Special Episode: Current Credit Market Trends Heading into 2026

Hello, and welcome back to the HPScast, I'm your host, Colbert Cannon. If you're new to the pod, HPS is a global alternative credit manager with approximately 180 billion in assets, managed on behalf of institutional investors, financial advisors, and family offices around the world. That capital is invested across private credit and public credit strategies. Currently, we are between seasons, but we have a special timely episode we want to share with you discussing current credit market trends. I recently sat down with investment leaders from our private and liquid credit teams, as well as a senior member of BlackRock's macro-credit research team. I hope you find the discussion insightful. Joining me today is the Couscazwani, who helps lead our direct lending business here at HPS, Scott Crocom, a managing director on the HPS liquid credit team, and Amanda Lynam, head of macro-credit research within BlackRock's private financing solutions platform. Man, I'd like to start with you. You recently published your fourth quarter global credit outlook, where you expressed a generally constructive view on the macro backdrop and credit risk. What are some of the key factors that make you feel that way? Sure. Thank you, Colbert, for having me, and thanks everyone for joining. We titled our fourth quarter outlook, still climbing the wall of worry, which I think is an appropriate characterization. And I would say we've had a fairly constructive view on risk assets, including liquid and private credit since April 10th. So this wasn't a new development, this has continued, and I would say it's really underpinned by four key factors. One is the macroeconomic growth backdrop is solid enough for credit. One-half 2025 growth was not that far below potential, it was around 1.7%. We see scope for a re-acceleration into 2026. And I would say that is a pretty supportive backdrop for risk. Coupled with that, fundamental characteristics of the corporate credit market, again, both liquid and private are holding in well. I think the second quarter earnings season, in particular, was instrumental as companies were a lot more forthcoming about the myriad of operational levers that they're using to navigate what is a very dynamic backdrop, both policy shifts and kind of just news events. But in general, a lot of the worst market participants fears about companies having a hit to margins and profitability haven't played out. There's certainly dispersion under the surface, but in general, I think the operational resilience of corporates has shown through, and we expect that to continue as we enter third quarter earnings as well, which has just gotten underway. And then third, from a technical perspective, we just think there's a really strong tailwind, especially when investors are allocating to credit for yield. So really, our mantra over the past several months has been, if you're allocating to credit, to allocate to credit for yield, for income, for carry, not because we think there's material scope for spreads to move tighter, because they're already quite tight, and not because we think there's material room for rates to move lower, because they're already, I would say, they've rallied a bit from the local high, and also we just think we're in a structurally higher rate environment. So you kind of put all of those things together. We think there's an opportunity cost to being too defensive in this market. And I think if you take a step back and you think about a lot of the uncertainty that was very palpable in April and in May, oftentimes the reflexive market participants is to generically move up in quality. And if you look at performance that hasn't been the right move, in terms of performance, Lev Finn has actually held in really well from a total return perspective versus higher rated credit. So that's really underpinning our view. The key risk that we are monitoring is this feedback loop between corporate margins, consumer spending, and the overall economy. Right now the layoff rate is very low. Corporates are not hiring a lot, but they're also not firing. If margins come under pressure, we see scope for corporates to flex that layoff tool more aggressively. That could weigh pretty materially on consumer sentiment, and we know the consumer is two thirds of GDP. So that's the key risk, but we're not really seeing anything real time to validate that. But I think micro level commentary from third quarter earnings will be really important. Super awful, man. That's very useful macro backdrop. I want to talk about rates and what appears to be a start of a cutting cycle by the forward curve. Scott spreads in the high yield and loan markets remain near historic tights, while yields are still wide on a historical basis. How have you guys been positioning given this backdrop with the expectation for further cut rates through 2026? Sure. When I love what Amanda said about focusing on yield as a credit investor, because that's been our view for quite some time now. And if you go back to the beginning of this year, right, where the Fed was just coming off of the cuts in late 2024, and it wasn't certain when they'd start back up again or how severe they'd be, we have the ability to dynamically allocate in our portfolios between loans and bonds. And inherently, you're fixed versus floating. And you can overlay that view when we do our fundamental underwrites. And so at the time, if you go back to the beginning of the year, loans and bonds, loans were trading about a hundred basis point yield premium to where bonds were. And the expectation was that we'd probably see cuts over a period of time, but it wasn't clear when they'd start up or how deep they would be. And what we liked about that yield premium, if you will, was about eight and a half percent