Cracks Appear in Credit Markets Amid Echoes of Great Recession
Continued deterioration in commercial real estate and the private credit markets bear monitoring.
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I posted on the Daily Diary on Wednesday that I didn’t know whether the continued deterioration throughout a large chunk of the commercial real estate market or more cockroaches starting to emerge in private credit markets was more worrying.
One thing seems certain; both areas bear close monitoring for prudent investors. I will take a deeper look at both these developments in this column.
On Wednesday, UBS hiked its worst-case scenario that default rates go to 15% in private credit, up from recently posted 13% worst case scenario as fears around AI disruption have grown. Current default rates in private credit are between 3% and 5%. Of note, the private credit markets have heavy exposure to the technology and software sectors which have been hit hard recently by growing fears of those business models being significantly disrupted by improving AI capabilities.
Jamie Dimon, CEO of JPMorgan Chase & Co. (JPM) was out this week noting that some of the conditions in the financial markets remind him of the years leading up to the Great Financial Crisis. He went on to say that some people are doing some dumb things again and there is always a surprise in a credit cycle. His bank took a $170 million charge in connection to the bankruptcy of Tricolor Holdings this summer which along with the insolvency of First Brands around the same time sent ripples across the credit markets.
Much more recently, problems at some funds at a direct lender called Blue Owl Capital (OWL) have generated their share of negative headlines over the past week. Of note, more than two thirds of loans at Blue Owl are to the software industry.
Meanwhile on the commercial real estate front, the commercial mortgage-backed securities (CMBS) delinquency rate against properties in the office sector hit nearly 12.5% in January. To put this in perspective, this is more than 150 BPS above the levels during the peak of the Great Financial Crisis.
The plunge in office values in many major cities since the pandemic has been breath taking. Some buildings in Chicago have sold for just 40%, 30% or even 20% of their assessed value from a few years ago. A foreclosure suit filed against owners of Worldwide Plaza in New York City appraised the building that was built in 1989 at just under $350 million. The same complex had a valuation of $1.7 billion in 2017.
Multi-family is also under increasing stress. CMBS delinquency rates have roughly doubled to 7% against this sector over the past five quarters. With national average rents falling for six straight months now and loans needing to be refinanced at higher rates in coming years, things are going to get worse in this sector before they can get better.
You can see the increasing stress in the credit markets reflected in exposed names like Blackstone (BX) , Blue Owl Capital, KKR & Co. Inc. (KKR) , SL Green Realty Corp (SLG) and Ares Management Corporation (ARE) , all of whose stocks are down 40% or more from their highs since this summer.
And deteriorating credit conditions certainly aren't reflected properly in overall market valuations with equities trading with a Shiller PE ratio north of 40x. Stocks have traded above this level only once. At the end of the Internet Boom. Therefore, investors should pay increasing attention to some of the cracks developing in the credit markets.
At the time of publication, Jensen had no positions in any securities mentioned.
