Q2 2023 Lincoln Senior Debt Index
Lincoln International is pleased to release the quarterly Lincoln Senior Debt Index (LSDI). The LSDI represents years of research and analysis of data and was developed by professionals from Lincoln’s Valuations & Opinions Group in collaboration with Professor Pietro Veronesi of The University of Chicago Booth School of Business.
For the quarter ending June 30, 2023, trends in the direct lending market were positive. The Lincoln Senior Debt Index yield reached another record high at 11.7%, a seven basis point increase relative to the previous high of 11.6% in the first quarter of 2023. Fair value also continued to climb, finishing the second quarter of 2023 at 96.9. Finally, the default rate declined approximately 30 basis points since Q1 2023, breaking a six quarter trend of observed increased rates of default in the direct lending market. In other words, lenders continued to benefit from high interest rates resulting in record yields and stable prices while also getting a better handle on the credit stresses in portfolio companies that were resulting in continued defaults. This somewhat surprising decrease in defaults may be explained by Lincoln’s observation of over 450 amendments executed in 2023, or approximately 20% off all companies that Lincoln tracks. We believe this demonstrates that borrowers and lenders anticipated defaults, which primarily resulted not from declining earnings but from increases in interest rates, and proactively addressed the issue by amending the loan documents. Lincoln also noted that, of these amendments, 31% had sponsors injecting equity while 38% had increases in interest spreads (33% of which included some payment-in-kind interest).
In the second quarter of 2023, the direct lending and broadly syndicated loan (BSL) market continued to experience a contraction in their yield differential with only a 2.1% yield difference relative to the historical average of 3.9%. LSDI yields have risen from 10.2% to 11.7% (1.5%) from June 30, 2022 to June 30, 2023 whereas BSL yields have risen from 7.0% to 9.6% during this same period (2.7%).
The LSDI provides insight into the direct lending market as it is a fair value index consisting of four components:
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Each of the four components are then categorized into three types of senior loans:
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Quarterly Overview
- Covers Q2 2023
- The LSDI provides insight into the direct lending market as it is a fair value index consisting of four components: 1. Total return (income return plus capital gain return); 2. Price (i.e., fair value); 3. Spread; and, 4. Yield to maturity.
- Each of the four components are then categorized into three types of senior loans: 1. All senior loans – consisting of first lien, Unitranche, and second lien loans; 2. Senior loans consisting of first lien and 3. Second lien loans.
- Click here to download a printable version of this report.
In addition, we provide additional descriptive statistics including: (a) loan-to-value; (b) the impact of interest rate and credit changes on total return; (c) the results of stress testing spread changes in the current and subsequent quarters and (d) default rates.
The U.S. non-investment grade corporate loan market has two segments: the BSL market, which attracts investors investing in broader syndicated deals and the direct lending market for investors investing in club deals. While correlated, there are subtle but significant differences between the two markets. Both markets primarily provide floating rate loans; however, divergences exist in terms of market liquidity, company size and credit facility size. Given the greater liquidity in the BSL market, pricing and terms are a function of the technical market and competitive factors, whereas the more illiquid direct lending market has a stronger orientation to assessing company fundamentals.
In contrast to the Morningstar LSTA U.S. Leveraged Loan 100 Index which is comprised of companies borrowing in the BSL market, the constituents in the Lincoln Senior Debt Index are virtually all companies borrowing in the direct lending market.
The direct lending market is a significant source of capital to private equity backed middle-market companies. The Lincoln Senior Debt Index benefits market participants by providing information to facilitate a greater understanding of the attributes of this important source of capital to the private sector.
How We Obtain the Information
On a quarterly basis, Lincoln values over 4,750 private companies primarily owned by over 150 alternative investment funds and lenders to funds. Most of these companies are levered via borrowings from the direct lending market. A significant percentage of the Lincoln Senior Debt Index constituents are based upon valuations of loans provided for non-public business development companies and other private investment vehicles and, therefore, not disclosed in public filings.
For many of the private companies valued quarterly, Lincoln advises on the fair value of at least one senior debt security in the capital structure. All valuations conform with GAAP and fair value principles and have been reviewed by fund management, fund boards, limited partners and auditors.
