Q3 2024: Investment Grade Private Credit update
Amid continuing pressures on social infrastructure, SLC Management discusses investor opportunities to enhance returns, while advancing public interest initiatives.
Market statistics for the private placement market sourced from Private Placement Monitor, a standard proxy for the investment grade (IG) private credit market.
The third quarter of 2024 continued the theme of robust IG private credit volumes, with both large and small deals exhibiting healthy transaction levels. Meanwhile, many investors in this market are finding opportunities in social infrastructure that exhibit sound investment characteristics.
Market
The momentum of the record-setting volume of the second quarter of 2024 continued into the third quarter, with over US$23 billion of transaction volume. This was substantially higher than the third quarters of 2022 and 2023 (roughly US$14 billion each), albeit with volumes lower than the second quarter of 2024. At close to US$95 billion, 2024 year-to-date volume has set a record year of activity in recent times for the IG private debt market.
Billion-dollar transactions continue to price, with two completed in the third quarter. The largest transaction in the third quarter closed at US$1.3 billion in the digital infrastructure sector, signaling robust investor appetite and available liquidity for attractive transactions with good risk–return profiles. At the other end of the spectrum, the number of smaller deals at US$100 million or less generally kept up with the levels in 2023 but saw a sharp drop from the number of small issuances in 2022. The smaller issues tend to be marketed to a smaller base of investors.
The largest sector contributors to volume year to date have been the industrial sector (mainly service, energy and technology), followed by financials and utilities. While U.S.-dollar volume is still the main driver for overall growth, there was an increasing level of non-U.S. currencies contributing 25% of total volume in the third quarter, compared to 17% in 2023. The market remained competitive, with growing demand for the asset class from both traditional and new market participants. Attractive opportunities were well oversubscribed (up to 4–5 times), at times resulting in modest price tightening (5–10 basis points). Investors also showed discipline as a few transactions that exhibited less-than-optimal structures, credit or relative value did not have a successful fund raise. While spreads for both IG public and private debt markets have narrowed this year, the relative value generated by the private debt market remained strong, in our view.
Outlook
SLC Management maintains its disciplined approach to credit underwriting. We believe we were able to garner a leading position in a large number of competitive bids, and successfully improve structures in several instances (source: Private Placement Monitor and SLC Management internal data). Heading into the fourth quarter, there is some market uncertainty related to the election cycle in the last months of the year, with the potential for fewer issuances. However, the team remains open to take advantage of any opportunistic pricing or market disruption.
In focus: The role of investment grade private credit in social infrastructure
Economic growth traditionally measures economic improvement in quantifiable terms, such as wages and employment levels. Economic development on the other hand tends to focus on qualitative issues and policy interventions that are longer term in nature. This can take many forms, from access to health care and affordable housing to care for vulnerable segments of society. Social infrastructure, the physical means by which these development measures are delivered, typically falls into the realm of government.
However, there is a growing role for private capital in social infrastructure. For example, specialist providers in the private sector may have greater expertise than government in managing the effective delivery of certain public goods and services. Further upstream, capital providers can play a role in facilitating development by reducing the upfront burden on budgets through contract monetization. These and other factors can result in an alignment of public interest and private capital, fostering some of the more compelling opportunities in today’s IG private credit market.
Financing urban city shelters
For a hands-on illustration, we can look to how investment into helping unhoused individuals and families can benefit both social policy goals and the IG private credit investor. In the case of the private credit team at SLC Fixed Income, the team found compelling opportunities in the financing of two emergency shelters in a major U.S. city.
Emergency shelters provide vital support and safe housing to vulnerable populations. Access, however, is often limited due to a lack of available space due to high demand. SLC Fixed Income helped address this critical need in the financing of these projects:
- Family shelter – Co-lead investor in a financing for a family homeless shelter. The shelter will provide transitional housing facilities and services for women and families with at least one child under 18.
- Women’s shelter – Co-lead investor in a financing for a purpose-built, 200-bed women’s shelter. The shelter is one of two women’s intake and assessment shelters in the city, providing 24/7 intake services. The shelter is accessible in accordance with the Americans with Disabilities Act.
