Revisiting private credit: what’s old is new again
John Simone, Managing Director—Head Insurance Solutions Group, Voya Investment Management explores why historically low interest rates mean private credit is growing in popularity
John Simone, Managing Director—Head Insurance Solutions Group, Voya Investment Managementposted on Friday, September 11, 2020
Defining Investment Grade Private Credit
Investment grade private credit is an investment sector that more and more insurance companies are looking to add to their portfolios.
We group investment grade private credit into three buckets – corporate debt (private placements), infrastructure debt (privately placed project finance) and commercial mortgage loans (core and light transitional). Here we will focus on private placements.
Borrowers utilise the private placement market for a variety of reasons: to maintain the confidentiality of their financials, to obtain more flexible terms than offered by the public market or to borrow money when their credit histories are more complex in nature.
Borrowers use the proceeds to finance acquisitions, refinance existing debt, support business expansions and other general business purposes.
"Investment grade private credit is an investment sector that more and more insurance companies are looking to add to their portfolios. "
Although the perception persists that private placements are illiquid, it is actually a byproduct of the fact that the primary investors (mainly life insurance companies) are “buy-and-hold” investors.
Although there is limited ability to buy holdings, the liquidity to sell is very good. For example, the prices for bonds sold during the 2009 financial crisis average 98% of par and 99.9% of prior month-end prices--based on our experience.
Historically this space has been dominated by large life insurers--however, new investment vehicles, and the willingness of life insurers to accept sub-advisory assignments, have brought private placements within reach of a broader range of property and casualty (P&C) companies and other insurers of all sizes.
There is also another factor that has made this sector increasing attractive to insurers of all sizes.
Why Private Credit?
Although there are approximately 50 insurance companies active in the private placement market, the top ten participants represent approximately 70% of the market on an annual basis.
Each investor places a bid on the transaction; if the borrower accepts the proposed pricing and terms, the investors are included in the deal. Often, investors will have comments on the legal documents or covenants, making each transaction unique.
The grind down in yields across the credit curve, along with the Fed’s buying of publicly traded corporate credit, has created opportunities for insurance companies that need yield but don’t want to necessarily increase their capital associated with going down in credit quality. These investors find the investment grade private placement market highly attractive.
"The grind down in yields across the credit curve, along with the Fed’s buying of publicly traded corporate credit, has created opportunities for insurance companies"
Private credit investments are known for their flexible structure with respect to maturity dates, delayed drawdowns and multiple funding for a given borrower. Most are fixed-rate offerings, but they also may be structured with floating rates.
This flexibility gives the private market an important advantage over the public market and results in increased opportunities for active private lenders.
Also, issuers are willing in many cases to offer differing tenors of investment and given the heavy non-US issuance borrowers are also willing to provide debt in varying currencies. This is especially attractive for clients who have a global book of business and/or are willing to hedge non-dollar exposures into their local currency.
Although private placements and commercial mortgage loans have long been ‘core ‘ allocations for life insurance companies, we are seeing demand from non-life insurance companies picking up significantly.
The hunt for high-quality yield due to historically low and lower rates is here to stay given the pandemic and the resulting central bank actions globally to keep rates low and apply a plethora of liquidity tools to ensure markets are functioning normally (i.e. TALF, buying publically traded corporate debt to name a few).
For selective investors, the market has provided attractive spreads to similar rated public corporate bonds and the quality of the deal flow, as measured by rating, has increased. This combination offers investors an attractive combination of increased spread with higher average credit quality.
"The hunt for high-quality yield due to historically low and lower rates is here to stay given the pandemic"
Lastly, the covenant protections provided by the private placement market continue to support the case for adding privates now given the global uncertainty surrounding the pandemic.
Unlike the public fixed income markets, privates provide investors with the ability to structure covenants that if tripped provide for a make whole provision which can add an additional 20-30bps of return on average to investors.
Combine the improved spread to public fixed, make whole provisions and lower credit losses compared to similar industry/ratings of corporate debt and we have averaged over 120bps of additional return over the past decade.
What’s old, is new again
As an industry, we are sailing in not just choppy seas, but oceans filled with tidal waves and sharks. With only a few months left in 2020, insurers will still be dealing with a number issues that will impact the market—the ongoing pandemic, low interest rates and the impact of the U.S. presidential election as we head into 2021.
"As an industry, we are sailing in not just choppy seas, but oceans filled with tidal waves and sharks. "
Much like a well-tailored suit or dress, private credit continues to provide its worth to investors-- as not just a portfolio diversifier, but also a way to increase yield without drastically increasing your risk. That said, high quality lower risk private debt is here to stay and is becoming a larger portion of debt risk budgets for a wider range of insurer.