Insights

Performing Credit 3Q
Quarterly 2023

TAILS, YOU LOSE?

How healthy are today’s leveraged credit markets? If you focus on averages, you’d likely conclude that fundamentals
are fairly strong despite elevated interest rates and slowing earnings growth. The average debt-to-EBITDA ratio for U.S.
leveraged credit was around 4.0x at the end of the second quarter, down from a high of 6.5x in 4Q2020 and just under
5.0x in 4Q2019.1 While average interest coverage ratios2 have deteriorated over the last year, the current levels – 5.3x
for U.S. high yield bonds and 4.5x for U.S. leveraged loans – aren’t sounding alarm bells.3 However, this environment
reminds us of one of our co-chairman Howard Marks’s favorite adages, concerning the six-foot-tall man who drowned
crossing the stream that was five-feet deep on average.

We believe investors in leveraged credit should be focusing less on average risk and more on tail risk: How is the
weakest cohort of the borrower universe positioned? Can these companies service their debt if interest rates remain elevated?
When do these companies face debt maturities? What might happen to the value of various debt tranches in a restructuring?
When one scrutinizes the weak tails of the leveraged credit markets, it becomes clear that many companies – especially those
with outstanding leveraged loans or private debt – borrowed too much at a time when interest rates were near zero, creating
capital structures that have become unsustainable now that interest rates have risen by more than 500 basis points.

Importantly, the amount of debt represented by these tails is enormous. Not only have the U.S. leveraged loan (aka
broadly syndicated loan) and private credit markets grown roughly twofold and sevenfold, respectively, since the Global
Financial Crisis,4 but the percentage of lower-quality debt in these markets has also increased.5 Loans with credit ratings
of B or below represented almost 75% of U.S. leveraged loans at the end of 3Q2023, compared to roughly 35% in 2000.6
(See Figure 1.) Additionally, our market observations indicate that private debt experienced a similar deterioration in
quality in the decades leading up to the recent interest rate spike.

When the weakest segment of the credit markets is both sizable and more vulnerable than usual, investors face
elevated risk that (a) defaults will increase more than expected; (b) average recovery rates will be lower than
anticipated; and (c) even healthy companies will experience temporary volatility. If this tail risk becomes a tail reality,
both performing and distressed credit investors are likely to encounter an expanded set of pitfalls and opportunities.

Figure 1: Leveraged Loan Quality Has Declined as the Market Has Grown

($ in billions)
$1,600 80%
Leveraged Loan

$1,200 60%
$800
AUM

$400 40%
$0 20%
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

YTD 2023

Par Amount (LHS)

Percentage of the U.S. Leveraged Loan Market Comprised of Loans Rated B and Below (RHS)

Source: Preqin, Pitchbook LCD, JP Morgan; Credit Suisse Leveraged Loan Index

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 Insights

A Tail of Two Markets

When analyzing the U.S. leveraged credit markets, it’s important to first acknowledge the significant difference in
quality between high yield bonds and leveraged loans. Almost half of the high yield bond market is now rated BB (the
highest rung of below-investment-grade credit), which is near a ten-year peak.7 While BB-rated debt represented more
than 30% of the leveraged loan market ten years ago, that figure has since fallen to just above 20%, and B-rated debt now
accounts for approximately 65% of the market.8 This reduction in quality has only worsened over the last year, as the
ratio of downgrades to upgrades in the loan market has risen to nearly two to one.9 We believe downgrades will almost
certainly increase for weaker B-rated loans if borrowers’ earnings strength continues to weaken as their interest expense
remains elevated. Finally, while broadly syndicated loans have slightly lower average leverage than high yield bonds,
that’s not the case with private debt. CreditSights estimates that median net leverage among private loans was almost
twice that of high yield bonds at the end of 1Q2023.10

This divergence is driven primarily by two key factors: (1) loans became the financing tool of choice for leveraged
buyouts (especially those involving highly leveraged healthcare and technology companies) in the years leading up to
the interest rate spike in 2022 and (2) loans, unlike bonds, are predominately floating-rate instruments. We estimate that
roughly two-thirds of outstanding U.S. leveraged loans were unhedged as of YE2021.11 As a result, loan-only borrowers,
which now represent the majority of the U.S. loan market, have seen a roughly 50% increase in interest expense over the
last year, compared to only 21% and 3%, respectively, for bond-and-loan and bond-only issuers.12

When honing in on tail risk, the difference in quality between these asset classes becomes even more marked.
Tail risk has increased moderately in the high yield bond market over the last year. The percentage of issuers with both
interest coverage ratios below 1.5x and cash-to-debt ratios below 10% climbed to a post-GFC high in 2Q2023.13 But the
risk in the public and private loan markets is far more pronounced:

• Slim interest coverage ratios: Moody’s Investors Services looked at the impact that a federal funds rate of
5.25%-5.50% would have on the interest coverage ratios14 of more than 300 companies in the U.S and Canada
with credit ratings of B3 (the equivalent of B- at other rating agencies). They projected that, when accounting
for capital expenditures, the interest coverage ratios of 62% of these companies would fall below one by the
end of 2023.15 (See Figure 2.) This deterioration would primarily be driven by spiking interest costs, though
slowing EBITDA growth would likely also play a role.

