Episode 62

AUGUST 10, 2022

Elaad Keren on investment grade private credit in the current market environment

Elaad Keren, Senior Managing Director, Head of Private Fixed Income Portfolio Management at SLC Management, discusses the investment grade private credit market, including the current supply of opportunities, the changing profile of investors, and how portfolios are faring.

Steve Peacher: Hi, everybody. This is Steve Peacher, president of SLC Management, and thank you for listening to this episode of “Three in Five.” And today I’m joined by Elaad Keren, who is a senior managing director in our private fixed income team. Thanks a lot for taking the time to join us today.

Elaad Keren: Thanks, Steve. Happy to be here.

Steve Peacher: So we want to talk about the market that you focus on, which is investment great private credit. It's been a big area for us for a long time. I’ll give my biased view that we have, I think, a premier team that you're a senior member of in this market. So we see a lot of what's going on in this market, not just in North America, but around the world. So I want to first talk about supply – supply of new transactions, given that we've got a lot going on the macroeconomic front. We got very high inflation, we've got rising interest rates we have fears of a recession. What has all that meant in terms of supply of investment opportunities that you and the team are seeing in the investment grade private credit market?

Elaad Keren: Thanks, Steve. That's a really good question. It's been an interesting year for sure. Volatility was high in some markets, even closed for issuance. However, the investment grade private credit market was robust, and actually launched and successfully closed on a number of transactions. You know the investment grade private credit market actually has always had a reputation of being a dependable source of capital, especially in uncertain times and 2022 is just a further validation of that. As a private credit by definition it's tough to accurately measure total activity, but a good proxy would be the U.S. Private placement market, where there's decent statistics made available, and the numbers actually show that the first half of 2022 eclipsed last year's issuance, which, by the way, last year was a record year of issuance. Year to date so far by twenty percent over last year's total. The financial sector really anchored this year's volume, strongly supported by large issuance in the REITS, and while the financial sector was strong, general corporate issuance was not, and actually could have been characterized as weak. We suspect the reason for weak corporate issuance is that companies rather still awash from cash from adding liquidity during the pandemic. Perhaps they didn't like the current interest rate environment, or they were compelled by short-term financing from aggressive bank markets that is generally less attractive to institutional investment-grade investors who prefer long tenors and durations, or perhaps a combination of the three. I would characterize our supply as strong in our market. However, with that being said, we did see projects being deferred, as some CFOs were waiting for world events and markets to settle, and they were revising their financial models to accommodate for the higher cost of debt. However, it is our expectation that these deferred projects won’t last forever. They will eventually come online, and they will need to be financed even with higher costs of debt. While these two forces were going on, I think definitely our market could be characterized by strong issuance, in spite of all the headwinds that the market was facing.

Steve Peacher: You know, we use a couple of different names for this market. We call our team, your team, the private fixed income team within SLC Management. You've used the term investment grade private credit, also private placements. And where I’m going with this is that historically the private placement market would have been kind of the purview of big insurance companies. But that's changing a lot. So, what I want to ask you is how do you see the competitive landscape in this market, investment grade private credit, private placements. However, you want to refer to it. How do you see it changing? And how do you think it will continue to evolve?

Elaad Keren: Yeah, absolutely, Steve, you're right historically with very few exceptions, investors in this market, whatever you want to call it, especially in the investment grade arena were insurance companies investing for their general account. But truly, since Covid we've seen quite a bit of a changing profile in the market, especially investment grade private credit investors. You know, we think it's the strong adjusted risk-adjusted return characteristics of this asset class and the growth of the asset management industry in general has attracted attention of large global investment managers, investing not only for insurance company funds, but also pension funds and other alternative clients, or clients looking for alternative assets. You know, through 2021 we heard of some new entrance forming, and we weren't sure if they were going to be being able to the money to work. You know, this year we have seen some evidence of participation in the market, I think in general it's fair to say that there's more capacity in the markets today than there was in the past, however it's still too early to tell if your entrance will be here to stay. You know one thing for us that has become clear is that as the investor market continues to evolve in favor of large asset managers with deep underwriting experience, strong deal sourcing, and a reputation of working with issuers through business cycles, we feel that that's going to continue to drive the shape of the market and continue to really center around those firms as deals get launched. You know it's funny we're seeing actually quite a bit of deals this year that aren't being broadly distributed, instead they're being placed with a small group of sophisticated, like-minded investors that have the capability of writing big checks. We think this is going to continue, and this force is going to continue as the market evolves. So while we have some new entrance it's still really too early to tell if they're going to be here to stay, or if it's just a stop in their evolution as asset managers.

