David E. Czerniecki, chief investment officer at Nassau Financial Group, talks about the US economy and its implications on the investment grade private credit market.
How would you describe the investment grade private credit market and its development in recent years.
This is a very old market that's been around for a really, really long time, and it was pioneered and developed over the years alongside the growth of life insurance companies. As a company, we've been involved in it for over thirty years, during which time we've seen it go through a number of evolutions. The core part of the private credit market has been a focus on investment-grade corporate credit, although other asset classes have come in and out. One aspect of the private placement market is that it tends to be a place where new asset classes and strategies are tested and pioneered. It's also a very deep market, and the subsectors within it will have different degrees of liquidity. The private markets are not as liquid as the public markets, but some, like the established corporate credit market, have a fair degree of liquidity. You can also deal with asset classes that are a little more esoteric, so there's a bit more experimenting and development. It's in those places where you will see less liquidity.
What would you say was an 'esoteric' asset class?
There's been a number of things over the years, such as the initial foray into ABS, away from traditional RMBS created by the establishment of the mortgage market in the 1970s. The more-modern versions of ABS include investments such as commercial loans and leases, and even CBOs and CLOs. These were all born in the private placement market, where transactions were put together on almost a bilaterial basis, with insurers often taking the lead. More recently, ESG and alternative energy markets have grown. There's been a lot of activity there. The credit tenant lease (CTL) market has also been a mainstay and active program in the insurance private placement markets.
ESG is an interesting one. A year or two ago, that was the hottest topic in the market, but that fever seems to have abated.
There has definitely been a shift. The factors that contribute to its ebb and flow are global energy demand and global energy acceptance. The demand for fossil fuels can increase or decrease over time and fall in and out of favour. And there has been this steady growth in the alternative energy markets such as with solar and wind coming to the private placement sector more regularly. That's because some of the issuers may not be large enough or have the market capitalisation to tap into the public markets.
We've touched on energy, which is an important topic over here in Europe, particularly in light of Russia's aggression against Ukraine and the impact it had on gas prices over winter. How badly was the market impacted then? And to what extent was that down to geopolitics?
Geopolitics certainly impacted supply and demand from a debt issuance perspective. But the bigger drivers are distribution and exploration. So, where you saw that play through in the public and private markets was the alternative ways to get energy or the alternative sourcing of energy. Europe needed to source natural gas from other places, and that actually impacted the shipping markets indirectly, as opposed to the overall demand. The other factor that has impacted supply and demand are the shifts and norms for or against fossil fuels.
What's the landscape looking like at present? What are you looking at?
It's a combination of how the market is being impacted by rates and the fact that there's been very significant issuance. Before the rise in rates, most balance sheets were pretty well fortified. Most issuers had extended out their debt and that was another factor in borrowers needing to borrow.
You're speaking to me from New York. How does the US market compare to the UK and European markets?
Let me preface this by saying that we're based in the US, and we write US liabilities and have a dollar-denominated balance sheet. That means that we're not particularly active in the international private placement markets, although we do a little bit of it. So please take this with a pinch of salt. In general, I think there are probably more issuers in Europe that cannot easily tap the US market, so you have a group of issuers that are more dependent on the private markets.
This is often true globally, but US issuers will tap both public and private markets as they see fit in order to diversify their sources of capital. The big European ones may do that, but a lot of the smaller ones may not be well set up to go to the public markets.
We touched on CPACE before, which is largely a US-centric concern. What would be your take on it?
I don't know all of the details, but there's been a push to try to get alternative energy products out to consumers, whereas a lot of big borrowers will borrow themselves or through partnerships. While a big corporation may own its own solar panels, small firms cannot do this, so these programs have been set up to allow for the pooling of these loans. To stay with the example of solar panels, you can borrow through these programs to pay for those, and there's a high priority in the repayment of debt, so it's right up there with the mortgage. This means that there's a predictable and steady cashflow that's led to a securitisation type of approach, good demand, and a pretty steady flow of supply. It's not as broad or as deep as other securitised markets, but it's grown steadily. There is some concentration risk with residential CPACE, though, because housing in the US is concentrated on the coasts.
While we're speaking about the US, there's an election coming up in November that our readers might be aware of. What could the outcomes on the market be from that?
As an investor, we're trying to be mindful of what the long-term impacts might be from an investment perspective. The thinking is that it's not dependent entirely on the Presidential candidate—there's also the House and the Senate – the three have to work together. In general, you're looking at what situation would end up being supportive of business, which might translate to being in support of a government deficit or being in favour of more borrowing. What we have seen over the years, looking at research that's been done, is that you get a pre-election run in the markets if you think one party or the other is going to win. Everyone thinks that 'X' will win and so there's a short term rise or sell off., But what we've seen over time is that it tends to be growth, inflation, and debt prospects that have the longer-term impact. If you look out six months to a year, you tend to get back to trendline of where the economic backdrop is headed.
How would you characterise that backdrop right now?
It's mixed. The Federal Reserve has been making a very significant effort to reduce inflation, and that seems to be working. We're seeing inflation expectations come down, and there's a view that the Fed will cut rates in September. The tightening efforts have started to put a bit of pressure on employment. The US is still at near-record unemployment rates, so there is room to move. It's also had an impact on GDP. And then there is yet another side, which is that not all inflation indicators have come down. So, there is a tightrope being walked. But, inflation seems to be coming under control and the outlook for the economy is okay. Consensus appears to be that a soft landing is expected, or that any recession would be fairly mild against a strong backdrop and fundamentals.
Pete Carvill
