The surge in funding costs over the last 12 months has left many rated NBFIs relying on secured and equity markets to fund growth and address liquidity needs. In 2023, we believe debt markets may not meet new funding needs at satisfactory conditions for some NBFIs in North America. Investors have become more selective as credit quality has weakened and spreads have widened. Large institutional investors, such as asset managers and pension funds, have become more risk averse, investing more in investment-grade companies despite higher yields on speculative-grade companies. Within speculative-grade companies, investors tend to favor seasoned issuers and higher-rated companies, primarily in the 'BB' category. While financing options through the unsecured debt markets remain limited, the secured bank funding and securitization markets remain open, albeit at yields much more restrictive than a year ago.

Anticipating a deteriorating funding environment, many NBFIs issued new bonds and loans and extended maturities in 2021. Many companies have succeeded in refinancing--many times prefunding--maturing debt and reinforcing liquidity levels. As a result of proactive treasury management, debt maturities for 2023 have declined to $4.5 billion, from $11.1 billion as of May 2022.

The easy access to capital came to an end in the second half of 2022 amid rapidly rising interest rates and there is little to suggest that rates will decline any time soon. In 2022, new NBFI debt issuance (rated by S&P Global Ratings) fell to about $22 billion, from $62 billion in 2021 and $37 billion in 2020. While the markets remain open for investment-grade companies, we expect NBFI issuance--which primarily comprises speculative-grade companies--to continue to decline this year, with rated issuance year-to-date (as of March 8, 2023) totaling just $1.0 billion.

The 101 NBFIs that S&P Global Ratings publicly rates in North America have about $202 billion in debt outstanding, about 10% (approximately $22 billion) of which was raised or refinanced in 2022. Over the next five years, these companies have about $108 billion in nonrevolving, nonsecuritized debt maturing, with a peak of $35 billion in 2026. About 52% of total outstanding debt is speculative grade (see Appendix for individual debt maturity profiles).

Although the amount of NBFI debt maturing through 2027 represents a narrow slice of the North American financial services debt maturing over the same period, we note that tighter financing conditions for NBFIs could spill into the broader credit markets because NBFIs play an important role in providing funding and liquidity to leveraged borrowers and various financial services to consumers in North America.

Consistent with the decline in NBFI issuance, as interest rates started rising in 2022, issuance declined across all rating categories for North American financial services issuers. Having said that, investors preferred investment-grade issuers over speculative-grade issuers. As a result, North American speculative-grade financial services issuance declined 81% in 2022 to $15.5 billion. However, speculative-grade financial services issuance showed signs of rebounding in the first two months of 2023, climbing to $11 billion--more than double the amount issued over the same period in 2022 and exceeding the amount issued in the last three quarters of 2022 combined.

Chart 1

Credit spreads for North American financial services narrowed after November 2022 as the Federal Reserve began to slow the pace of its rate hikes, but the narrowing has slowed in 2023. After investment-grade financial services spreads narrowed in January and February of 2023, they widened swiftly to 154 basis points (bps) in early March, reflecting investor concerns about risk among regional banks. This recent widening brings the investment-grade spread back to its level at the beginning of 2023.

While speculative-grade financial services spreads have only widened by 4 bps year-to-date (to 431 bps), they have been considerably more volatile. These spreads had narrowed to 354 bps by Feb. 9, before rapidly widening by 77 bps in the subsequent four weeks.

Chart 2

Chart 3

2022 NBFI Debt Issuance: Unfavorable Unsecured Debt Market Financing Conditions Led To Disappointing Issuance Volume

The majority of 2022 issuance occurred between January and mid-March, when rates were still relatively low and allowed companies to lock in low-cost funding. The Fed hiked the fed funds rate seven times in 2022, to 4.25%-4.50% at the end of the year, officially ending an era of low interest rates and taking a hawkish stance to curb inflation. In 2022, we saw interest rates rise and credit spreads widen as investors pivoted to risk-averse strategies. Consistent with the decline in NBFI issuance, speculative-grade volume waned this year, with fewer issuers coming to market amid choppy conditions. As a percentage of total 2022 NBFI issuance, speculative-grade issuance declined to 29% in 2022, from 53% in 2021 and 50% in 2020.

