Andy Kleeman, senior managing director and co-head of private fixed income for Sun Life Capital Management, discusses some of the interesting new developments in the investment grade private credit space.
What makes investment grade private credit an interesting space to work in at the moment?
It's a fascinating asset class, just because of the breadth of it. There's so many different types of issuers and companies. And I'm a curious person, so it's interesting to see lots of different business models while meeting different business leaders and entrepreneurs, and trying in turn to understand what is driving their business model.
You are based in the US, but how does the UK market compares to the US one?
There's a lot of similarity between the two markets. A number of the larger US players also have boots on the ground in the UK. The roots of this industry go back 40 or 50 years, and it has predominantly been the large life insurers that had more demand for investment-grade, long-duration fixed income that the public markets could provide. This market has always been a bespoke solution for issuers. The primary difference is in market scale. The US is the deepest bond market in the world, and the investment grade private credit investors are used to a heavy underwriting process. When the public markets are choppy, the markets are open. Essentially, the flow is driven by the consistent demand for long duration, investment grade bonds for US insurers.
How does Europe differ?
For example, several European issuers came to this market after the Russian invasion of Ukraine. There was a tightening in capital markets across the continent as the risk profile changed around issues such as energy and inflation. The investment grade private credit market in the US continued to underwrite deals from Europe. While the change in the risk premium was reflected in the market, European issuers were able to come to the US and get deals done. It is a really attractive market and has traditionally always been open. As another example, last year, the public ABS markets were pretty choppy and issuers were able to exclude private ABS with predominantly insurance investors.
And where would they be similar?
Both US and European issuers use the market when public markets or bank markets can't offer the best financing solutions for them. The public fixed-income markets are very good if you have multiple ratings, are ready to have your financials be public, and intend to be a consistent issuer. But if you're a smaller issuer that only does a $300m issuance, you're not going to be able to really get the pricing efficiencies even if you're in the index. The public market works well for the traditional three-, five-, seven-, 10-, 30-year bullets, but the investment grade private credit market has a lot more flexibility. If an issuer needs a 14-year bullet, we can do it. We can also do delay drawdowns, where we agree to a coupon now for a funding that's going to happen in six months—this might allow an insurer to get certainty around a pending debt maturity, for example.
How have you seen the European market evolve over time?
It's been attractive to European issuers coming to the US for a long time. It used to be primarily in dollars, but many investors now purchase bonds in GBP or Euro and do a currency swap themselves. Typically, the issuer offers a swap indemnification so that if there is a prepayment, the US investor achieves the desired return after swap termination costs in USD. More recent years have seen insurance companies, which have natural liabilities in GBP, euros, or other currencies, so there are more non-USD deals without that swap indemnification. It's become a very attractive asset class for the UK-based investors where you can get a healthy premium for the illiquidity and the amount of work it takes to originate, underwrite, and monitor these credits. You also get the benefits of collateral and covenants, which really protects your downside. That's super important when you have something that's less liquid.
Overall, I don't think there's too many differences. With both markets, it's a bespoke solution for the issuer and there are strong relationships between investors and issuers. The underwriting and diligence process result in a much-closer relationship with the issuer, and investors typically are like-minded. That means that you're all on the same page and holding the same information if there is a need to talk about a covenant. For issuers and investors, it's not a free lunch but you're getting better yields with less downside.
Russia's war against Ukraine has obviously been a big issue in Europe, but what else is on the horizon that you think may have an impact on the market?
This market has done a phenomenal job of weathering all kinds of conditions, whether it's the financial crisis of 2008 and 2009, the global pandemic, the euro crisis, or the invasion of Ukraine. I'm very cognisant of all the risks when you start to deal with investment grade as there's typically a lot of room and, even in good times, when you're doing longer duration deals, there's no assumption that the good times will last while the debt is outstanding. You always have to protect against deterioration in the credit.
There's been a lot of noise around the US election of whether there will be a clear winner or not. That seems to be resolving itself although you never know until it's over. Both political parties in the US have stepped back from a more free-trade, globalisation agenda that has dominated politics for decades to a more populist, deglobalized approach. That's going to have risk for every economy around the globe. We're sensitive to that, but we think that appropriate structures along the lines of covenants and protections can help maintain credit quality and the returns of the portfolio.
There have been issues around duration with this market, what can credit tenant leases (CTL) do to alleviate that?
Well, these are examples of bespoke solutions that the market offers. The idea is that a developer or the owner of a property has signed a long-term lease with an investment-grade tenant, typically a single tenant. It'll then be rented out on the basis that that tenant is responsible for all aspects of the property such as insurance, paying taxes, and maintenance.
In reality, the leaser is going to be sending their cheque into an account that will pay that service first, then out to the equity or the developer who owns the property. It is a really interesting way to get access to both public and private credits.
It could be for tech companies who are about to do an IPO and need a data centre that they want to lease but not have on the balance sheet. And, so, you get access to a credit that maybe you couldn't get in the public market.
We also see them a lot for public credits, where you have the alternative of buying the bond direct, and you can get a substantial premium over their public bonds. In addition, you have, as collateral, a facility that they need for their business.
Commercial property-assessed clean energy (CPACE) is also an interesting development. Is that something you can speak upon?
It's another unique structure, and one that's been authorised by various local and state governments across the US. It's a way to encourage energy efficiency and financing. A business owner can apply for the program, and then the cost of the energy enhancements essentially get repaid through an assessment that's paid alongside the property taxes.
That payment essentially becomes senior to even the mortgage lenders. It could be a hotel that's improving its windows or installing a HVAC system. It benefits the city because the utility systems might be strained.
Pete Carvill