KBRA Financial Intelligence

3 Things in Credit: Soft Landing, Big Bank Color, and Private Credit Maturity Wall

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about. As I scroll through the headlines this Friday, I see that Chicago Fed Head Austan Goolsbee says the Fed is data dependent. Can we all agree never to use that term again? If the Fed is not data dependent, what exactly is it dependent on? For what it’s worth, I want you all to know that 3 Things is data dependent.

This week, our 3 Things are:

1. Anatomy of a soft landing. We’ll walk you through our building blocks.

2. Big bank color. Our latest update on how the largest lenders are seeing credit.

3. Private credit maturity wall. Here’s the data.

Alright, let’s dig a bit deeper.

Anatomy of a soft landing.

It’s not quite as bad as 2020, when we were trying to figure out what shape the recovery would take. You remember: V-shape, L-shape, Nike swoosh-shape. But figuring out what “the landing” looks like is the markets’ latest obsession. Of the choices—no, soft, or hard—we are squarely in the soft category. So, what does that look like?

We start with economic growth. By definition, that means we are in the 50% of market strategists that see no recession. By the way, that 50% comes from a Bloomberg survey of 18 strategists back in December. We see modest growth—sub-potential—if potential is the Fed’s 1.8% longer-run estimate it shares with us in the Summary of Economic Projections. Consensus, according to Bloomberg, is 1.3% for 2024, and that’s where we are. Underpinning that view is the consumer’s ability and willingness to spend based on its strong balance sheet including savings at 135% of pre-pandemic levels, near-record net worth, low financial obligations burden, and the confidence that goes with being employed in a strong jobs market.

Spending is coming down, judging by data we see from the Bank of America Institute, but that’s consistent with a soft landing. On the commercial side of things, we also see relatively strong balance sheets and improving earnings growth, and both are a function in part of the long lead time to prepare for the growth slowdown, and favorable financial conditions over parts of the pandemic period.

Speaking of which, interest rates and interest rate volatility are settling down, and while we are not expecting “The Great Monetary Pivot” implied by Chair Powell back in December, we do believe cuts are coming. We see three cuts starting at midyear, and the absolute level of rates—sub 4% 10-Year by year-end—is benign.

How about the financial system? Well, it’s in good shape. Capital from banks, nonbank lenders, and markets is flowing to its productive uses, and concern over systemic threats suggested by last March’s bank failures has largely been put to rest.

And finally, geopolitical risk. It’s out there, but game-changing risks we believe are tail risks. The one to watch closely is possible escalation of war in the Middle East, as that could impact the price of energy and the efficiency of trade. But for now, steady state is manageable from an economic standpoint.

Add it all up, and you get a reasonably performing economy in the U.S.—no small feat having come through the fastest hiking program in 40 years and a banking crisis. Let’s count our blessings.

Alright, on to our second Thing—Big bank credit color.

So, when trying to think through what kind of economic landing we are facing, regular listeners of the podcast know we look to the quarterly earnings presentations and calls from the big banks for insight and forward guidance.

So, what have we gotten at this important point—this inflection point—in this cycle? In a word? Stability. In two words: cautious optimism.

Being a big bank CEO means you’ve been through more than a couple of cycles. You also grew up professionally in a business where the big banks were the kingpins of the financial system. You also grew up in an environment where too much competition and deregulation often drove risk and reward out of synch. Banks became turbo-cyclicals that went bad every five to seven years, in the words of one still-standing bank CEO. And so, given that heritage, you could almost hear a faint air of disbelief in management commentary on the latest quarterly results. As in, “we’ve just gone through the strongest rate shock in 40 years, we had the federal government step in to prevent a banking crisis, and credit has still yet to crack!” But it’s true.

Yes, there is lots of talk of writedowns of commercial office loans and “normalization” of loss rates in cards, but elsewhere, and there’s a lot of elsewhere loans—like $3.5 trillion—that seem to be just fine, like superfine. The banks have been reserving under a 5%+ unemployment rate assumption, reserving for that rainy day that just doesn’t seem to be on the horizon. Managements mentioned the improved macroeconomic environment as a positive development underpinning loan quality. JP Morgan Chase said it is “uncontroversial that the economic outlook has evolved to include a significantly higher probability of a soft landing.” OK then. Wells Fargo, which has tightened underwriting standards, and is “closely monitoring” credit—there’s that baggage from the past—has seen what it calls modest deterioration consistent with expectations.