Figure 2: Interest Coverage Ratios in the U.S. Loan Market Could Decline Meaningfully

100%
10%
Percentage of Issuers

45% 38%
75% 55% 52% 28%
Rated B3

50% 32%
21% 28%
22% 62%
25%
23% 27% 27% 30%
0%
Jan-2022 Jun-2022 Sep-2022 Dec-2022 Dec-2023 F
Below 1.0x Between 1.0x-1.5x Above 1.5x

Source: Moody’s Investor Services, as of July 27, 2023, forecasts as of July 2023

• Worrisome maturity profiles: While many issuers in both the bond and loan markets were able to refinance
debt in recent years and thus extend their maturities, refinancings were less common among lower-rated
borrowers. (See Figure 3.) Leveraged loans rated B3 and lower now represent the majority of 2024
maturities.16 Private loans are facing an even more troubling near-term outlook. Almost 40% of the direct
lending market is scheduled to mature by year-end 2025, compared to roughly 15% of broadly syndicated
loans, according to Bank of America.17
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 Insights

Figure 3: Low-Rated Loans Haven’t Materially Improved Their Maturity Profiles

40%

30%

20%

10%

0%
BB B+ B- B- CCC
2024/25 Maturities, as of YE2022 2024/25 Maturities, as of August 2023

Source: Pitchbook LCD, Bloomberg, Morgan Stanley Research, as of September 15, 2023; issuer rating by S&P Global

Importantly, we believe these overleveraged, interest-rate-sensitive borrowers could find themselves struggling to service
their debt whether the Federal Reserve sticks a hard or soft landing. A recession would obviously further impair many
vulnerable companies’ fundamentals, but so would a sustained period of elevated interest rates, the likely outcome if there
isn’t a near-term recession. As we wrote in Performing Credit Quarterly 2Q2023: Fighting the Fed:

… recession or no recession, we think the probability of higher-for-longer interest rates is far greater than
the likelihood of near-term cuts. Therefore, we believe leveraged finance markets are likely to experience
higher default rates going forward even if the economy avoids a recession.

Thinking Big
How should credit investors respond in this environment? First, they should recognize that what most distinguishes this
environment from those in the past is the sheer size of the global universe of potential dislocated debt. It has quadrupled
since the GFC.18 U.S. markets have grown so significantly that even if the annual default rates for U.S. leveraged loans
and high yield bonds were to remain below their recessionary averages and only increase to their normal long-term
averages for a three-year period, the resulting total would exceed the three-year default volume recorded during either
the GFC or the dot-com crash in the early 2000s.19 This would both dramatically expand the universe for distressed
debt investors and give skilled performing credit managers the opportunity to distinguish themselves through their
superior risk control.

In short, we may increasingly discover which credit investors have been able to – as we like to say at Oaktree – avoid
the losers. These investors will likely have fewer problems in their legacy portfolios and thus be in a good position to
take advantage of the bargain-hunting opportunities that may increase in the coming quarters. Meanwhile, less prudent
investors may – like that six-foot-tall man – find themselves struggling to deal with an unexpectedly sharp drop.

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 Insights

Credit Markets: Key Insights for 4Q2023

What trends, risks, or opportunities are Oaktree experts focused on today? Below are key insights that we believe
investors should keep in mind when navigating today’s markets.

(1) Limiting duration and taking credit risk has benefited investors in 2023 and may continue to do so – if
it’s smart credit risk

In the first three quarters of 2023, credit spreads have narrowed, while Treasury yields continued to rise. Thus,
debt investors who kept duration short by accepting some credit risk typically outperformed those who bet on an
imminent recession by meaningfully increasing their sensitivity to interest rate increases. (Oaktree discussed this
dynamic in a recent podcast.) Consider that U.S. investment grade bonds lost 1.2% in the first three quarters of
the year, while U.S. high yield bonds and leveraged loans – which both have much shorter duration than IG debt –
returned roughly 6.0% and 10.0%, respectively.20 Clearly, most investors have been better off if they’ve avoided
making large bets on macroeconomic forecasts and instead simply taken advantage of the high yields on offer.

However, in a highly uncertain environment in which companies’ ability to service or refinance their debt is likely
to become more challenging, it’s essential that investors engage in rigorous bottom-up analysis and risk control.
By doing so, they can potentially reduce the likelihood that they’ll surrender return through defaults and be better
able to build a portfolio that can perform well regardless of the twists and turns of the economic cycle.

(2) Technical factors are increasingly benefiting the high yield bond market

We’ve long noted that technical factors (i.e., factors unrelated to issuers’ fundamentals) have helped support
prices in the leveraged loan market, but we’re now seeing a similar trend in the high yield bond market. While
demand for the latter has been negatively impacted by the spike in interest rates since YE2021, supply has also
been declining over this period. In the last two years, the par value of outstanding high yield bonds fell from $1.6
trillion to $1.2 trillion in the U.S. and from $692 billion to $490 billion in Europe.21

This contraction partly reflects the aforementioned increase in interest rates, as rising yields have caused many
companies to refinance existing debt via alternative instruments (e.g., convertible bonds) or avoid issuing new
debt. Additionally, in the last year, fallen angels (i.e., bonds downgraded from investment grade to below-
investment grade) have been outpaced by bonds whose credit ratings have moved in the opposite direction.
Finally, many of the weakest companies defaulted during the pandemic and have been unable to reissue. While
interest rate volatility could weigh on all fixed-rate assets in the coming months, we believe positive technicals,
moderate duration, and high quality will continue to provide counterbalancing support for the high yield bond
market.

(3) In private credit, risk is concentrated in legacy portfolios, not recent deals

When assessing risk in private credit, it’s important to recognize that quality varies meaningfully by vintage.
Private credit deals completed in the last year have typically had fairly strong fundamentals: Senior leverage has
been only 3.5x on average; the average equity contribution from sponsors has grown to roughly 60%; and the
average yield spread has widened by 100-150 bps since YE2021.22

Risk is therefore concentrated in deals put in place before 2022 – when base rates were near zero, earnings
estimates were optimistic, and investor protections were typically nonexistent. Specifically, we believe the
weakest 20 to 30% of private credit portfolios have a meaningful risk of experiencing defaults or write-downs in
the near term. Indications of rising stress are already present, as publicly traded business development companies
(BDCs), which hold private debt, have begun to announce that some of their underlying borrowers are having to
amend loan terms or engage in other actions associated with credit deterioration.

