued dispersion and supply of stressed opportunities
The weaker part of the credit market is struggling to meet upcoming maturities against a backdrop of anaemic economic growth and pockets of rising unemployment, alongside vulnerabilities connected to deglobalisation and the imposition of tariffs.
Consequently, CCC downgrades ticked up across Europe in the latter half of 2024 and yields of CCC rated notes are close to historical wides vs higher rated notes. Similarly, dispersion between CCC rated notes in the European Union has been increasing vs the US since 2022.
Exhibit 4: Continued dispersion of US and European lower-rated credit
Source: Bloomberg, ICE BofA Euro High Yield Index & ICE BofA US High Yield Index. As of 31 December 2024.
The European market for stressed credit has grown to around €104 billion, based on the share of traded credit yielding above 12%. Unlike many past cycles, there is a diversity of opportunity across multiple sectors, some of which have historically been defensive such as tele-communications, utilities and healthcare.
As a result, the opportunity set in European Special Situations promises to be active once again in 2025 and we continue to see a strong flow of secondary trading as well as rescue financing opportunities from bank debt and private credit led situations.
Global Structured Credit
Elevated carry set to continue driving record CLO supply
2024 delivered strong CLO performance driven by solid technicals, high carry and supportive credit fundamentals. CLOs globally experienced record gross supply. Despite this, US AAA supply was negative due to elevated levels of amortising / redeeming CLOs. This combined with strong demand from US/Asia banks drove US AAA spreads tighter which is a dynamic we expect to continue into 2025. Conversely, Europe experienced much higher net AAA supply against a backdrop of weaker demand.
Exhibit 5: Strong technicals led by historically low US net supply
Source: BSP-Alcentra/Intex. Data as of December 31, 2024. Net Supply is the change in amount outstanding per month of AAA USD CLOs.
Credit spreads encroached on record tights, but CLOs lagged and notably have more room to tighten, especially in Europe. EUR AAs and Single-Bs remain our top value picks into 2025. As 2025 looks likely to be another record-breaking gross supply year, the CLO manager base continues to grow, and US rates likely to be higher for longer, we expect continued demand for floating rate CLO tranches.
We expect credit fundamentals for loans to continue to be softer in the US vs EU. Higher US rates will likely put pressure on the free cash flow of underperforming borrowers. Whilst we expect muted macro growth in Europe, expected rate cuts will result in fewer credit issues, but the default rate will rise from the current low run-rate. Despite the strong demand, record supply and rising defaults could lead to pockets of volatility in 2025. Tail risk in the loan markets remains and will continue to drive dispersion, more so in the US vs EU.
Global Multi-Asset Credit
Evolving central banks and fiscal policies offer compelling value creation
Sub-investment credit markets generated strong returns in 2024 though global high yield and loans pathways were less linear given evolving technicals and differing central bank policies. For multi-credit mandates, this environment was ripe for stronger returns. To begin 2025, we continue
to favour floating rate global bank loans for the incremental yield and spread advantage relative to fixed HY. Global HY should generate coupon-like returns in 2025. We also remain positive on alternatives, particularly toward CLOs.
Exhibit 6: High income sub-investment grade opportunities given subdued default outlook
Source: Alcentra, CS, ECB, ICE, JPM and Bloomberg, 31 December 2024.
Global trade wars potential, resultant inflation pressure and global central bank divergence are some 2025 challenges. We remain vigilant on security selection, focused on issuers with defensive cashflows, strong margins and less sensitivity toward tariff impacts. Given strong technical alongside stable underlying fundamentals (positive earnings and a modest default outlook), we see multi-credit funds generating solid returns driven by income and boosted by tactical allocation within liquids and alternatives.
DEFINITIONS
Collateralised Loan Obligations (“CLOs”) are tranches of debt securities backed by Senior Secured Loans to US and European corporates.
Free cash flow represents the cash a company can generate after accounting for capital expenditures needed to maintain or maximize its asset base.
Credit Suisse Western European Leveraged Loan Index excluding USD: A multicurrency index tracking term loans syndicated to European loan investors, excluding USD denominated loans.
Credit Suisse (US) Leveraged Loan Index: Tracks the investable market of the U.S. dollar denominated leveraged loan market. It consists of issues rated “5B” or lower, meaning that the highest rated issues included in this index are Moody’s/S&P ratings of Baa1/BB+ or Ba1/BBB+. All loans are funded term loans with a tenor of at least one year and are made by issuers domiciled in developed countries.
ICE BofA US High Yield Index is an index which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market.
“ICE BofA US High Yield Index is an index which tracks the performance of US dollar denominated below investment grade rated corporate debt publicly issued in the US domestic market.
J.P. Morgan USD HY CLOIE Index tracks the performance of USD- denominated broadly syndicated, arbitrage collateralized loan obligations that are BB and Single-B rated.
ICE BofA European Currency High Yield Index is designed to track the performance of euro- and British pound sterling-denominated below investment grade corporate debt publicly issued in the eurobond, sterling domestic or euro domestic markets.
ICE BofA Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets.
ICE BofA US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued and settled in the US domestic market.
ICE BofA HG EM Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities rated AAA through BBB3, inclusive. ICE BofA Emerging Markets Corporate Plus Index tracks the performance of US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. In order to qualify for inclusion in the Index an issuer must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the U.S. and Western European countries. The FX-G10 includes all Euro members, the US, Japan, the UK, Canada, Australia, New Zealand, Switzerland, Norway and Sweden.
WHAT ARE THE RISKS?
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Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor's ability to dispose of them at a favourable time or price. Past performance does not guarantee future results.
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