for loans, seven and a half percent for bonds, was that we'd kind of like the option actually that that would sustain for a bit longer than, let's say, the curve was implying. And I should say, when I talk about loan yields, I'm talking about a three year yield with the downward sloping curve or whatever the slope of the curve is. It turns out that, you know, with tariffs and with the noise in the economy and some risk off activity in the markets over the course of kind of April, May of this year, a lot of people's rate expectations for cuts got pulled forward. And there was some actual yield convexity in fixed rate paper, right? And so you've got high yield up about seven, seven and a half percent this year. Loans are up about four and a half percent this year. That's purely in our view, been a function of rates five and ten year are both up about eight percent, if not more, which kind of matches that high yield return where we stand today is that loans that premium, that yield premium has ticked up to about 150 basis points. That's the pickup for loans versus bonds. We still find that pretty attractive for core yields. I will say we feel a lot more certain of how we're looking at the rate cut environment here. That three to four cut seems pretty likely in our view. We don't think it's going to be more, more severe than that. And so we're comfortable kind of taking advantage of that yield premium given that, you know, we don't think the floating rate under underlying loans is going to fall below what the three to four cut curve implies. But at the same time, we actually think it's quite interesting to start layering in some fixed rate convexity in the form of new issue bonds because, you know, I think we'll get to kind of where supply and demand dynamics are in that market, I think, but it's really compelling when issuers have to come to market and kind of sell that price upside into the market to refinance their balance sheet. So we're going to try to take advantage of that in terms of layering and some fixed rate risk. Amanda, if you think from the macro perspective, you talked about a relatively benign macroeconomic environment, if we continue to see rate cuts as projected, that'll give companies even more breathing room, right? How do you think about that for 20 seconds? I would say yes, marginally. And what has been really striking to us is that the Fed has delivered 125 basis points of cuts. We're still structurally elevated in terms of the rate environment, at least relative to the past 15 years, specifically the period between the financial crisis and the pandemic. And if you look at the resilience of corporate, they've largely navigated this and just taking the broadly syndicated leverage loan market as an example. If you look at Moody's issue-reweighted 12-month trailing defaults, so these will include distress exchanges that you reference at the start. That peaked at 7.7% in November of 2024. That waived the pandemic. So a lot of times we get asked the question on our teams, when will defaults pick up? And the answer is they kind of already have, right? In the syndicated markets, and especially for floating rate borrowers, because they've been dealing with that transmission of monetary policy ever since the Fed started hiking rates in 2022. And now it's actually been on the decline. Again, still have a lot of volatility under the surface. But I think in general, I think corporates are accepting a higher rate environment. You see that in the recent pickup and M&A activity. You see it in corporates and willingness to refine into this environment. And again, you see it in default statistics that kind of, I think, really pressured companies that couldn't grow into their debt capital structures at a higher cost of capital. And now I think those kind of effects are wearing through the system. But yes, you are right. We think this is a normalization cycle coming from the Fed, not a sharp easing cycle. I agree with Scott that it's really difficult in our view to see the Fed cutting below neutral when growth is holding up as well as it has. And importantly, inflation has been above targets since 2021. So I don't think the Fed has a lot of flexibility to ease apps in their sharp downturn in growth, which is not our base case. Rather, we think there's just an ongoing normalization of policy. Now, whether that happens in the fourth quarter of this year or the first half of 2026, the timing for us is less important than the drivers of the rate cutting cycle and the depth. So if the drivers are inflation is cooperating and we just want to normalize, that's a great outcome for credit. If the drivers are growth is really deteriorating because the labor market is deteriorating in a non-linear way that is not a good outcome for credit, we should expect wider spreads in that environment. So that's really what we're focused. Picasso, I want to bring you in here. What are you seeing in terms of companies managing through what's been a really dynamic environment for quite an extended period of time? From a private credit lens as we look out at what's happening to companies writ large more broadly, it's very clear to us there's a tale of two cities. You know, when you look at larger businesses, they tend to be able to withstand all of the shocks we've seen in the economy. Perhaps they're not as dramatic as the headlines have made them seem, but companies are dealing with a lot today throughout the year, uncertain tariff situations, movements in those tariffs week by week by week, uncertainty around interest rates, potential immigration labor issues, all these sorts of things, and of course, the putting tariffs aside the complexity around trade. As these companies work through all of these issues, it is very clear to us that large companies can withstand these issues with far more ease than