Our economists expect the Fed to keep monetary policy tight, despite economic damage, until inflation begins to moderate. We expect the fed funds rate to peak at 5.00%-5.25% by second-quarter 2023 and remain near that level in 2024. The risk is for more rate hikes this year and the next, which could make 2023 another subdued issuance year.

Business development companies (BDCs) and commercial lending and asset managers (traditional and alternative) accounted for about 87% of the capital raised by NBFI companies in 2022. The remaining 13% was split among commercial real estate, consumer finance, and other subsectors.

Chart 4

BDCs and asset managers comprised the largest subsector of NBFI issuers in 2022 by debt amount, raising about $18 billion. Despite the higher cost of funding, we saw perpetual, non-traded BDCs like Blackstone Private Credit Fund (BCRED) and Owl Rock Core Income Corp. (ORCIC) actively issue debt to fund portfolio growth. In 2022, BCRED (BBB-/Stable/--) was by far the largest issuer, issuing $4.1 billion in senior unsecured notes that mature over the next three to five years. ORCIC (BBB-/Stable/--) issued $1.6 billion in unsecured notes that mature over the next five years, and Ares Capital Corp. (BBB-/Stable/--) issued $500 million in senior unsecured notes due 2027. So far in 2023, BDCs have not issued any debt and we expect them to address their maturities by drawing on their revolvers or accessing the secured markets.

On the traditional asset manager side, the $3.0 billion issued was driven by speculative-grade credits that resulted in financing through secured bank loans. Focus Financial Partners Inc. (BB-/Stable/--) was the largest issuer in 2022, with a roughly $2.0 billion senior secured loan due 2027-2028. In 2022, alternative asset managers issued $5.9 billion in unsecured debt, $3.0 billion of which was issued by Blackstone and $1.1 billion by Brookfield Asset Management Inc. (A-/Stable/A-1) across two tranches.

Of the remaining subsectors, commercial real estate companies issued $1.9 billion in secured and unsecured debt in 2022, with Starwood Property Trust Inc. (BB/Stable/--) issuing $500 million in unsecured notes due 2027 and $600 million in senior secured notes due 2027. Blackstone Mortgage Trust Inc. (BB-/Negative/--) issued a $825 million term loan due 2029. Through 2022 and year to date 2023, residential mortgage companies have not issued any public unsecured debt as they grapple with low origination volume and compressed gain-on-sale margins. So far in 2023, we have seen Cushman & Wakefield (BB/Stable/--) issue a $1.0 billion term loan due 2030.

Chart 5

Maturities And Funding Costs To Gradually Increase Through 2026

Many NBFIs have chipped away at near-term maturities, reducing the amount of debt maturing in 2023 to a manageable $4.5 billion across about a dozen companies. However, starting in 2024, maturities will increase to about $18.0 billion in 2024 before rising to $25.6 billion and $35.4 billion in 2025 and 2026, respectively.

In addition to the refinancing risk, assuming interest rates don't meaningfully decline, we expect NBFIs will face higher funding costs. Borrowers with floating-rate debt--most of which are speculative grade--were the first hit by higher rates, followed by borrowers issuing debt or refinancing debt. Looking forward, in addition to higher base interest rates, companies with weak operating performance will see wider spreads, amplifying the pressure on debt service coverage ratios and credit ratings. Furthermore, we expect higher interest rates will force some companies to prudently manage excess cash flow by scaling back shareholder initiatives to either reduce leverage or fund portfolio growth.

Of the roughly $108 billion of NBFI debt maturing over the next five years, we rate about 49% as investment grade. In the investment-grade category, there is $33.2 billion of debt rated at the 'BBB-' level, composed primarily by BDCs. Within speculative-grade ratings, $40.4 billion of debt was issued by companies rated in the 'BB' category, $13.1 billion in the 'B' category, and $2.5 billion in the 'CCC' category.

