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Investor insights

August 05, 2020

Q2 2020: Investment grade private credit update

While the outlook for the pandemic remains unclear, demand has been strong as investors remain attracted to the incremental yield and structural protections offered by investment grade private credit.

Market update

Estimated U.S. investment grade private credit (also referred to as private placements) volume for the first half of 2020 was almost $32 billion, based on 131 reported transactions. This was down roughly 25% compared to the first half of 2019 due to the pandemic-related market disruption. Similar to the public markets, deal flow dried up during March and April before rebounding in May and June as the public markets stabilized in response to various federal stimulus programs.

While the outlook for the pandemic remains unclear, demand has been strong as investors remain attracted to the incremental yield and structural protections offered by investment grade private credit. The market rebound also opened the door for investors to source attractive deals at significant yield premiums to similarly rated public bonds. Insurance companies and retirement plans all saw an opportunity to add additional spread premium and diversification while retaining a high correlation to long-term financial liabilities.

The uncertainty related to the pandemic has also contributed to an upward shift in credit quality, with the proportion of NAIC-1 rated transactions (A or higher) accounting for 51% of year-to-date volume in 2020, compared to 37% in 2019. Deals denominated in USD accounted for almost 90% of the volume – a larger than usual share – and reflects both the disruption in currency markets and the overall bias in favor of USD issuers.

Pricing in the private market tends to lag the public markets, which can create opportunities to capture strong relative value. While public investment grade (IG) spreads have tightened significantly from the peak in March, private investment grade spreads have remained attractive on a relative basis. Even oversubscribed deals for high quality issuers have priced wide of the traditional 20-25 basis points (bps) premium to publics, as investors expect greater compensation for providing liquidity in a more uncertain market.

U.S. private placement volume

U.S. private placement volume graphic

SLC Management update

At SLC Management, we focus on value over volume. We seek to outperform the larger U.S. private placement market by leveraging our broad origination capabilities and unique industry expertise. We are focused on offering our clients proprietary and bespoke opportunities that provide better returns and more favorable allocations compared to broadly marketed transactions. SLC Management’s 5-year average relative value to public benchmarks has been close to 90 bps.* Through June 30, 2020 we averaged 165 bps of relative value.

Through the first six months of 2020, we committed to $1.2 billion across 36 transactions. These transactions had a weighted average tenor of 15.7 years, average life of 11 years, rating of A3 and a spread of 327 bps.** We found strong value in all segments of the market, especially in the second quarter. Several broadly marketed corporate transactions offered relative value in excess of 100 bps, due to a higher than normal liquidity premium, and strong value was also obtained from transactions in SLC Management focus areas such as alternative asset managers, infrastructure and sustainability-related investments.

YTD 2020 Avg WAL Avg rating Avg spread

Private placement market

16 yrs

51%: A

49%: BBB

250

SLC Management

16 yrs

60%: A

40%: BBB

327

Outlook for the second half of 2020

The strength of the U.S. private placement market in the second half of 2020 will be influenced to a large degree by the economic and health impacts of the pandemic. Positive news related to Covid-19 coupled with ongoing fiscal and monetary support will buoy both the public and private credit markets. At this point, we expect to see solid deals through the summer as issuers capitalize on favorable conditions, with less certainty around volume heading into the second quarter and the U.S. presidential election.

In focus topic: ESG

Environmental, Social, and Governance (ESG) considerations are becoming more prominent in investment decisions. With growing demand from investors for ESG friendly assets, the investment grade private credit market offers investors unique access to investments with positive impact ranging from utility-scale solar and wind power projects to energy efficiency improvements at government and commercial buildings and campuses.

SLC Management has a longstanding expertise in sustainable investing. A substantial portion of our investment grade private credit assets under management – $12.2 billion as of December 31, 2019 – qualify as sustainable investments under the International Capital Markets (ICMA) standard. And new investments totaling $1.3 billion in 2019 were also sustainable, and included renewable and energy efficiency projects, green buildings, clean transportation, sustainable water management and access to essential services.

As an example, SLC Management was the sole investor in a $63 million energy savings performance contract for a U.S. federal government historical capitol building. This project will generate over 20 million pounds per annum of carbon emission reductions, which is equivalent to eliminating 4,318 cars or adding 16,814 acres of forest. In addition, we were also the sole investor in a family emergency homeless shelter in a major metropolitan area, evidencing our commitment to investments that provide strong social impacts as well as environmental benefits.

$63M energy savings performance contract graphic

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