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 Insights

We believe private creditors are less likely to face these legacy portfolio issues if they limited their participation
in LBOs during the boom period and instead focused on non-sponsor-backed deals with companies that needed
capital for less speculative activities, like strategic growth initiatives. Private creditors that refrained from
reaching for yield when interest rates were near zero may now be well positioned to secure both high yields and
downside protection.

(4) The opportunity in CLO equity has historically been superior in dislocated markets

Many investors say “you make money on your buy” and, historically, this has been the case for those investing
in CLO equity. We conducted back-testing using an approximation of an average new CLO portfolio, which
indicated that the strongest performance for equity investors is likely to occur during periods in which a majority
of loans are trading below par.23

Even though it may be more expensive to finance a CLO in a dislocated market, once the market strengthens,
managers can typically refinance their liabilities at much narrower yield spreads. Managers obviously don’t have
a similar opportunity to reprice their assets once markets recover.

If CLO managers have done their credit work and sought to limit the risk of default and, more importantly, the
risk of loss, then the discounted portfolio should recover to par over time. And because of the leverage inherent in
CLO equity, that movement back to par has the potential to generate a very attractive total return. But, of course,
such performance is only possible if managers avoid (or limit) defaults and losses, which is why we believe credit
expertise, experience over multiple cycles, and risk control are essential for successful CLO managers.

(5) The risk/return calculus for credit versus equity investment may be shifting

We’ll give Howard the last word, with an excerpt from his recent memo Further Thoughts on Sea Change:

• Will asset ownership be as profitable in the years ahead as in the 2009-21 period? Will leverage add
as much to returns if interest rates don’t decline over time or if the cost of borrowing isn’t much
below the expected rate of return on the assets purchased? Whatever the intrinsic merits of asset
ownership and levered investment, one would think the benefits will be reduced in the years ahead.
And merely riding positive trends by buying and levering may no longer be sufficient to produce success.
In the new environment, earning exceptional returns will likely once again require skill in making bargain
purchases and, in control strategies, adding value to the assets owned.… Lending, credit, or fixed income
investing should be correspondingly better off.24

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Assessing Relative Value Insights

Performance of Select Indices

14%

11%

8%

5%

2%

-1%

-4%
Bloomberg U.S. U.S. European U.S. European EM EM Corporate Global S&P 500
Government/ High Yield High Yield Leveraged Leveraged Corporate High Yield Convertibles TR Index
Credit Index Bond Index Bond Index Loan Index Loan Index Bond Index Bond Index Index

QTD Return YTD Return

As of September 30, 2023

Source: Bloomberg, Credit Suisse, FTSE, ICE BofA, JP Morgan, S&P Global, Thomson Reuters24

Default Rates by Asset Class

4%

3%

2%

1%

0%
9/30/2021 12/31/2021 3/31/2022 6/30/2022 9/30/2022 12/31/2022 3/31/2023 6/30/2023 9/30/2023

U.S. High Yield Bonds European High Yield Bonds U.S. Senior Loans
European Senior Loans Global Convertibles

Source: JP Morgan for high yield bonds; Credit Suisse for loans through 2Q2023, UBS for 3Q2023; Bank of America for Global Convertibles
Note: Data represents the trailing-12-month default rate; excludes distressed exchanges

6
Strategy Focus Insights

High Yield Bonds Market Conditions: 3Q2023

U.S. High Yield Bonds – Return: 0.5%25 | LTM Default Rate: 1.3%26
• Yield spreads were relatively unchanged over the quarter: While spreads compressed in July, they widened throughout the
remainder of the quarter, remaining in the middle of the historically normal range of 300–500 bps.27
• Yields in the asset class increased slightly: They rose over the period along with interest rates and remain well above the ten-
year average. (See Figure 4.) Approximately 85% of high yield bonds (by market value) had yields above 7% at quarter-end,
compared to less than 7% at the beginning of 2022.
• CCC-rated bonds continue to outperform: The lowest credit ratings category returned 2.6% for the period, while B- and BB-
rated bonds returned 1.0% and -0.3%, respectively. CCCs have benefited from their short duration as interest rates have risen.

European High Yield Bonds – Return: 1.7%28 | LTM Default Rate: 0.2%29
• The asset class strengthened in 3Q2023 despite rising interest rates: European high yield bonds benefited from their relatively
short average duration and the offsetting impact of tightening credit spreads.
• Every sector recorded a positive return, but there was significant dispersion among sectors: Energy and retail recorded the
strongest performance, while real estate lagged for the fourth consecutive quarter, as property valuations remained under pressure
in a rising-interest-rate environment.

Opportunities Risks

• High yield bonds are trading at a steep discount to par: • Concerns about medium-term maturities may soon be
Investors have the potential to earn meaningful capital reflected in bond prices: Companies needing to refinance in
appreciation while retaining strong call protection. 2027 will likely do so in 2025 or 2026, and the market may
• The risk of widespread defaults remains low in the near begin to price in concerns about rollover risk as early as 2024.
term: Issuers’ fundamentals are fairly healthy, and there are few Low-rated corporate issuers might struggle to roll over debt if
significant maturities in 2023 and 2024. financial conditions remain restrictive.
• Quality in the high yield bond market has improved: The • High inflation may impair issuers’ fundamentals: While
percentage of BB-rated bonds in the U.S. market is near a ten- inflation has slowed, it remains elevated. Companies may be
year high, while the percentage of CCC-rated credits declined unable to pass along price increases to customers. Weaker
during the decade. Thus, the asset class’s ability to weather an earnings could negatively impact leverage ratios and potentially
economic downturn appears to have improved. lead to credit rating downgrades.