Chart 6

Because NBFI represents a small share of total debt, maturities of financial and nonfinancial corporates more broadly will weigh more heavily on financing conditions. We estimate that nearly $5.2 trillion in debt (including bonds and loans but excluding revolving credit facilities) from financial and nonfinancial issuers is scheduled to mature from 2023-2027 in the U.S. and Canada, and 30% of this is from financial services. Financial services' maturities remain below $375 billion annually through 2027--considerably lower than recent bond issuance volumes, which have held above $450 billion annually for the past four years. In comparison with nonfinancial corporates, financial services' annual maturities show less of an overhang of pandemic-era debt scheduled to mature from 2025 on, with a more gradual climb of 44% from 2023 to their peak in 2025, versus 89% for nonfinancial corporate maturities over the same period.

Chart 7

Qualitative Factors By Sector

Of the roughly $108 billion of debt maturing between now and 2027, $35 billion is from BDCs and commercial lending; $15.3 billion from traditional asset managers; $13.7 billion from commercial real estate; $11.9 billion from consumer finance; $10.3 billion from money/payment companies; $7.7 billion from alternative asset managers; $7.5 billion in "other," which includes investment holding companies; and $6.2 billion from the residential mortgage sector.

Chart 8

Liquidity remains key but will likely be squeezed on higher funding costs from future debt issuance

We believe higher interest rates will continue to limit companies' refinancing options. Companies that amassed cheap liquidity over the past several years will face rising interest costs as they refinance maturing debt. We expect future debt issuances will likely occur in waves, when volatility is perceived to be low and capital markets are favorable to refinancing. From a credit perspective, we expect this will create pressure on ratings as companies see their debt service coverage ratios decline.

We continue to believe that a well-staggered debt maturity ladder is the best strategy from an issuer credit rating perspective. We believe issuers with concentrated debt stacks will face the greatest risk of refinancing near-term maturities, while those with well-staggered debt and adequate liquidity can wait for pockets of market volatility to pass.

Sector-specific considerations

Asset managers

We recently revised our traditional asset manager sector view to negative from stable while maintaining our stable sector view for the alternative asset management and wealth management sectors for 2023. We expect rising interest rates, heightened inflation, continued market volatility, and a shallow recession to pressure debt and equity markets this year. Credit metrics will weaken for some asset managers should earnings decline, and those with significant variable-rate debt exposure will see compressed interest coverage metrics.

Of the three subsectors, traditional managers are the most exposed to market volatility, which we expect to weigh on credit metrics in 2023. Net outflows could compound this pressure for some managers. While wealth managers are similarly vulnerable to market movements, their asset base is stickier, resulting in more stable earnings. Alternative asset managers are the best positioned of the three, considering the locked-up nature of their assets under management base, solid records of performance and fundraising, diversified platforms, and capital available for deployment during market dislocation.

Many asset managers issued debt opportunistically over the last several years, supported by low capital costs and buoyant asset valuations. As such, debt issuance for asset managers in 2022 declined nearly 50% from 2021. From a liquidity perspective, most asset managers remain well positioned, with very few having to address near-term maturities in 2023.

Auto finance

We expect easing supply chain pressures and pent-up consumer demand to drive higher vehicle sales and normalizing used-car prices in 2023. Having said that, a rise in credit loss reserves and higher interest rates could weigh on recoveries and profitability, particularly for subprime lenders. For companies with large auto leasing operations, declining used-vehicle prices may lead to lower estimated residual values and additional depreciation expenses--both of which could impact profitability--although we'd expect a limited impact on captives catering to prime-plus borrowers.

Auto lenders will continue to face a higher cost of funding their operations given high interest rates. Tougher financing conditions could depress subprime lenders' origination volumes and profitability, as access to funding to support new originations is crucial to auto finance company operations.

