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Trouble is brewing in the US credit market, and there are two pain points that could emerge as financial contions remain tight, according to billionaire investor Howard Marks.
The founder of Oaktree Capital Management raised concern over high debt loads in private equity and the real estate market, two highly leveraged areas that depend on the easy flow of capital.
Those sectors could are under mounting pressure as rates look poised to stay higher for longer, Marks said.
"The leverage, the use of debt to amplify your returns, has been the lifeblood of these two asset classes," Marks said in an interview with Bloomberg this week. "But that's where the pain will come in the future. And you can't increase a company's debt service cost markedly without affecting its returns."
Debt in private equity and commercial real estate rose sharply between 2009 and 2021, when interest rates hovered at historic lows. Nonfinancial corporate debt securities and loans soared 83% from the start of 2009 through the end of 2021, while commercial real estate loans grew 46% during that time frame, according to Federal Reserve data.
But banks have started to tighten their lending practices over the past year. Firms are loaning money at higher rates, which poses a problem for highly-levered industries. Total loans and leases across commercial banks grew around 2% in the 12 months ending July 26, Fed data shows, compared to the 9% increase recorded in the same period through 2021 and 2022.
The slower pace of lending is partly due to higher borrowing costs. Rates are at their highest levels since 2001, a consequence of the Fed's battle to lower inflation.
Banks have also taken hits on their balance sheets, which have made them more stringent on loan-dealing. US banks are holding onto around $517 billion in unrealized losses in their portfolios, according to a May report from the Federal Deposit Insurance Corporation.
"Right now, and I think going into the future, leveraged companies will not be able to renew their leverage as easily, and the cost of doing so will be higher," Marks said.
That's created "fundamental questions" in specific parts of the real estate market, like office and retail properties, he added. Offices in particular have been a pain point as remote work persists and landlords deal with higher vacancies and declining property values.
The wider commercial real estate sector has over $1 trillion in debt set to mature in 2024, per Goldman Sachs.
"You put that together, we think you'll see some disruption, which will give us and people like us opportunity," Marks added.
Other big investors have predicted more refinancing pain for companies, particularly as interest rates aren't likely to fall back to pandemic lows.
Billionaire investor Barry Sternlicht recently said he foresaw weekly bank closures and extreme losses in commercial real estate as high interest rates impact the sector.