Figure 4: High Yield Bonds Are Offering Attractive Yields and a Low Average Price
Cents on the Dollar/Euro

105 10%
Hundreds

100 8%
95 6%
90 4%
85 2%
80 0%
Aug-2022

Sep-2022

Aug-2023

Sep-2023
Oct-2022
Apr-2022

May-2022

Apr-2023

May-2023
Jul-2022

Jul-2023
Jan-2022

Jun-2022

Jan-2023

Jun-2023
Mar-2022

Mar-2023
Feb-2022

Feb-2023
Dec-2021

Nov-2022

Dec-2022

Price: U.S. High Yield Bonds (LHS) Price: European High Yield Bonds (LHS)
Yield-to-Worst: U.S. High Yield Bonds (RHS) Yield-to-Worst: European High Yield Bonds (RHS)
10-Year Average YTW: U.S. High Yield Bonds

Source: ICE BofA US High Yield Constrained Index and ICE BofA Global High Yield European Issuers Non-Financial Excluding Russia Index

7
Strategy Focus Insights

Senior Loans Market Conditions: 3Q2023

U.S. Senior Loans – Return: 3.4%30 | LTM Default Rate: 1.9%

• U.S. senior loan prices rose in 3Q2023 along with interest rates: Performance was supported by rising interest rates as well as
inflows from retail funds, healthy demand from CLOs, and reduced recession fears.
• The asset class gained favor with retail investors: Loan mutual funds and ETFs experienced quarterly inflows after 15
consecutive months of outflows through July. Net inflows in 3Q2023 totaled $900 million. The reversal in flows likely reflected
declining recession fears and the recent outperformance of loans versus other fixed-rate asset classes. However, fund flows
remain negative for the year to date.

European Senior Loans – Return: 3.5%31 | LTM Default Rate: 0.5%

• European loans strengthened over the quarter as government bond yields rose: The average loan price increased by over two
cents. CCC-rated loans recorded the strongest performance, returning 5.6%.
• New issuance continues to be very attractive: While primary market activity has been limited, it’s presenting investors with
compelling opportunities to purchase quality loans at elevated yields.

Opportunities Risks

• High coupons may continue to attract investors: The • Elevated interest rates may be burdensome to heavily
spike in reference rates since YE2021 could make floating- indebted borrowers: Companies that didn’t hedge their
rate loans more compelling than fixed-rate assets. (See interest rate risk – especially those in highly leveraged
Figure 5.) sectors like technology – may experience meaningful
• Low issuance could support performance: Activity in deterioration in their interest coverage ratios.
the primary market increased in August and September but • CLOs’ buying activity could decline: CLO creation has
is expected to be fairly limited through year-end.32 The been erratic during 2023 and isn’t expected to accelerate
performance of existing loans typically benefits when the meaningfully before year-end.
supply of new loans shrinks. • High inflation could harm companies’ fundamentals:
• Loans may experience less volatility than many other While inflation has moderated, it remains elevated.
asset classes because of loans’ stable buyer base: CLOs Companies with outstanding loans may struggle to pass
– the primary holders of leveraged loans – have limited along cost inflation to customers, which could negatively
selling pressure, and the asset class tends to attract long-term impact their earnings. This could cause leverage to
institutional investors due to the lengthy cash settlement increase and coverage ratios to decline, resulting in further
period. downgrades and liquidity challenges.

Figure 5: Reference Rates for Floating-Rate Loans Have Spiked

6%

5%

4%

3%

2%

1%

0%
Sep-2020

Sep-2021

Sep-2022

Sep-2023
Jun-2021

Jun-2022

Jun-2023
Mar-2021

Mar-2022

Mar-2023
Dec-2020

Dec-2021

Dec-2022

3 Month SOFR 3 Month LIBOR

Source: Bloomberg, as of September 30, 2023

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Strategy Focus Insights

Investment Grade Credit Market Conditions: 3Q2023

Return: -3.1%33
• Investment grade debt was negatively affected by rising U.S. Treasury yields: Surprisingly robust U.S. economic data,
hawkish guidance from the Federal Reserve, and significant amounts of Treasury issuance have put upward pressure on interest
rates.
• Higher-quality credit outperformed: The AAA-rated segment of the corporate bond index outperformed the BBB-rated
segment by almost 90 bps in 3Q2023.

Opportunities Risks

• Investment grade corporate debt yields have remained • Interest rates may remain elevated longer than investors
elevated in 2023: Yields in the asset class ended the quarter are currently anticipating: The futures market is pricing
at 6.0%, well above the five-year average. (See Figure 6.) in a high probability of multiple interest rate cuts in 2024,
• Investment grade debt may benefit if economic activity which may be overly optimistic.34 If the U.S. doesn’t
slows: Investment grade debt is likely to outperform high experience a meaningful recession or crisis, the Fed would
yield bonds if widening yield spreads – as opposed to have little incentive to reduce interest rates. Moreover,
rising Treasury yields – prove to be the primary driver of disinflation could slow, which would further reduce the
performance in credit markets in 4Q2023 and 2024. likelihood of near-term interest rate cuts.
• A slowdown in economic growth could weigh on
corporate earnings: Issuers’ fundamentals remain fairly
strong on average, and the U.S. economy has proven to
be resilient. But earnings growth is slowing, and margin
compression could negatively impact credit metrics, leading
to mark-to-market weakness.

