Morningstar - Q3 2022 - 24

Dispatches
Whatever the definition, global talk of a
recession has been on the rise, with
many investment firms, economists, and other
pundits recently weighing in. Canada
has experienced five or six recessions of varied
impact and duration since 1970 depending
on the definition. So, they are relatively
rare but not unprecedented and should be an
expected part of an investing lifetime.
Successive rate hikes from the Bank of Canada
to rein in inflation and excess demand have
ignited some natural concern, as many, but not
all, rate-tightening cycles have resulted in
recessions in the past. GDP growth has also slowed,
with measures of first-quarter growth in Canada
coming in below previous rates and below
consensus expectations. And domestic investors
can't just focus their attention on local
activity. Canada is integrated into the global
economy, so global supply chain issues, elevated
commodity prices, and the uncertain path
of the global coronavirus pandemic factor into
the equation.
All told, it's reasonable to think there's an elevated
probability of a recession in Canada, but it isn't
a foregone conclusion or even the base case.
Beyond the specific probability of a recession, there
is also uncertainty about the depth and length of
such a downturn, as well as the timing of the onset.
There are a lot of moving parts to this type of
prediction. We're not convinced that most people,
including professionals, can consistently get it right.
Recession predictions are unsettling and can
evoke anxiety about more than just investments.
TRENDS
BBB or better
BB
B
C or worse
Risks in the Leveraged Loan Market Threaten Private Equity Buyouts
The U.S. leveraged loan market-the lifeblood
of private equity buyouts-has continued
to mature at a rapid pace. It recently surpassed
$1.4 trillion in outstanding value, from less
than $100 billion in 2000, amid strong demand for
high-yielding credit and protection from rising
interest rates. The continued growth of
this financing market has provided private equity
investors with an ample source of cheap
credit that has supported the surge in buyout
activity since the middle of 2020.
However, the market is facing several risks
that could have an impact on both buyout
dealmaking as well as buyout-backed companies.
First, if interest rates continue to rise, it would
01/31/2003
Declining Credit Quality The credit quality of the overall
leveraged loan market has deteriorated since 2017,
suggesting that companies are at an elevated risk of an
economic downturn.
BBB or better
BB
B
C or worse
100%
75
9
50
25
01/31/2003
01/31/2007
Source: LCD. Data as of 04/30/2022.
01/31/2011
01/31/2015
04/30/2022
01/08/2010
01/08/2014
Source: LCD. Data as of 05/31/2022.
01/08/2018
05/31/22
3
6
01/31/2007
100%
place pressure on valuations and coverage
ratios. Second, a recession would not only
diminish margins and worsen liquidity, but it
could also cause a further deterioration
in credit quality and weaken investor demand.
Andrew Akers, CFA, is a quantitative research analyst
at PitchBook.
75
50
25
01/31/2011
01/31/2015
04/30/2022
Rising Borrowing Costs Borrowing costs are increasing at
the same time, driven by both spreads and benchmark
interest rates.
Yield to Maturity
Libor
Spread to Maturity
15%
12
24
Morningstar - Q3 2022

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