Quarterly Market Outlook
Q1 2025
Author
Chief Investment Officer
The trend of credit contraction affecting the consumer over the last 18 months seems to be slowing, and in some cases, reversing. We believe this is a positive sign for growth and the consumer’s ability to continue spending patterns. Wage growth continues to be strong, though running in line with inflation. All that said, we remain cautious on some segments within consumer lending, and focus on areas where the use of proceeds are known and point of sale underwriting has been tested over time.
Real Estate continues to be a source of opportunity for our platform, although the fundamentals could not be more different when looking at the residential versus commercial segments of the market. Residential real estate is experiencing a significant supply shortage requiring capital to fund new construction and renovation, against a backdrop of the highest levels of aggregate home equity in 70 years. Given this level of home equity, combined with low outstanding mortgage rates, we products have seen growing issuance in products that allow homeowners to access their home equity without having to sell or refinance their first mortgage at a higher interest rate.
Commercial real estate is a far more mixed bag of circumstances – where trouble in the office sector remains a major concern (though with potential opportunity for the patient and careful). We believe, sectors like industrial and multi-family offer far better fundamentals and risk/return dynamics. Bank retrenchment across the real estate lending space has allowed private credit managers to step in to provide much needed capital at very attractive rates of return.
Corporate direct lending remains healthy, as default rates continue to normalize from 2023 peaks, though spreads and competition for transactions have tightened. Demand for bank loans from the CLO market, which has tightened across all tranches over the last 6 months, in combination with High Yield spreads under 300 basis points, creates supportive demand for corporate credit and downward pressure on spreads within the sponsor-backed direct lending space.
Spreads across most sectors within private credit have tightened by 50-200 basis points over the course of 2024. The greatest spread tightening has been in sponsor-backed corporate direct lending, and more modest tightening in asset based, real estate and specialty finance. We expect a continuation of spread tightening into 2025, and see private credit as more attractive than public credit on a relative value basis.
- Default rates across both private and public credit remain benign. Private credit and HY public credit have exhibited improved default rates (i.e. lower) QoQ, while leveraged loan default rates are up, but modestly QoQ.
- The Federal Reserve rate cuts in 3Q and 4Q are immediately accretive to corporates.
- Commercial real estate (CRE) continues to be burdened by high interest rates and valuation uncertainties given low transaction volumes.
- With over $1T of CRE debt coming to maturity over the next three years, there will be material demand for credit setting up an attractive opportunity in bridge and gap lending.
- Residential real estate has continued to see an appreciation of home equity value driven by a structural supply / demand imbalance as well as limited inventory on the market. Homeowners are locked into low mortgage rates. Finding ways to “attach to the home” should continue to provide attractive risk-adjusted credit returns.
- The expected seasonal pickup in delinquencies across consumer assets leading into the year-end is upon us, though most of these delinquencies typically cure during tax season.
- While consumer assets remain well bid, it is worth noting that delinquencies and losses f rom recent vintages remain elevated. The market is still uncertain on the impact of the new administration on consumers given speculation on higher tariffs and deregulation.
The views expressed in this chart are those of the Investment Team of Nomura Capital Management LLC and are based on the Investment Team’s forward looking assessment of credit markets as of the date referenced above. The views expressed herein are subject to change at any time following the publication of this report. The arrows in the chart reflect the change in the Investment Team’s outlook of each credit market since its prior quarterly market commentary. This chart is provided for informational purposes only and is not intended to represent a recommendation from Nomura Capital Management LLC to invest in, or divest from, the credit market ass et classes referenced herein.
The views expressed in this chart are those of the Investment Team of Nomura Capital Management LLC and are based on the Investment Team’s forward looking assessment of the general macro economic environment as of the date of this report. The Bull/Base/Bear Market (“Market Scenarios”) outcome probabilities noted in this report reflect the Investment Team’s forward looking estimate of the probability of each Market Scenario occurring within the next 12 18 months from the date of this report. The market metrics noted within this report (Growth, Inflation, Unemployment, Risk Assets, Base Rates and Volatility) represent the Investment Team’s forward looking estimate of each market metric resulting from the corresponding Market Scenario. All views and estimates contained within this report are as of the date of this report and are subject to change at any time following the publication of this report.
Data sourced from Bloomberg
CPI = The Consumer Price Index PCE Personal consumption expenditures Cleveland Fed NTRR Federal Reserve Bank of
Cleveland New Tenants Repeat Rent Index CPI OER Consumer Price Index Owners’ Equivalent Rent
Data sourced from Bloomberg
Data sourced from Bloomberg
C&I Large = Commercial Industrial Large Energy Users C&I Small Commercial Industrial Small Energy Users
US Residential Real Estate
Affordability continues to be an issue given elevated home prices and mortgage rates. Many homeowners have opted to remodel their homes rather than move both helping to improve home value while keeping a low mortgage rate. A historically high increase in homeowner equity enables this decision.
Federal Reserve Bank of St. Louis
State of the Consumer
When underwriting asset based lending, structure is just as important as the underlying borrower and collateral profile to protect investors from losses. It is important to not only understand the underlying borrower pool in asset based lending, but also the structure of the transaction.
Below are two examples of asset based transactions. The left is prime, and the right is subprime:
- The AA and A tranches, which provide credit subordination to the AAA tranche, in the prime transaction (left graph) make up less than 10% of the transaction.
- The BB through AA tranches in the subprime transaction comprise just under 50% of the deal (right graph).
- The conclusion that can be drawn from these structural differences between prime and subprime deals is that the subprime transaction is meant to withstand significantly higher losses (as one would expect for a lower tier consumer) than the prime transaction.
Source Morningstar DBRS, S&P Global Ratings, Bloomberg
These materials reflect the opinion of NCM on the date of production. Opinions and statements of financial market trends that are based on current market conditions constitute our judgement and are subject to change without notice. Past performance does not guarantee future results. Where data is presented that is prepared by third parties, such information will be cited, and these sources have been deemed to be reliable. However, NCM does not independently verify or otherwise warrant the accuracy of this information. All investments are subject to risks, including the risk of loss of principal.