We are now entering a third calendar year where the impacts of COVID-19 continue to inform strategic and operational decision making both in loan markets and in broader financial contexts. At the same time, central banks globally have been increasingly clear about their intent to readjust the approach to interest rates and stimulus programs that provided pandemic support. A new economic reality may be coming into play.
Accordingly, Wilmington Trust’s Loan Market Solutions team has closely analyzed factors from its perspective as a provider of administrative services in loan markets. These factors are most likely to set the tone for lending in 2022, from loan originations to refinancing, upsizing, and potential distressed debt scenarios.
These factors, grounded in our broader bank-wide view of macroeconomic trends, affect how we are readying ourselves for the year’s market conditions. However, they will also set the agenda for the full spectrum of loan market stakeholders: borrowers, lenders, CLO arrangers and other intermediaries, asset managers, and institutional investors.
A continued surge
These factors, which we break down in further detail below, add up to one single headline for loan market stakeholders: be prepared for a continued surge in demand. While the timing and probability of market considerations are challenging to pin down, we believe that many of them will help sustain intense demand for lending activity and supporting services. As a result, every market stakeholder involved in such activities should take a careful look at their current exposure to loans and reinforce their ability to respond to quick acceleration and spikes.
For instance, the amount of available “dry powder” (committed capital that remains uninvested) continues to accumulate. This long-term situation has now reached an estimated peak of nearly US$3 trillion across all private equity categories, per J.P. Morgan Private Bank.
While credit funds do not intend to allocate all of this capital to lending, it certainly illustrates the “pressure cooker” climate of funds and investors looking for yield outside public equities markets. Deferred investments over the past two years certainly have played a part in such a significant accumulation. And among the other factors we consider as hanging in the balance for 2022, “dry powder” is already definitively here.
The macro view
Wilmington Trust economists are closely watching several factors that will set the overall tone for 2022’s economy. In the U.S, moderate GDP growth seems likely. According to Dominick D’Eramo, senior director of Investment Oversight for Wilmington Trust’s Institutional Client Services, including both Global Capital Markets and Retirement and Institutional Custody Services lines of business, anticipated actions from the U.S. Fed will play a definitive role, with a rate hike as early as March 2022 extremely likely. A January 26, 2022 FOMC statement clearly indicated the Fed’s intent, saying “with inflation well above two percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.”
Globally, most central banks and monetary policymakers have also strongly indicated that they will raise interest rates at some point. Similarly, they have commented openly on tapering quantitative easing (QE) and other stimulus programs.
Yet these policy stances face multiple questions, including 1) inflation and the resulting political pressures for action that it creates, 2) the severity and duration of the Omicron variant of coronavirus or potentially others that may emerge, and 3) the risk that Fed policy slows the economy without making the expected dent in inflation because inflationary factors such as wages have already become embedded.
Per D’Eramo, “the greatest concern for loan markets is a potential policy error that brings about a recession that negatively impacts spreads.” The market faces a significant maturity wall, with $118 billion due in 2022, over 70% higher than in 2021 per S&P. “We are paying attention to how much of that maturity falls on the near versus the far side of Fed actions.”
Of course, these questions are out of the hands of investors or loan market stakeholders. As Wilmington Trust’s Tony Roth, Luke Tilley, and Meghan Shue stated in a December 1, 2021 Wilmington Wire, “the Omicron variant is yet another hurdle being thrown into the path of the recovering economy, and we do not yet know the magnitude of the risk it poses.”
Current conversations with loan market stakeholders
The mere potential of rate hikes, continued inflation, and QE has already shifted the considerations preoccupying loan market stakeholders. These factors come up in many industry conversations we have had lately.
At the root, market participants expect that borrowers will look to raise new money because they are concerned that interest rates will start to climb, potentially even faster than expected. And as we have discussed, dry powder provides an additional accelerant for demand. Bonds may not offer much of a debt alternative either. As Bloomberg reported in early January 2022, over US$10 trillion in bonds globally have negative yields.
Raising money may occur in various forms: new originations, refinancings, or adding tranches to existing deals to help contain the impact on margins and legal costs. The last of these emerged as a trend in Europe and the U.K. in 2021 and will likely continue as a means to address pressures to accelerate.
Looking at this phenomenon through the lens of service providers, we see that the capacity for speed is vital. In some ways, it’s simple. Since loan market stakeholders believe the clock is ticking, speed becomes paramount. It raises the stakes for what a service provider must deliver and how quickly. The speed question persists when clients consider a provider’s ability to process trades and monthly activities promptly on an ongoing basis. Similarly, transition from LIBOR may place additional pressure on servicers’ capacity.
However, speed also raises the specter of risky shortcuts, with lenders allowing gaps in loan terms and documentation simply in the interest of getting loans done quickly in a borrower-friendly way. We do not see the potential consequences of overly leveraged borrowers or messy litigation as acceptable trade-offs even in the face of accelerated demand. In fact, these issues raise the bar for the level of operational soundness and experience a loan agent brings to the table without jeopardizing lenders’ interests.