Steve Peacher: Let's go back to macroeconomic factors. You know your team does a lot of different types of transactions, from loans to private equity back firms, to loans to infrastructure projects in jurisdictions around the world, but you know, worldwide there, as I mentioned before, concerns about recession. Obviously, we've got central banks raising rates. So when you think about the portfolios that you and your team are managing for our clients, you have any concerns about how those portfolios could fare given the economic uncertainty?

Elaad Keren: Yeah, yeah, we do a lot of stress testing in our portfolio. And certainly with this year's continued release of headlines we've continued the base of that stress testing. End of June, we did a really bottoms up approach, and looking at our exposures in light of inflation and those other risks that came out throughout the year. Now, if I take a step back and I think about our portfolio, it's really as you said, it's a broad portfolio. It's very diversified by geography, by asset type. Often, we invest with the benefit of having a senior secured position. And the cap structure, our obligors are usually a very decent level of quality and high level of liquidity, which helps to absorb bumps in the road. We often have cash flow tests and early mitigants to be able to ensure that if there are issues down the road, we can be there to work out those and be able to mitigate problems before they become too large. And finally, a lot of our exposure benefits from really strong sponsorship. We usually work with project sponsors or owners of companies that have deep pockets and experience, institutional experience, so they're able to really work through issues as they arrive. You know if I just look at some of our specific examples in our portfolio, I think about project financing, infrastructure debt, as you mentioned, we have quite a bit of that in our portfolio. Those cash flows are often generated by ticker pay availability contracts not dependent on usage. We also have issuers in our portfolio that benefit from service agreements that are tied to an indexation to pass on CPI related increases to their payers which are often government entities. So these are natural protections that help in the rising cost environments. We are expecting potential noise as some of our corporate exposure, where concern about rising costs and rising the cost and the ability to pass that on to the consumer. So you know, there might be some noise there, Steve, but by and large we're expecting our portfolio to be quite resilient, as it has been in the past to microeconomic factors when they come up.

Steve Peacher: Well, one of the things I've observed obviously over years now of watching the team's investments play out, is that there's so much structural protection that are built into so many of the transactions that if there's a bump in the road those really become very important, and I think it's a hallmark, and the reason why the portfolio is to different economic ups and downs that perform so well. Well, thank you for all that. Let me let me turn as I like to do with Ah, more of a personal question. You know you have three young daughters. I'm jealous because I have three kids, but they're up and out and I wish they were around. We’re recording this and on a hot, sunny day in the summer. And so what are your daughters up to in the summer, when they think back on their summers at this age what are they going to remember, what are the things they’re involved in?

Elaad Keren: This is an interesting summer for us. Yes, we have a very busy household of three young kids involved in numerous things. But really this is the first full summer where there's really little or less Covid constraints. So we're trying to maximize it. We're trying to ensure that they are keeping busy, and my wife and I are very focused on being screen-free for them, so we're filling their days up with activities and we're hoping to have them remember the activities that they've been part of this summer, and also some travel that we're looking forward to do at the second half of August.

Steve Peacher: Well, we should all be screen free. That's my that would be my motto. But listen, thank you a lot for us for spending time, that was great, and thanks everybody for listening to this episode of “Three in Five.”

Elaad Keren: Thanks, Steve.


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