Figure 6: Investment Grade Bond Yields Remain Elevated Due to Rising Treasury Yields

7%

6%

5%
Yield-to-Worst

4%

3%

2%

1%

0%
Sep-2018 Sep-2019 Sep-2020 Sep-2021 Sep-2022 Sep-2023

ICE BofA Current 10-Year U.S. Treasury Index ICE BofA U.S. Corporate Index
Trailing 5-Year U.S. Corporate Average YTW

Source: Bloomberg

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Strategy Focus Insights

Emerging Markets Debt Market Conditions: 3Q2023

EM Corporate High Yield Bond Return35 – 3Q2023: 1.2% | YTD: 5.5%

• EM high yield bonds recorded a positive quarterly return, driven by the performance of debt with shorter tenors: Policy
rates in many developed markets rose during the quarter, which weighed heavily on long-duration securities. EM high yield
bonds maturing in seven years or more posted a small loss, while those maturing in less than seven years (the majority of the
market) recorded a positive return.36 (See Figure 7.)
• EM debt default rates remain low in most regions: EM default rates in the first three quarters of 2023 were in line with those
in global high yield bond markets, when excluding China’s troubled property sector.37 While the expansive Brazilian market has
experienced an increase in corporate distress this year, most risks related to specific countries remained under control through
September, as evidenced by the fact that there has been only one sovereign default this year.
• Outflows from EM debt retail funds accelerated during the quarter, while primary market activity rebounded modestly
in September: Cumulative YTD outflows are significant but still smaller than the record-high total in 2022.38 Similarly, total
issuance in 2023 is expected to be slightly above the ten-year low recorded in 2022. However, interest rate volatility may cause
issuance to slow into year-end, and EM companies’ aggregate bond payments in 2023 continue to far exceed new corporate debt
fundraising.39
• Latin American economies remained resilient: The region enjoyed solid economic growth, led by Brazil and Mexico, despite
tight global financial conditions. Central banks in this region are expected to reduce interest rates in 2H2023 by nearly 100 bps,
on average, from the current double-digit levels.
• In China, new government policies helped moderate pessimism about the country’s growth outlook: Industrial activity and
consumer demand stabilized, as policymakers seeking to achieve the country’s 5% growth target announced policies designed to
stimulate economic growth, boost the property sector, and shore up the currency.

Opportunities Risks

• Opportunities for EM investors have improved due to • EM debt investors are potentially being inadequately
the prolonged period of tight monetary policy globally: compensated for risk, despite the increase in yields:
Rising yields in U.S. and European debt markets have Yield spreads in EM debt are only slightly wider than the
caused many cross-over investors to exit EM debt markets. historical average despite tight capital markets,41 slowing
Consequently, EM-dedicated investors with capital to deploy economic growth, and elevated default rates.
can now typically enjoy enhanced investor protections and • Geopolitical tensions in EM remain elevated: The war
high yields. in Ukraine, complicated China-U.S. relations, elections in
• The yield spread differential between EM and U.S. high Latin America, and instability in the Middle East could all
yield bonds now exceeds the long-term average: The erode investor confidence in EM credit.
average yield spreads in EM high yield bond indices are 100
bps wider than those of their U.S. counterparts, even though
the former market features companies with lower leverage
and more defensive business models on average.40

Figure 7: Performance in EM Debt Varied Significantly by Tenor in 3Q2023

EM High Yield Bond 3Q2023 Returns, Categorized by Year of Final Maturity

1.4% 1.1% 1.2%

0.9% 0.7%
0.4% 0.0%
-0.1%
-0.6% -0.4%
1-3 Years 3-5 Years 5-7 Years 7-10 Years 10+ Years

Source: JP Morgan Corporate Broad CEMBI High Yield Plus Index, as of September 30, 2023

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Strategy Focus Insights

Global Convertibles Market Conditions: 3Q2023

Return: -2.3%42 | LTM Default Rate: 3.0%43

• Declining equity prices weighed on global convertibles’ performance in 3Q2023: Most global equity markets weakened
during the period, which caused convertible bond prices to fall. This trend was driven by expectations that the Federal Reserve
will keep interest rates higher for longer and the attendant spike in U.S. Treasury yields to levels not seen since 2007. In addition,
economic weakness in China put further pressure on convertibles in Asia and Europe.
• Energy stocks outperformed, while high-multiple equities lagged: Many energy companies’ stocks rallied as production cuts
by OPEC+ and resilient global demand drove oil prices higher. On the other hand, rising Treasury yields negatively impacted the
performance of growth-oriented and high-multiple equities.
• Primary market activity remained fairly strong: In 3Q2023, new issuance of global convertibles totaled $21.5bn across 37
new deals. This exceeded the sluggish pace seen through most of 2022 and was in line with the pre-pandemic quarterly average.

Opportunities Risks

• Issuers may turn more to the convertibles market in the • Numerous trends threaten to slow global economic
coming year: Since the Global Financial Crisis, issuance of growth and weigh on equity prices: These include elevated
high yield bonds has dramatically outpaced activity in the inflation, tightening global monetary policy, concerns about
convertibles market. However, expectations that interest slowing consumption, and geopolitical risk.
rates will remain higher for longer may encourage issuers to
turn to convertibles, which currently offer average coupons
that are more than 2.2 percentage points lower than those of
straight debt. (See Figure 8.)
• Convertibles are offering attractive yields and enhanced
protections: The average coupon for a new global
convertible is 3.1%, compared to the low of 1.4% in 2021.
Newly issued convertibles also feature more investor-
friendly terms.
• The convertibles universe is broad and diverse: Many
of the new deals in 2023 have come from historically
underrepresented sectors (e.g., utilities and financials),
investment-grade-rated issuers, and large-cap companies.

