Corporate debt, real estate on the rise, judging the cycle – structured finance hot topics from SFIG

Partners Angus Davison, Simon Felton and Mark Santangeli attended SFIG – the largest capital markets conference in the world – in Las Vegas last month, and after dozens of meetings, panels and presentations, here are the four key talking points:

The view on 2019…

Last year was a strong year for new issuance but although market participants are optimistic about prospects for 2019, particularly in the US, the sense was that 2018 may yet prove to have been a peak of the market. High yield corporate debt remained reasonably strong in 2018, commercial real estate CLOs had a record year, and early signs appear positive for that market in 2019. There was no consensus view as to the next direction for interest rates, with a divergence of views as to whether the FOMC has effectively ruled out rate increases in the short term, or if the current pause is likely to be short lived backed by a strong US consumer and rates would increase in the second half of the year.

The direction of the market was the big talking point…

Most participants agreed that a downturn in the medium term was the most likely outcome, but as with interest rates, there is no clear consensus as to when. There is broad optimism for 2019 (although subject to the comments above re 2018 having potentially seen the peak of the market), but looking further out to 2020 or 2021 a cyclical recession seems more likely and some asset managers are beginning to position their portfolios accordingly. There's not a lot of doubt in the market that a cyclical downturn is on its way, but in the US market there does not seem to be an expectation of a 2008 level generational event.

Things are not the same as they were ten years ago…

US corporate debt is currently around $9 trillion, which is around 50% greater than at the time of the financial crisis. Central banks also lack the capacity for interest rate cuts, which were one of the immediate international policy responses – there is some capacity for cuts in the US, but very little in the UK and none in Europe and Japan. US banks and those in the UK have made significant inroads in repairing their balance sheets and structured finance products are widely regarded as more robust. Corporate debt is high and in most cases has been used to finance share repurchases and dividends rather than funding investment and growth.  The US consumer is viewed as having made progress in restoring their personal balance sheets and overall are better positioned to weather a downturn. There were some concerns in relation to credit quality in the auto lending market in the US, it was not perceived as having the same systemic impact as sub-prime mortgage debt 10 years ago.

Strategies across asset classes…

The US structured finance market is in rude health and has had a record year across a number of asset classes, investor demand remains strong and while the general sense was one of optimism for 2019, that was tempered by caution in relation to the direction of the economic cycle in 2020 and beyond with investors already considering defensive strategies within certain asset classes. One consistent theme was the level of corporate debt, either through high yield bonds or increasingly covenant lite loans and how sustainable this would prove to be.

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