All agree the consumer, in the aggregate, is in good shape. CEO Moynihan at BofA sums it up well: “their balance sheets are in good shape, and while impacted by higher rates, many have fixed rate mortgages and remain employed. [They] have access to credit and are borrowing responsibly.” But, to be clear, the largest banks bank higher-income consumers. Wells Fargo did point out that while the aggregate dimensions of the consumer look very solid, lower-income cohorts are stressed, and losses will eventually flow from there. But put it all together and the bank is seeing performance in the consumer portfolio consistent with that pre-COVID, nothing worse.

On the commercial side of things, concern is centered almost entirely on the office portfolio, where the loss phase is underway. JP Morgan Chase acknowledged a deterioration in its CRE valuation outlook. Wells opted for a movie analogy when describing where we are in the office loss recognition cycle as opposed to the hackneyed baseball innings one: “we’re past the opening credits, but we’re still in the beginning of the movie.”

BofA said outside of the office sector, loan quality remains in a “very, very …”—that’s two verys—"… good place.” The improving backdrop also shows up in lower marks on leveraged loans—another indicator that all is OK, even among riskier credits.

So, that forward-looking loan quality indicator—the loan loss provision—remained better than just about anyone would have expected a year ago. BofA actually had a net release of reserves. JP Morgan Chase’s and Wells’ modest reserve builds were driven by card growth and office losses.

But to sum it all up, so far so good in credit, and the forward look is that this turn in the credit cycle feels relatively benign, consistent with a soft landing.

Alright, on to our third Thing—Misplaced concern over a 2024 maturity wall in private credit.

We have long been wary of fear stoked in the marketplace around maturity walls. Sure, they exist, but I’ve never met a maturity wall that can’t be climbed (it’s kind of like another overused descriptor, the “wall of worry”). It really comes down to a risk assessment.

So, when we hear of concerns over an impending maturity wall in private credit, I suppose the worrier is concerned about loan underwriting in private credit.

I bring this up to highlight a piece of research published by KBRA this week entitled Private Credit: 2024 Maturity Wall Is a Myth. Our researchers examined loan maturity data gathered across the private credit landscape, including credit estimates of more than 1,800 middle market private credit borrowers representing over $750 billion of debt, and concluded that there is no pending outsized maturity wall. We estimate that only 10%-15% of the total loans in the market are scheduled to mature over the next two years. This is similar to what we see among traditional corporate debt issuers.

Now, near-term maturity risk is real—the piece points out—for a relatively small subset of sponsored companies, whose debt is scheduled to mature in 2024 and whose values have weakened because they have either not grown to potential and/or have declining values that substantially diminished liquidity cushions. However, based on our ratings analysts’ surveillance of KBRA’s growing portfolio of private credit ratings and estimates, KBRA believes these risks remain idiosyncratic and relatively muted.

Our researchers take on the view promulgated by some, including certain legacy rating agencies, that there is systemic risk because of conflicts of interest in private markets. KBRA’s surveillance of transactions sponsored by numerous direct lenders concludes the opposite. Medium to large direct lenders remain uncompromising in their strong lending position and have the resources needed to extract value from their investments. In fact, 2024 may see the migration of value to private credit lenders from private equity sponsors, as equity cushions get consumed by lenders in defaults, or as sponsors need to inject additional equity into their investments to protect their positions.

Overall, KBRA continues to believe that the greatest risks in the private credit market remain idiosyncratic, where companies facing higher interest costs and slower growth are placing outsized pressure on their liquidity, valuation, or both. The research piece adds that the universe of smaller and newer companies sponsored by inexperienced owners that lack the resources necessary to restructure their overleveraged investments are particularly vulnerable.

You can find the research piece on our website, KBRA.com. It’s a worthwhile read.

So, there you have it, 3 Things in Credit:

1. Anatomy of a soft landing. We’re cautiously optimistic.

2. Big bank color. Outside of office lending, there is little on the horizon that is worrisome.

3. Private credit maturity wall. The data suggests it’s not as ominous as some would have you believe.

As always, thanks for joining. Make sure you pick up our latest research piece in private credit, Private Credit: 2024 Maturity Wall Is a Myth. See you next week.