Figure 8: The Difference Between the Coupons of Straight Debt and Convertible Bonds Is the Largest Since 2016

2.4x
Straight Debt/Convertibles

2.2x
Average Coupon:

2.0x
1.8x
1.6x
1.4x
1.2x
1.0x
Sep-2016

Sep-2017

Sep-2018

Sep-2019

Sep-2020

Sep-2021

Sep-2022

Sep-2023
Mar-2017

Mar-2018

Mar-2019

Mar-2020

Mar-2021

Mar-2022

Mar-2023

Source: BofA Global Research; represents secondary market convertible bond coupons and secondary market straight debt coupons

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Strategy Focus Insights

Structured Credit Market Conditions: 3Q2023

Corporate – BB-Rated CLO Return: 7.0%44 | BBB-Rated CLO Return: 5.8%45

• Collateralized Loan Obligations strengthened in 3Q2023: The asset class benefited as concern about a U.S. recession
decreased and demand for CLOs outpaced supply growth.
• Activity in the primary market rose moderately: Issuance of CLOs in the U.S. totaled nearly $30bn in the period, up from
$22bn in 2Q2023. Issuance in Europe totaled €7.5bn, compared to €5.4bn in 2Q2023.46 Despite the recent increase, YTD
issuance remains below levels in the first nine months of 2021 and 2022.

Real Estate – BBB-Rated CMBS Return: -2.2%47

• Primary market activity has continued to decelerate: Issuance of commercial mortgage-backed securities has decreased by
66% in the year to date, with just $31bn of private label CMBS issued in the last nine months, compared to $92bn in the same
period last year.
• Performance varied meaningfully by sector: All sectors were negatively impacted by rising interest rates, higher capitalization
rates, declining transaction volumes, and reduced bank lending. However, debt secured by residential assets has benefited from
the ongoing supply/demand imbalance in the housing market. In commercial real estate, the office sector continued to face
additional headwinds.

Opportunities Risks

• Corporate structured credit offers higher average yields • CLOs have historically experienced increased volatility
than traditional credit asset classes: CLOs have attractive during bouts of equity market weakness: Performance
yields as well as strong structural enhancements. (See could be negatively affected if investors’ risk appetite
Figure 9.) declines or if the loan market experiences a large wave of
• Volatile markets could create compelling opportunities: downgrades and/or defaults.
CLO managers can now often buy B- or BB-rated loans at • Activity in the CMBS primary market will likely
discounts to par, meaning managers can potentially benefit remain muted: Uncertainty surrounding the trajectories for
from both the CLO arbitrage and capital appreciation. interest rates, inflation, and the cost of financing may limit
• Weakness in the CMBS market could create compelling transaction volumes in the near term.
opportunities for disciplined investors: Investors with • Weakness in the office sector may persist: The sector
available capital and limited problems in their existing continues to face multiple headwinds. The performance of
portfolios may be well positioned to take advantage of these this sector will likely weigh on real estate structured credit
opportunities. But in this challenging environment, it will indices.
be especially important to (a) conduct disciplined credit
analysis and (b) remain senior in the capital structure.

Figure 9: Structured Credit Offers Higher Yields Than Most Traditional Debt

CLOs
Structured Credit
25
25% CMBS - SASB 22.6%
Traditional Debt 21.2%
Yield-to-Worst

20
20%
15.9%
15
15% 13.5%
12.1%
9.1% 9.9%
10
10% 7.7%
6.3%
5
5%

0
0%
BBB-Rated BB-Rated B-Rated

Source: Bloomberg Index Services, ICE Index Platform, Credit Suisse, JP Morgan, as September 30, 2023

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Strategy Focus Insights

Private Credit Market Conditions: 3Q2023

• Private credit has been resilient in 3Q2023, but it’s likely to weaken in the near term: Strong YTD performance has been
supported by robust U.S. economic growth and proactive actions taken by sponsors and lenders to stave off liquidity problems
among vulnerable borrowers.48 But companies haven’t yet felt the full impact of rate increases, so performance may deteriorate
moving forward.
• Average private credit terms remain relatively lender-friendly: While yield spreads compressed modestly during the quarter,
they remain wider than the historical average, and covenants continue to be more restrictive than in recent years.49 Additionally,
average loan-to-value ratios have decreased for new deals, as private equity sponsors have been under pressure to contribute
higher percentages of equity capital due to portfolio companies’ elevated interest burdens.50
• Private deal volume in Europe remains muted: The region continues to be beset by high inflation, economic uncertainty, and
geopolitical risk. Deals are taking longer to complete, as weak macroeconomic conditions are extending due diligence timelines.
And small banks, which underwrite a significant proportion of deals in Europe, are curtailing their lending.

Opportunities Risks

• Demand for private debt financing appears to be • More borrowers are likely to feel the negative impact
increasing: Sponsor-backed M&A activity has risen since of higher interest rates: We expect a greater number
Labor Day.51 Moreover, demand for refinancings is likely to of companies to face liquidity challenges in the coming
grow significantly in the coming years, as an estimated 40% quarters, especially borrowers with unitranche floating-rate
of the direct lending market is maturing in 2024-25.52 Only debt structures put in place in 2021 and earlier.
about 15% of both the high yield bond and leveraged loan • Monetary policy could remain tight, negatively
markets are expected to mature in 2024-25. (See Figure 10.) impacting the lending environment: Central banks have
• Private lenders could continue to gain market share in signaled that they intend to keep interest rates higher for
large-cap financings: Bank lending in this market may longer to combat persistently high inflation. This may
remain inconsistent and limited for multiple reasons: discourage new borrowing and make it challenging for
(1) In 2022, many banks suffered meaningful losses on current borrowers to roll over their debt, especially highly
LBO debt commitments. leveraged sponsor-backed companies.
(2) In 1H2023, the six largest U.S. banks wrote off $5.0bn • Fears about a near-term U.S. recession have moderated,
of defaulted loans and set aside an additional $7.6bn to but the economic outlook remains uncertain: The labor
cover future defaults.53 market has been resilient, and spending on services is
(3) The syndicated market has become less reliable. In increasing. But high borrowing costs may curb growth, and
YTD 2023, CLO formation has been uneven, and loan even though inflation has decelerated, it remains elevated.
retail funds have experienced meaningful outflows. Moving forward, private equity sponsors may not inject
• European banks may continue to lose market share to capital into struggling companies as they did in 2020–21.54
private lenders: The challenging macroeconomic backdrop
could cause banks to continue curtailing lending. Moreover,
we’re increasingly seeing European banks partnering with
direct lenders on new deals.

