Turning Rock Partners released the following Q1/25 market commentary:
U.S. policymakers played that song repeatedly into the early part of May as they beat the tariff drum, seeking to both modify regimes across foreign trading partners and to create disruption in the market.
The U.S. corporate credit market has shown resilience in the face of shifting economic indicators and evolving monetary policy. Credit spreads have tightened modestly year-to-date, with the ICE BofA U.S. Corporate Index Option-Adjusted Spread hovering near 92 bps—down from a peak of 133 bps in late 2023—reflecting improved investor risk sentiment.(2)
Corporate credit quality offers a divergent picture. On the one hand, credit quality has remained broadly stable, but signs of divergence are becoming more evident between investment-grade and high-yield issuers. As of Q1 2025, BBB issuers had the highest number of companies with a negative outlook or credit watch within the investment grade bond universe suggesting weakening.(3)
Markets were bracing for tariff impacts potentially resulting in a pickup in default rates as the effects flowed through. Trailing twelve-month default rates in leveraged loans and high-yield bonds are trending at 5.2% and 2.5%, respectively.(4) These trends could most certainly change by the end of the year with prolonged or increasing tariff uncertainty likely to result in a pickup in defaults. Nevertheless, rating agency downgrades have begun to outpace upgrades for the first time in three quarters, reflecting pressure on margins from higher-for-longer interest rates as structural risks are mounting. Lower-tier high-yield issuers face the dual challenge of margin compression and limited refinancing windows. Companies reliant on global trade are especially vulnerable, as tariff-related disruptions escalate. While a temporary pause may have softened near-term impacts, the trade picture is complicated.
The relationship between banks and alternative credit players is evolving. We believe cross-capital structure solutions are key to creating more reliable balance sheets. U.S. bank balance sheets are notably more conservative in 2025, following increased regulatory scrutiny and deposit flight concerns that emerged during the 2023 regional banking turmoil and persisted somewhat within certain sectors. The Tier 1 capital ratio for U.S. banks continued to grow, reaching the upper end of their ranges from over the past decade.(5) However, tighter credit conditions persist. The latest Federal Reserve Senior Loan Officer Opinion Survey (as of April 2025) shows ~20% of banks continue to tighten lending standards for commercial and industrial (C&I) loans, particularly for mid-sized firms. This trend may contribute to a moderation in corporate borrowing and refinancing activity, especially among speculative-grade issuers.(6) The amend and extend craze might be drawing to a close. Refinancing risk is of concern with $1.4T of global debt maturing in 2025 and $5.2T maturing in 2026-2027, much of it issued at pre-2022 ultra-low rates. The refinancings that are getting done are occurring at wider yields with more restrictive covenants. (7)
We see the U.S. economic outlook as mixed coming into the back half of 2025. While recession fears are increasingly looming, the U.S. has defied expectations of a hard landing. Real GDP grew at an annualized rate of 2.1% in Q1 2025, buoyed by reasonable levels of consumer spending and resilient labor markets (outside of the dramatic government employment cuts).(8) Forward-looking indicators suggest a more cautious environment. The IMF has revised down its U.S. growth outlook to 1.8%, down from 2.7% in January, pointing to expected slower growth in the second half of the year.(9) Softening consumer spending, declining capex expectations, and weaker manufacturing sentiment further point to increased risks ahead.
These headwinds are reflected in reductions in earnings expectations and resounding messaging on unclear ability to forecast 2025. This complexity drives substantial opportunities for investment firms like Turning Rock. We take our time, we challenge growth assumptions, we enhance the required risk premia we demand for our capital. We partner with founders and operators who seek to play offense to their advantage of weaker competitors or who need capital to shore up defensively during uncertain times. This is an apt market for TRP.
Endnotes
- Quote from Tom Petty
- Federal Reserve Bank of St. Louis, as of May 2025
- S&P Global Investment-Grade Credit Check Q2 2025, as of April 2025
- Fitch Ratings, as of April 2025
- Federal Reserve Financial Stability Report, as of April 2025
- Federal Reserve Senior Loan Officer Opinion Survey, as of April 2025
- S&P Global Credit Trends Report, as of April 2025
- Federal Reserve Bank of St. Louis, as of April 2025
- International Monetary Fund, as of April 2025