smaller companies to give you an anecdote, which I like to use to think about this and frame it. A large company will look at the tariff situation and say, "You know what? I'll just pay it and put product on the shelves. I'll take market share." That corollary for a smaller business is much more complicated to have the liquidity to pay for those tariffs up front is pretty dramatic. And we've seen a lot more pressures at the lower end of the market. So while I agree with you, Amanda, that perhaps defaults aren't as dramatic as we've seen historically, I do think there's a little bit of a shift in that as you go deeper in terms of size, you know, small versus big. So I want to pick up on a couple threads there, because Amanda, you mentioned that the M&A activity started to pick back up, and you mentioned some of the uncertainty over these earlier this year of a cost around tariffs. You know, every M&A banker I knew in the fourth quarter of last year was celebrating. It was potentially more accommodative than a trust regime. Rates were starting to come down, and then the tariffs put a huge chilling effect on M&A. We have in recent months seen that really start to pick up. And because I'm curious, if you think about the rate picture started to normalize towards neutral, you know, we're getting past some of the sort of draconian downside cases of tariffs, how do you feel about the M&A volume activity going into the next 12 months? It's complicated question to answer. I do think the obvious is true. Companies will have an easier time accessing the credit markets today. As rates come down, the obligations a borrower has with respect to its leverage capital structure is obviously more palatable. That all being said, I do think one of the big drivers of a lack in M&A is not just economic uncertainty. It's the fact that a lot of folks in the private equity community were trying to see higher evaluations and not realizing them. Case in point, we'd hear from friends and investment banking community, and they would indicate we're really, really busy. We're just not getting deals done. In other words, they were running processes, getting through the finish line, but Byron Seller, we're not transacting. I think a lot of the logic that owners of assets have had is, well, I'll just wait. I'll wait, get through tariffs, get through lower rates, and I'll see the valuations I want, which connects to some of the comments Amanda. You were making around, well, what's going on with course in the economy? Because valuations are probably more impacted by underlying growth than they are with short-term borrowing costs. I do think it's a complicated question. You're definitely going to see attractive, pristine, high-quality assets get sold under any circumstance, and you will see more of those. That all being said, there are plenty of businesses that still haven't reached a point where they are valued in a way that you'll see buyers and sellers meet in terms of value. So, Scott, then to you, and we've got 200 billion of high-yield bonds, maturing in 26 and 27. If we see some M&A pick up, the rate picture evolving, how does that impact your thinking about the opportunity set in new issue, and in particular, about relative value amongst loans, high-yield, and CLO debt? Sure. I'm going to stay focused on what we were saying about bonds, and I think the cost makes a great point about the types of issuers that are embedded in that 200 million. These are on the high end of a quality spectrum as it relates to high-yield. These are companies that have had the luxury A to issue at very low coupons over the course of the last five years, and Treasurers and CFOs are being very smart to wait, because they have very low coupons when they reprise, given where base rates are, they're going to have to be higher. That's why this wall, this manageable wall exists, but you think it's an opportunity. Because of that, I think it's like 215 or 225, the last estimates I saw, 50% of that is double be your higher, 75% of that is single be your higher. So you can kind of put the triple C, which isn't that much of a functioning market, especially for a new issue. You can kind of put that to the side, and this is still a very meaningful number. What does that mean for us? We like when the higher quality issuers have to come to market, and essentially sell what is price upside or convexity, because they need to refinance their balance sheet and push out their maturities. We've been waiting a while for it, and we're finally starting to see it. This last quarter was the highest new issuance of high yield bonds since Q2 of 2021. And Q2 of 2021, the 10 year was around 1.2%. So that tells you why people were waiting, but now they finally have to do it and issue with this higher underlying base rate. I just looked at October year to date in high yield, and this excludes any triple C. There's no triple C in these numbers. The average coupon that's been issued or is talked for October new issuance is about 7.7% for high yield. That's versus an index coupon of 6.6%. And you're talking about five non-cal2, seven non-cal3, and 100 basis points of coupon pickup. That's real upside, right? And that's what it's going to take, I think, at least for us, to look towards getting off that yield premium from floating rate assets and into the convexity opportunity and fixtree. I want to close out with where we see the biggest opportunities and risks as we finish 2025 and look ahead to 2026, Amanda, let's start with you from a macro perspective. What are the potential headwinds and tailwinds for the credit market? Sure. So I think one of the themes that we've been really leaning into over the past few months has been this convergence across the liquidity spectrum in periods of episodic volatility where private credit has stepped in. We've gotten a reminder of that