Figure 10: Private Debt Faces a More Imposing Near-Term Maturity Wall than BSLs and High Yield Bonds

40%
Market Maturing
Percentage of

30%

20%

10%

0%
2023 2024 2025 2026 2027 2028 2029 2030+
Private Debt Broadly Syndicated Loans High Yield Bonds

Source: BofA Global Research, ICE, DLD, as of June 30, 202354

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About the Authors Insights

Armen Panossian
Head of Performing Credit and Portfolio Manager

Mr. Panossian is a managing director and Oaktree’s Head of Performing Credit, as well as a member of
the investment committee for Oaktree’s Direct Lending and Global Credit strategies. He also serves as
portfolio manager for the Strategic Credit strategy and co-portfolio manager for the Global Credit Plus
and Diversified Income strategies. His responsibilities include oversight of the firm’s performing credit
activities including the senior loan, high yield bond, private credit, convertibles, structured credit and
emerging markets debt strategies. Mr. Panossian also serves as co-portfolio manager for Oaktree’s Life
Sciences Lending platform, which focuses on investment opportunities across the healthcare spectrum
from biotechnology and pharmaceuticals to medical devices and healthcare services. Mr. Panossian
joined Oaktree in 2007 as a senior member of its Opportunities group. In January 2014, he joined the
U.S. Senior Loan team to assume co-portfolio management responsibilities and lead the development
of Oaktree’s CLO business. Mr. Panossian joined Oaktree from Pequot Capital Management, where
he worked on their distressed debt strategy. Mr. Panossian received a B.A. degree in economics with
honors and distinction from Stanford University, where he was elected to Phi Beta Kappa. Mr. Panossian
then went on to receive an M.S. degree in health services research from Stanford Medical School and
J.D. and M.B.A. degrees from Harvard Law School and Harvard Business School. Mr. Panossian serves
on the Advisory Board of the Stanford Institute for Economic Policy Research. He is a member of the
State Bar of California.

Danielle Poli, CAIA

Managing Director and Assistant Portfolio Manager

Ms. Poli is a managing director and portfolio manager within the Global Credit strategy. She is a founding
member of the strategy, having helped design its portfolio management processes and having served as a
member of the Global Credit Investment Committee since 2017. Ms. Poli has led the expansion of the
firm’s multi-asset credit offerings, including a product for Brookfield Oaktree Wealth Solutions which
she has co-managed since 2021. In addition, Ms. Poli oversaw Oaktree’s product management activities
globally across Credit, Private Equity, Real Assets and Listed Equities from 2019 to 2023. Prior to
joining Oaktree in 2014, Ms. Poli earned her M.B.A. at the UCLA Anderson School of Management,
where she received the Laurence and Lori Fink Investment Management Fellowship. Prior thereto, she
worked at PAAMCO KKR Prisma (formerly PAAMCO) where Ms. Poli helped manage hedge fund
portfolios for institutional clients. Ms. Poli holds a B.S. degree in business administration from the
University of Southern California and is a CAIA charterholder.

Oaktree’s Performing Credit Platform

Oaktree Capital Management is a leading global alternative investment management firm with expertise in credit
strategies. Our Performing Credit platform encompasses a broad array of credit strategy groups that invest in public and
private corporate credit instruments across the liquidity spectrum. The Performing Credit platform, headed by Armen
Panossian, has $71.4 billion in AUM and approximately 190 investment professionals.55