Additional information can be found in our methodology discussion and on our website.
| 96.9 |
| Average Fair Value of Loans in the Index as of Q2 2023 |
Results
Total Return
Comparison of Total Return – Lincoln Senior Debt Index (All Loans) to Morningstar LSTA U.S. Leveraged Loan 100 Index
Correlation and Comparison of Quarterly Returns – Lincoln Senior Debt Index (All Loans) to Broadly Syndicated Loan Market
Yields
Comparison of Yields – Lincoln Senior Debt Index (All Loans) to Broadly Syndicated Loan Market
Decomposing Yields in the Direct Lending Market – LIBOR Floors and Spreads
Decomposing Yield – LIBOR, LIBOR Floors and Spreads – All Loans
Fair Value – Price – Trends
Fair Value – Lincoln Senior Debt Index (All Loans) Compared to the S&P / LSTA U.S. Leveraged Loan Index
Bifurcation of the Impact on Total Return Due to Credit Risk and Interest Rate Risk
Decomposition of Index Returns: Interest Rate versus Credit Risk
Default Rates
Direct Lending Default Experience
Methodology
Source of Data and Sample Size
On a quarterly basis, Lincoln determines the enterprise fair value of over 4,750 portfolio companies for approximately 150 private equity sponsors and lenders. These portfolio companies report quarterly financial results to the sponsor (i.e., private equity group) or lender. Lincoln obtains company and loan level information to create the Lincoln Senior Debt Index.
All information is prepared in accordance with the fair value measurement principles of generally accepted accounting principles. Finally, each valuation is then vetted by auditors, company management, boards of directors and regulators.
Additional information about the methodology of the LSDI can be found at: www.lincolninternational.com/perspectives/an-overview-of-the-lincoln-senior-debt-index.
Academic Advisor
Professor Pietro Veronesi is the Chicago Board of Trade Professor of Finance at the University of Chicago, Booth School of Business. He is also a research associate of the National Bureau of Economic Research and a research fellow of the Center for Economic and Policy Research.
Professor Veronesi’s research has appeared in numerous publications, including the Journal of Political Economy, American Economic Review, Quarterly Journal of Economics, Journal of Finance, Journal of Financial Economics and Review of Financial Studies. He is the recipient of several awards, including the 2015 AQR Insight award, the 2012 and 2003 Smith Breeden prizes from the Journal of Finance, the 2008 WFA award, the 2006 Barclays Global Investors Prize from the EFA, the 2006 Fama / DFA prizes from the Journal of Financial Economics and the 1999 Barclays Global Investors / Michael Brennan First Prize from the Review of Financial Studies. Professor Veronesi teaches both masters- and Ph.D.-level courses. He is the recipient of the 2009 McKinsey Award for Excellence in Teaching.
His undergraduate work was in economics at Bocconi University where he received a laurea magna cum laude with honor in 1992. He earned a master’s degree with distinction in 1993 from the London School of Economics. He joined the Chicago Booth faculty upon obtaining his Ph.D. in Economics from Harvard University in 1997.
SummaryQ2 2023 Lincoln Senior Debt IndexFrom 2014 through June 30, 2023, a portfolio of direct lending loans has yielded higher returns and lower volatility relative to broadly syndicated loans. The Lincoln Senior Debt Index provides market participants many unique valuation insights into the fair value of direct lending loans and represents a significant enhancement to the information available within an opaque market. |
Contributors
I find immense fulfillment in enabling clients to achieve their objectives and navigate the complexities of today's ever-changing landscape.
Chris Croft
Managing Director & Co-head of Transaction Opinions
New York
I enjoy sharing insights about market and valuation trends with my clients, while also leading a differentiated and high-touch process.
Brian Garfield
Managing Director & Head of U.S. Portfolio Valuations
New York
I enhance my clients’ decision making and governance processes by providing independent and objective financial advice in a highly responsive manner.
Chris Gregory
Managing Director & Co-head of Transaction Opinions
New York
I enjoy the opportunity to provide clients with insightful and unbiased advice that will help them make the most informed decisions possible.
Ron Kahn
Managing Director & Co-head of Valuations & Opinions
Chicago
