Q2 2023: Investment Grade Private Credit update

Market

The IG private credit market shook off the market volatility associated with the failure of Silicon Valley Bank (SVB) in March and reported Q2 volume of US$26.6 billion, compared with US$21 billion in Q1 2023 and US$23.5 billion for Q2 2022 (market statistics for the private placement market are provided by the Private Placement Monitor, and serve as a proxy for the IG private credit market). As often happens, issuers turn to the private credit market for execution when other markets falter. Despite the strong quarter, year-to date issuance is approximately 4% lower year over year, largely due to robust volume in March of 2022 as issuers rushed to market to get ahead of credit spread widening as geopolitical tensions rose with the invasion of Ukraine. H1 2022 volume was also pulled forward by a large amount of delayed fundings (more than double H1 2021 and 2023) as issuers sought to lock in financing costs as central banks began to raise rates.

High interest rates have impacted all sectors, most notably the financial sector. The difference between H1 2023 and H1 2022 volume is largely due to lower financial sector issuance (asset managers, REITs and real estate). Financial sector volume is down over 50% from the prior year while industrial and utility issuance has increased to partially offset the decline. Duration continues to be hard to find as issuers prefer to stay short rather than lock in today’s rates for a long tenor. Cross-border issuance has been holding steady over the last three years at approximately 35% of market volume, up from 2020, but below the historical average. The total number of deals are down year over year while the average deal size is up as the IG private credit market’s capacity to execute large deals (US$1 billion or larger) has anchored total volume in 2023. Most large deals have been project, infrastructure or acquisition related. Issuers have come to market in 2023 for a specific financing reason, unlike in 2020 and 2021 when borrowers would tap the market opportunistically because rates were attractive.

The market has been steady, with a consistent but not overwhelming number of deals to underwrite, and relative value has been robust. Public IG corporate bonds have tightened considerably since March (stemming from the failure of SVB) while private credit spreads have been flat, especially since May. Private spreads typically lag the public market, so we expect to see private credit spreads tighten to catch up with public spreads.

Outlook 

Many stakeholders have described the market as "uncertain.” Issuers are seeking to borrow shorter due to expectations that rates may come down in the next few years, while investors are seeking longer duration. We have observed evidence so far this year that many investors are not as active or are more selective for either portfolio reasons or product sale dynamics. Thinner demand has resulted in a wider dispersion of bid prices and created promising opportunities for us to invest in potentially strong credits exhibiting solid relative value characteristics and representing good allocations. As we enter Q3, our strategy is to continue to maintain our underwriting and pricing discipline and to opportunistically capitalize on any volatility or uncertainty to generate compelling potential value for our clients.

In focus: Private credit opportunities in specialty finance and securitization

SLC has a long history of providing non-recourse credit to finance companies. From our origins as a proprietary private fixed income desk of our parent, Sun Life Financial, we have been actively investing in private asset backed securitized credit since the early 1980s. Today, we believe that market conditions could further drive originators to consider private lenders that can provide them with certainty, and also flexibility. As we look at the rest of 2023, we remain bullish on opportunities in the private asset-backed securities (ABS) sector. Although we expect some “noise” in our current holdings, we believe they are all well-structured to withstand it. We continue to believe that senior investment grade private ABS can provide considerable potential value. The pipeline for 2023 looks robust, in our view, and indications are that 2023 could be an especially strong year from a volume and return perspective.

We view our role as private ABS investors as both providing non-recourse credit to finance companies (enabling them to focus on their “business of growing their business”) and delivering high relative value to our clients via a market that would otherwise be fairly opaque. Investing in private securitized credit is a highly specialized space, requiring investors to have deep expertise and resources, insights into a borrower’s business and a strong platform of securitization technology that can shape each deal to satisfy the needs of the borrower while preserving investor security and collateral, ensuring a strong alignment of interest with the originator/servicer in the form of credit enhancement while generating  attractive relative value.