14
Endnotes
1. JP Morgan, 2Q2023 Leveraged Loan Credit Fundamentals. September 25, 2023.
2. Interest coverage ratio defined as EBITDA/interest expense.
3. JP Morgan, 2Q2023 Leveraged Loan Credit Fundamentals. September 25, 2023.
4. References to GFC are based on data as of December 2007.
5. Preqin and Pitchbook LCD, as of March 30, 2023.
6. Credit Suisse Leveraged Loan Index.
7. ICE BofA US High Yield Constrained Index, as of September 30, 2023.
8. Credit Suisse Leveraged Loan Index, as of September 30, 2023.
9. JP Morgan, as of September 29, 2023. The downgrade-to-upgrade ratio is 1.65:1 on a dollar basis.
10. CreditSights. US HY Vs Lev Loan Fundamentals Comparison (1Q23). July 17, 2023.
11. Percentage based on loan volume at par value, as of September 30, 2023.
12. JP Morgan, 2Q2023 Leveraged Loan Credit Fundamentals. September 25, 2023.
13. Morgan Stanley, 2Q23 Fundamentals – A Faster Descent. September 29, 2023.
14. Interest Coverage ratio defined as (EBITDA – capex) / LTM interest expense.
15. Moody’s Investors Services, as of July 27, 2023. Data as of December 31, 2022.
16. Morgan Stanley, Climbing a Wall of Worry. September 15, 2023.
17. BofA Global Research. Private Debt: Opportunities and challenges in a new rates regime. October 2, 2023.
18. Universe of potential distressed credit includes debt related BBB and below and private credit. Bloomberg Barclays,
Credit Suisse, ICE BofA, Preqin, as of June 30, 2023. For Middle Market / Direct Loans data from Preqin as of
December 2022.
19. JP Morgan and Oaktree analysis.
20. Bloomberg US Aggregate Bond Index, ICE BofA US High Yield Constrained Index, Credit Suisse Leveraged Loan
Index, as of September 30, 2023.
21. ICE BofA US High Yield Constrained Index, ICE BofA Global High Yield European Issuers Index; statistics
comparing December 31, 2021 and September 30, 2023.
22. Refinitiv LPC’s Private Deals Analysis, Refinitiv, and Oaktree market observations, as of June 30, 2023.
23. In this analysis, Oaktree excluded the worst-performing loans (i.e., those with prices below 90 cents on the dollar)
when creating an approximate average new CLO portfolio, as CLOs are restricted from buying the riskiest loans.
Dislocations were defined as periods in which the loan portfolio was trading below particular price thresholds (i.e.,
below 99 cents on the dollar). We calculated hypothetical equity returns for two sets of CLO liability structures: (a)
one with a weighted-average cost of debt of the reference rate plus 150 bps, representative of “par loan” markets, and
(b) one with a weighted-average cost of debt of the reference rate plus 225 bps, representative of “dislocated” markets.
24. The indices used in the graph are Bloomberg Government/Credit Index, Credit Suisse Leveraged Loan Index, Credit
Suisse Western European Leveraged Loan Index (EUR hedged), ICE BofA US High Yield Index, ICE BofA Global
Non-Financial HY European Issuers ex-Russia Index (EUR Hedged), Refinitiv Global Focus Convertible Index (USD
Hedged), JP Morgan CEMBI Broad Diversified Index (Local), JP Morgan Corporate Broad CEMBI Diversified High
Yield Index (Local), S&P 500 Total Return Index, and FTSE All-World Total Return Index (Local).
25. ICE BofA US High Yield Constrained Index for all references to U.S. High Yield Bonds, unless otherwise specified.
26. JP Morgan for all U.S. default rates, unless otherwise specified.
27. The normal range refers to the average range over the last 25 years.
28. ICE BofA Global Non-Financial High Yield European Issuer, Excluding Russia Index (EUR hedged) for all references
to European High Yield Bonds, unless otherwise specified.
29. UBS for all European default rates, unless otherwise specified.
30. Credit Suisse Leveraged Loan Index for all data in the U.S. Senior Loans section, unless otherwise specified.
31. Credit Suisse Western Europe Leveraged Loan Index (EUR Hedged) for all data in the European Senior Loans
section, unless otherwise specified.
32. JP Morgan for all issuance data, unless otherwise specified.
33. Bloomberg US Corporate Index for all data in this section, unless otherwise specified.

15
Endnotes
34. As of September 30, 2023.
35. JP Morgan Corporate Broad CEMBI Diversified High Yield Index for all data in this section unless otherwise
specified. The emerging markets debt section focuses on dollar-denominated debt issued by companies in emerging
market countries.
36. JP Morgan Corporate Broad CEMBI High Yield Plus Index.
37. JP Morgan for default, issuance, and retail fund flow data.
38. Data as of September 30, 2023.
39. JP Morgan, Oaktree Capital Management, as of September 30, 2023.
40. JP Morgan Corporate Broad CEMBI Diversified High Yield Index compared to JPM U.S. High Yield Index.
41. JP Morgan, Oaktree Capital Management, as of September 30, 2023.
42. Refinitiv Global Focus Convertible Index, for all performance data, unless otherwise indicated.
43. Bank of America for all default and issuance data in this section, unless otherwise specified.
44. JP Morgan CLOIE BB Index.
45. JP Morgan CLOIE BBB Index.
46. JP Morgan for all data in this section, unless otherwise specified.
47. Bloomberg US CMBS 2.0 Baa Index Total Return Index Unhedged Index.
48. BofA Global Research. Private Debt: Opportunities and challenges in a new rates regime. October 2, 2023.
49. Oaktree observations in the market, as of September 30, 2023.
50. Refinitiv.
51. Based on Oaktree observations in the market, as of October 13, 2023.
52. BofA Global Research. Private Debt: Opportunities and challenges in a new rates regime. October 2, 2023.
53. Bloomberg, Financial Times.
54. BofA Global Research. Private Debt: Opportunities and challenges in a new rates regime. October 2, 2023.
55. The AUM figure is as of June 30, 2023 and excludes Oaktree’s proportionate amount of DoubleLine Capital AUM
resulting from its 20% minority interest therein. The total number of professionals includes the portfolio managers and
research analysts across Oaktree’s performing credit strategies.

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Notes and Disclaimers
This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an
offer to sell, or a solicitation of an offer to buy, any securities or related financial instruments. Responses to any inquiry that may involve the rendering of personalized
investment advice or effecting or attempting to effect transactions in securities will not be made absent compliance with applicable laws or regulations (including broker
dealer, investment adviser or applicable agent or representative registration requirements), or applicable exemptions or exclusions therefrom.

This document, including the information contained herein may not be copied, reproduced, republished, posted, transmitted, distributed, disseminated or disclosed,
in whole or in part, to any other person in any way without the prior written consent of Oaktree Capital Management, L.P. (together with its affiliates, “Oaktree”). By
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this document to you.

This document contains information and views as of the date indicated and such information and views are subject to change without notice. Oaktree has no duty or
obligation to update the information contained herein. Further, Oaktree makes no representation, and it should not be assumed, that past investment performance is an
indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.

Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party
sources. Oaktree believes that such information is accurate and that the sources from which it has been obtained are reliable; however, it cannot guarantee the accuracy
of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.
Moreover, independent third-party sources cited in these materials are not making any representations or warranties regarding any information attributed to them and
shall have no liability in connection with the use of such information in these materials.

© 2023 Oaktree Capital Management, L.P

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