CMP Overview

Credit markets finished 2023 very strong, with spreads closing near their tights for the year despite historic rate volatility, a short-lived regional banking crisis, and an overall increase in default activity.

In corporate credit, the U.S. and European high yield markets posted positive returns in the fourth quarter – extending positive performance to achieve double-digit full-year gains – and U.S. and European high yield bond spreads both tightened. Of note, the tone in the market shifted drastically in the fourth quarter, as prevailing expectations moved away from a higher-for-longer interest rate environment and toward an increased likelihood of a soft landing, with earlier and more aggressive easing by the Fed. This shift drove the 10-year Treasury yield to fall to 3.87% after topping 5% in mid-October. Within U.S. high yield, the trailing 12-month default rate, including distressed exchanges, increased to end December; given this sequential elevation, the default rate closed the year at a more normalized mid-cycle level. Within leveraged loans, December brought a price rally that resulted in record levels of loans trading above par, triggering a refinancing wave that boosted issuance volume in the fourth quarter and has continued at a feverish pace into 2024.

In structured credit, home prices continued to rise and RMBS spreads mostly continued to tighten during the fourth quarter. The average 30-year fixed mortgage rate in the U.S. dropped to 6.4% at the end of the year, down from a high of 7.8% at the end of October – the highest level since 2000. Supply of homes remained constrained, with the well-publicized “lock-in effect” limiting sales of existing homes and new listings below historical averages. In asset-backed securities, spreads were mostly tighter in the fourth quarter. Consumer performance data has generally been within underwritten expectations, but certain sectors are now underperforming pre-pandemic levels. In commercial real estate debt, the rally in the 10-year Treasury yield sparked life into the CMBS market through year-end. The prospect of lower interest rates, stable to improving operating fundamentals, and tighter spreads had CMBS originators and issuers more active to end 2023.

Direct lending M&A volume in the final quarter of 2023 was the highest it has been since the fourth quarter of 2022, with activity up across all three segments of the middle market. All-in yields increased and were highest for the lower and core middle markets. Additionally, interest coverage ratios have remained stable, suggesting borrowers have been able to manage the elevated rate environment by passing through or cutting costs.

Turning to real estate, with the worst of global inflationary concerns seemingly in the rearview mirror, market participants are taking stock of the aftermath. Real estate investment volumes declined meaningfully through 2023, making price discovery increasingly challenging during the year. Challenges related to limited financing availability, the rising cost of debt, and overall uncertainty regarding valuations kept many investors on the sidelines as the market witnessed significant downward pressure on real estate valuations. However, an increased level of clarity on go-forward rate movements from global central banks should be a catalyst to improve investment activity, and it is expected that we will see bid-ask spreads decrease and clarity on valuations increase moving ahead. Importantly, underlying real estate fundamentals have generally proven resilient – save for U.S. office – which should provide a ballast to the sector. That said, the dynamic of elevated debt maturities over the coming years paired with substantially higher interest rates is expected to create opportunities to identify high-quality assets at reset valuations.

In the U.S., consensus is pointing to a soft landing following a period of rapid interest rate increases. With greater clarity on the horizon, market participants expect to see a more active investment environment in 2024 following a 51% year-over-year decrease in investment volume in 2023. Valuations continued their downward trend in the fourth quarter, declining an average of 5.9% year-over-year through December 2023. Market sentiment points to a continued downward trend, as sellers who have been hesitant to transact will be forced to exit in the face of a material amount of upcoming debt maturities.

In Europe, central banks have tempered inflation across the region following a 400-basis-point increase in interest rates. This has put significant pressure on the real estate market, causing investment volumes to decrease by 55% year-over-year as of the end of the third quarter. Valuations have been impacted meaningfully across nearly all sectors; however, valuation levels are expected to level through 2024. We continue to expect the material amount of debt maturing beginning in late 2024 will result in a significant amount of stressed and distressed sellers entering the market.

In Asia, real estate investment volumes were less impacted in 2023 as compared to the broader global markets, as inflation has been broadly kept in check across the region and GDP growth has been relatively stable. Real estate fundamentals continued to favor industrial across the region, while there have been pockets of softness in office – particularly in China and Hong Kong.