Throughout our 40-plus years of experience as private ABS investors, we’ve identified several differentiating factors that we believe are critical components to successful investing:

• Expertise in borrower businesses – Requiring a comprehensive understanding of and experience in the wide range of asset classes in this investment universe, such as equipment finance, consumer prime auto, consumer non-prime auto and vehicle fleet leasing
• Due diligence and monitoring – As performance can vary significantly between two similar-looking portfolios, we believe that successful investing requires thorough due diligence in evaluating borrowers’ businesses, management team experience, credit underwriting, operations and other important characteristics. This process should include ongoing monitoring of the investment, with the in-house capability to conduct cash flow and operational audits
• Consistent and constant supply – An investor’s own track record and reputation can be critical, assuring borrowers of certainty of execution and resulting in an ongoing supply of compelling assets and opportunities
• Natural diversification – We believe a portfolio should represent a range of exposures to diverse consumer and commercial credit, with any areas of concentration (e.g., vendor, industry, equipment type) identified and addressed in lending structures

Looking ahead more broadly, we believe the environment of volatility and uncertainty in the bank and ABS market that started around the summer of 2020 will continue to provide considerable opportunities for investors. With our own originations having grown every year for the past five years, we believe that we are well positioned to continue growing in the private ABS sector, which has has potential to grow even further in the near term. Certain asset classes in which we have funded or strongly considered recently include:

 

Prime auto	Non-prime auto	Home improvement loans
Unsecured loans	Small-ticket equipment	Mid-ticket equipment
Solar ABS	Litigation finance	Small-business loans
Manufactured homes	Credit card receivables	Private student loans

 

Unless otherwise stated, all figures and estimates provided have been sourced internally. Data points have been calculated internally based on external market data sourced from Private Placement Monitor. All data, figures and commentary are as of June 30, 2023, unless otherwise noted.

Investment grade credit ratings of our private placement portfolio are based on a proprietary, internal credit rating methodology that was developed using both externally purchased and internally developed models. This methodology is reviewed regularly. More details can be shared upon request.

Although most U.S. dollar private placement investments have an external rating, for unrated deals, there is no guarantee that the same rating(s) would be assigned to portfolio asset(s) if they were independently rated by a major credit ratings organization.

The information in this paper is not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information contained in this paper.

The information may present materials or statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. As such, do not place undue reliance upon such forward-looking statements. All opinions and commentary are subject to change without notice and are provided in good faith without legal responsibility. This material contains opinions of the author, but not necessarily those of SLC Management, its additional investment teams or its affiliates.

There is no guarantee that the portfolios described will achieve their target returns nor will be able to source the assets. Past performance is not necessarily indicative of future returns. The value of investments and the income derived from investments will fluctuate and can go down as well as up. A loss of principal may occur. Performance is pre-distribution and gross of investment management fees (includes both capital appreciation and income), net of administration fees, and is calculated using the geometrically linked time weighted rates of return methodology to calculate the income returns and capital returns. There is no guarantee that historical investment activity, approaches or volumes will continue into the future.

SLC Management is the brand name for the institutional asset management business of Sun Life Financial Inc. (“Sun Life”) under which Sun Life Capital Management (U.S.) LLC in the United States, and Sun Life Capital Management (Canada) Inc. in Canada operate. Sun Life Capital Management (Canada) Inc. is a Canadian registered portfolio manager, investment fund manager, exempt market dealer and in Ontario, a commodity trading manager. Sun Life Capital Management (U.S.) LLC is registered with the U.S. Securities and Exchange Commission as an investment adviser and is also a Commodity Trading Advisor and Commodity Pool Operator registered with the Commodity Futures Trading Commission under the Commodity Exchange Act and Members of the National Futures Association. Registration as an investment adviser does not imply any level of skill or training. There is no assurance that the objective of any private placement strategy can be achieved. As with any strategy, the Advisor’s judgments about the relative value of securities selected for the portfolio can prove to be wrong.

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