BDCs and commercial credit

S&P Global economists forecast the U.S. will dip into a shallow recession in the first half of the year. We expect BDCs will maintain adequate cushions to regulatory asset coverage ratios (ACR), nonaccruals will rise, and debt service coverage will decline as companies may have difficulty passing along rising costs to consumers. This will constrain borrowers' ability to service their debt and increase the probability of default. Thus far, companies are maintaining adequate cushions to ACRs and loans on nonaccrual and unrealized losses appear manageable.

Commercial real estate lending

We expect higher rates will add to the woes in commercial real estate (CRE) markets, contributing to higher capitalization rates and lower property valuations, particularly affecting CRE lenders with exposure to office, retail malls, and hotels. Higher interest rates and wider credit spreads led to companies relying on secured financing over unsecured to fund growth. Over the past two years, many companies have negotiated margin-call holidays and made these facilities non-mark-to-market, which reduces the risk of margin calls.

Commercial real estate services

We expect the industry-wide decline in CRE transactions to weigh on the earnings of CRE services companies. Capital markets revenue across the sector declined during the second half of 2022, a trend that will likely continue into 2023 amid higher interest rates, capitalization rates, and uncertainty among buyers and sellers on market values. In the leasing segment, we remain cautious about a secular decline in office space requirements as companies transition to a hybrid work model. While property and facilities management has lower margins, it generates recurring revenue and we expect it to provide business stability for CRE services companies in 2023 compared with the more volatile capital markets and leasing segments. We expect a modest decline in multifamily origination volume for CRE services companies and anticipate increased delinquencies and charge-offs as the unemployment rate rises given the slowing economy.

Consumer finance

We think the likely rise in unemployment and high inflation will continue to squeeze the real purchasing power of lower- to middle-income consumers, leading to weakening asset quality among subprime consumer lenders. While such conditions could lead to increased loan demand, origination volumes will likely be lower than in 2022 as companies tighten underwriting standards to manage credit quality. Combined with high interest rates, we expect most consumer finance companies to be less profitable this year than in 2022. As always, regulatory changes could affect the lending strategies of consumer finance companies. While regulatory risk at the federal level has waned over the past few years, state governments continue to make regulatory changes that cap interest rates on payday loans at 36%. Further regulatory rate caps pose significant risks to these companies.

Residential mortgage

The rapid increase in interest rates and, consequently, the sharp decline in origination volumes during the second half of 2022 led to weaker operating performance for residential mortgage companies. There's considerable uncertainty regarding the overall outlook for nonbank mortgage originators that relied on refinancing volume, which we believe will remain subdued until mortgage rates decline. The Mortgage Bankers Assn. expects 2023 origination volume for the industry to decrease by about 16% year over year to $1.9 trillion, after declining by approximately 49% in 2022 to $2.2 trillion.

While most mortgage companies are stemming the earnings decline by decreasing their expenses and exiting certain origination channels, a spike in interest rates has benefited their mortgage servicing rights (MSR) businesses. As rates have increased, the speed of mortgage prepayments has slowed, which has extended the duration of the underlying cash flow and increased MSR values. In addition, MSRs have bolstered the liquidity position of the rated mortgage companies, as they may be used as collateral or sold on the secondary market. We generally view the on-balance-sheet MSRs favorably because they provide recurring cash flow and a natural, albeit imperfect, hedge to the companies' production platforms.

Money transfer and payment processing

The money transfer and payment companies we rate largely saw higher earnings in 2022 as transactional activity remained strong. Revenue sources for the sector are very diverse and include global money remittance, commercial fleet fuel cards, point of sale, peer-to-peer, travel, health care, toll roads, and ATMs.

Capital allocation strategies will likely diverge among the companies we rate. Companies that performed well through 2022 may increase stock buybacks, which will largely limit surplus cash available for netting against debt. Others will look to acquire complementary businesses at discounted valuations, which could entail higher debt, depending on the size of the target.

Appendix

Table 1

Related Research

• U.S. Finance Companies Face Murky Waters Amid Potential Recession, Rising Rates, And Weakening Asset Quality In 2023, Jan 19, 2023
• Asset Management Sector View Is Mixed As Conditions Turn Choppy, Jan 18. 2023