over the past two weeks. We saw it earlier this year. We saw it in August of last year with the online of the end-carry trade. I think this is a theme that's here to stay in very much in the opportunity camp in terms of tailwinds, especially as we think about private credit reaching areas that it previously couldn't, servicing borrowers that actually have demonstrated access to the capital markets and providing certainty of execution, customization, structuring, in periods where the syndicated markets for whatever reason aren't functioning the way we wish they had, largely technical reasons, but could be just based on market sentiment. So I think that's a structural shift. I think that's a post-pandemic development. I think that's something that's probably not talked about enough. In general, I think we mentioned the tailwinds at the start. The headwinds really go back to that feedback loop of margins, the labor market, consumer spending, and the overall economy. Then I just want to double down on something, the cost side. I mean, dispersion is alive and well. We see this actually in some of the areas that we talked about, defaults. Companies with less than 25 million in annual EBITDA are over contributing to covenant defaults in private credit. M&A, not all M&A is creative equal. Strategic M&A has rebounded. As the cost mentioned, sponsor M&A has really lagged. Private equity exits have been confined to the largest highest quality assets that hasn't yet broadened. So when we think about these markets, it's almost like a duck paddling. The duck is on the surface and it's calm, but then under the water, the feet are moving furiously. That's happening in a lot of these risk assets. It's happening in triple Cs, as Scott mentioned. So these are areas where I think the back-to-basics credit work has probably mattered more than it has in a really long time. And I think the trend of dispersion bottoms up credit work really just underscoring the structuring the due diligence, the underwriting. I think that's probably where I would pay the most attention into 2020-26. It's a kind of market where credit selection is paramount, totally great. Scott, let's move to you. From your liquid credit lens, where do you see the biggest opportunities and risks? So risk-wise, I'll stick to the underwriting for a minute. We obviously traffic in a lot of LBO paper. There are a lot of deals in our market that have done their best to sustain what we're highly leveraged structures in the face of rates that just won't go down as much as these companies need them to. And our view on rates is that's going to essentially persist. And so, a lot of our focus is where are the pain points relative to interest costs because those won't abate naturally. If a company's already done an LME, you know, 39% I think of LMEs have re-LMEs or defaulted. So, you know, that dynamic is certainly at play. Software is a big component of our market. The SaaS providers that are all the sudden potentially being displaced by AI, or just companies that made a bet on the consumer four or five years ago, they've made it this far, but will the consumer actually bail them out? Is probably unlikely for something that's too levered to begin with. So, it's the fundamental underwriting. It's the real cash flow potential for defaults of lower quality credits that we're very focused on as far as the risks. As far as the opportunity set, I'll circle back to the idea. I love that that issuers are going to have to meet the demand that's on the wide and long end of the curve. You know, annuity pickup, demand for longer duration, you know, higher upside paper in terms of price convexity. I think that the supply will ultimately have to meet the demand. Hopefully that pushes spreads out a little bit, and you can make money above par in credit, which is where you want to live in this credit environment. The cost, the private credit perspective? Yeah. My view on risk and opportunity is two sides of the same coin, which is the dispersion point we've all been referencing. I think it's pretty interesting that you've seen the spread premium for going down in size narrow quite dramatically over the last decade. It used to be quite significant. Now we're talking about 25 basis points or 50 at most. And what's fascinating about it is over that sort of decade period as these spreads have compressed, the makeup of the market has changed a lot at the lower end in terms of size. Today, you can think of 50, 60 private credit firms. You'd go out to raise a $5,000,000,000 loan for a small company. Meanwhile, in the upper end of the spectrum, the top five large private credit players have relatively been the same over the last decade. And so the competitive forces are quite different in the upper end of the market. And that really explains that spread compression in a lot of ways. I think that creates this idea that there will be dispersion. And I think that in the middle of that dispersion, the opportunity really is to take advantage of volatility. And you made the point, Colbert, which is spot on, being thoughtful on underwriting and being ready to attack the market when there's significant amounts of opportunity, which I think will be really, really interesting to do. Thank you. Very helpful. The cost, Amanda Scott. Thank you so much for your insights today. And for those of you listening, we appreciate you taking the time. This podcast was brought to you by @WillMedia with HPS Investment Partners. Please make sure to rate, review, and subscribe on Apple podcasts or wherever you'd like to listen. This material was presented by HPS Investment Partners LLC for information purposes only. The opinions expressed in this podcast are that of the guests and do not necessarily reflect the views of HPS Investment Partners. 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