We are also closely watching a scenario that could emerge as a consequence of the above. If loan activity begins to surge, will demand for managing and securitizing the resulting inventory follow? On the investor side, will the desire to hedge against the volatility of equities markets further heat up demand?
In that case, an echo effect could drive increases in CLO issuance to yet another peak after 2021’s record-breaking pace of almost $180 billion. The middle market offers exceptionally high potential. Morgan Stanley’s early view of this segment suggests issuance approaching US$20 billion.
As loans move through the broader market of investment activity, service providers of all stripes must make similar preparations, investing in readiness to address demand in the face of accelerating factors.
Prospects for distressed debt and restructuring
Another year of coronavirus impacts and their extended macroeconomic implications also brings the question of distressed debt and restructuring to the fore. While rising interest rates have some appeal to investors in floating rate instruments and new loans, they could also tilt issues into distress in both small club and broadly syndicated loans.
It remains unclear how future phases of the pandemic will shape the impacts on borrowers. Governments have not made firm commitments on whether and when they will scale back efforts to protect corporates and industries. However, no one expects a scenario of a kind of “permanent stimulus.” In addition, the risks are not uniform. Industries at the highest degree of exposure to the direct impact of COVID-19 or to the indirect impacts of various complex supply chain issues may see much more restructuring activity than others.
As our colleagues Vito Iacovazzi, Chris Monigle, and Jeff Rose discussed in an article last year, COVID-19 has shed light on some of the underlying complexity of loan markets. Complexity occurs not only from loan to loan but within them.
On this front, as with others in loan markets, preparedness will play an important role—at multiple levels. Preparedness includes the expertise and capacity to handle distressed scenarios quickly, but it also highlights the importance of stable, rigorous loan documentation. to help navigate workouts and other distress situations. Furthermore, it has been many years since we saw a genuinely challenging credit cycle overlapping with inflation. Because of this timing, much of the talent in loan market stakeholder organizations lacks direct, hands-on experience with what it takes to handle distressed debt with a minimum of turbulence.
Talent and market risks
While we have come back to considering preparedness several times as a critical factor for 2022, one additional factor raises additional market risks, that of talent. The so-called “Great Resignation” creates significant headwinds for attracting and retaining a great team. While labor economists and sociologists have not come to a definitive understanding of what is happening, it is safe to say that attitudes to talent, personal fulfillment, working locations, and work-life balance are changing quickly.
Competition for talent will likely span the entire loans industry from law firms to underwriters to service providers. Job changes, career changes, and early retirements can all affect the quality of service that clients receive.
To address this industry-wide challenge, Wilmington Trust is taking two approaches. First, we pay close attention to culture and flexibility, even at more junior levels. Teams work at the level of relationships rather than creating an artificial either/or scenario between task expertise and deal expertise. Second, we increasingly use technology to humanize job roles further.
As a result, arrangers and lenders should ask potential providers, agents, law firms, and beyond, what they are doing to create both capacity and continuity in the servicing of a deal.
A final word
Given the factors currently in view for 2022, we expect both heightened and accelerated demand for lending, loan services, and talent in every corner of the loan market. Stakeholders must work collaboratively across the lending value chain to thrive. They must also prepare to ask questions to ensure that everyone is acting both in their own and in each other’s best interests. We all share an essential responsibility to watch over the integrity of loan markets in a potential fever pitch of activity.
 Michael Cembalest, “Food Fight: 2021 Private Equity Update,” J.P. Morgan Private Bank, June 28, 2021.
 Luke Tilley, “Fed Positions Itself to React More Quickly if Needed,” Wilmington Trust, December 20, 2021.
 Howard Schneider and Ann Saphir, “Fed flags rate hike ‘soon,’ plans for ‘significantly reducing’ balance sheet,” Reuters, January 26, 2022.
 S&P Global Market Intelligence, “US Leveraged Loan Maturity Wall – Nothing to See Here (until 2023),” January 15, 2019.
 Tony Roth, Luke Tilley, and Meghan Shue, “Eye on Omicron,” Wilmington Trust, December 1, 2021.
 Robert Burgess, “The Most Important Number of the Week Is $10 Trillion,” Bloomberg News, January 7, 2022
 Glen Fest, “Morgan Stanley bullish on 2022 US CLO issuance,” S&P Global Market Intelligence, November 19, 2021.
 Vito Iacovazzi, Chris Monigle, Jeff Rose, “Navigating Complex Debt Restructurings,” Wilmington Trust, June 8, 2021.
Wilmington Trust’s domestic and international affiliates provide trust and agency services associated with restructurings and supporting companies through distressed situations.
This article is intended to provide general information only and is not intended to provide specific investment, legal, tax, or accounting advice for any individual. Before acting on any information included in this article, you should consult with your professional adviser or attorney. Facts and views presented in this report have not been reviewed by, and may not reflect information known to, or the opinions of professionals in other business areas of Wilmington Trust or M&T Bank. M&T Bank and Wilmington Trust have established information barriers between their various business groups.