The shelter operator is one of the leaders in shelter development and operation in the U.S. This underlines one important aspect of sourcing potential opportunities in this space: careful analysis of the operator, and identifying those that are leaders in their respective sectors.
Potential benefits in social infrastructure investing
The previous emergency shelters case exemplifies the potential benefits that selective investors like SLC Fixed Income look for in a social infrastructure investment. Such benefits might include:
- Strong counterparties – A well-structured and carefully selected social infrastructure investment can offer the equivalent exposure to high-quality public bonds, which can be in the AA-range or higher in many cases. In the aforementioned shelters case, for example, the financing arrangements provide attractive excess yields over the public bonds of that major city. Debt service payments themselves come from this city, which is a common arrangement in such deals involving one or more levels of government.
- Mission-critical assets – The need for social infrastructure continues to be supported by demand, which frequently outpaces supply. Furthermore, public policy initiatives that set clear goals for such major projects can further drive expansion in the market and, therefore, the opportunity sets available. In the previous example, the need for the emergency shelters’ financing is driven in part by the city’s own law that requires it to provide shelter to unhoused persons who qualify. Alternative solutions, such as hotel rooms and clustered apartments, are costlier to the city, as is often the case for governments in other municipalities providing such services.
- Structural features – The planning, development and/or operation of social infrastructure projects are usually backed by governments. Consequently, investors can benefit from the increased certainty provided by loan agreements with governments or their agencies. In the case of the emergency shelters, a major benefit to SLC Fixed Income has been the lender-friendly terms with the municipal government in question. These include loan repayments stipulated under a multi-decade human services contract, with rent payments even in the case of contract termination and not subject to reduction or offset. A first-mortgage lien on the property provides additional security as well.
Specialized partners for specialized opportunities
It is important to note that each social infrastructure opportunity is distinct. Individual transactions can vary considerably in the potential benefits to the lender. Accordingly, we believe that only a select number of asset managers have the expertise, scale and experience to be effective investors in this space.
The previously mentioned case of the shelter system is but one example of the increasing demand for social infrastructure globally. Against this backdrop, IG private credit managers in our view have a unique role to play in seeking to provide long-term, stable, risk-adjusted returns that reward investors.
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.
Unless otherwise stated, all figures and estimates provided have been sourced internally and are as of June 30, 2024. Unless otherwise noted, all references to “$” are in U.S. dollars. Past performance is not indicative of future results.
Nothing herein constitutes an offer to sell or the solicitation of an offer to buy securities. The information in these materials is provided solely as reference material with respect to the Firm, its people and advisory services business, as an asset management company.
Market data and information included herein is based on various published and unpublished sources considered to be reliable but has not been independently verified and there is no guarantee of its accuracy or completeness.
This content 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. Unless otherwise stated, all figures and estimates provided have been sourced internally and are current as at the date of the paper unless separately stated. All data is subject to change.
This information 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. An investor may not invest directly in an index.
No part of this material may, without SLC Management’s prior written consent, be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorized agent of the recipient.
This material is intended for institutional investors only. It is not for retail use or distribution to individual investors. Nothing in this presentation should (i) be construed to cause any of the operations under SLC Management to be an investment advice fiduciary under the U.S. Employee Retirement Income Security Act of 1974, as amended, the U.S. Internal Revenue Code of 1986, as amended, or similar law, (ii) be considered individualized investment advice to plan assets based on the particular needs of a plan or (iii) serve as a primary basis for investment decisions with respect to plan assets.
Sun Life Capital Management (U.S.) LLC. also referred to as "SLC Fixed Income,” offers pooled funds, separately managed accounts and other investment advisory services with the support of the investment operations of SLC Management.
Data presented in this article have been calculated internally based on external market data sourced from Private Placement Monitor.
Investment-grade credit ratings of our private placements portfolio assets 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. 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.
Investments involve risk, including loss of principal. Diversification does not guarantee against loss or ensure a profit. Nothing herein constitutes an offer to sell or the solicitation of an offer to buy securities. The information in these materials is provided solely as reference material with respect to the Firm, its people and advisory services business, as an asset management company.
© 2024, SLC Management
SLC-20241113-3995920