While increasing risk free rates have been the key drivers of rising yields and returns of syndicated loans during the last twelve months, the credit spreads, represented as discount margins over floating benchmark rate, have exhibited significant volatility during the same period.
Single B-rated loans have been widening disproportionately, with increasing risk premia sensitivity evident also on recently-downgraded split-rated BB/B loans. On a YTD basis, the discount margins have tightened due to multiple factors and also thanks to the economy avoiding a recession so far. At current discount margins of 560 bps (-130 bps YTD), single B loans are still pricing-in an annual default rate in the range to 8 to 9 percent. This is well above long term average except for recession periods. Nevertheless, diligent credit selection and proactive approach at times of high spread volatility remain key for a successful loan strategy.
