Fixed income is foundational for long-term investors, and as such the persistent low-for-longer scenario in sovereign debt and Covid-related effects on investible companies are fueling a voracious and increasing appetite among institutional investors for opportunities in credit markets.
To explore such opportunities, II recently spoke with Tyler Lindblad, Senior Managing Director, Chief Credit Officer, Antares Capital. Lindblad was a founder of Antares 25 years ago and has extensive experience successfully selecting and underwriting credits across various cycles. In short, Lindblad believes there are significant opportunities available and ample opportunity to be very selective.
What’s your overview of the credit market at the moment?
Tyler Lindblad: We’re seeing very robust deal activity, particularly coming out of the Covid period where activity was muted. We’ve seen private equity sponsors raise significant capital, and they’re now seeking to deploy that capital – and that is creating significant opportunities for firms and private credit to deploy capital, as well. We are seeing a lot of high-quality opportunities. From a senior debt standpoint, we’re seeing multiples creep up modestly and purchase prices rise. As a result, the amount of equity that the sponsors are putting into companies has significantly increased. Related to yields, there was an increase in pricing coming out of the pandemic. The terms were friendly from a lender perspective – but that has now certainly switched.
Are you seeing some compression in price?
Lindblad: We are, albeit at a more normalized level – almost at the 2019 level. Where we’ve really seen price compression is in the larger BSL [broadly syndicated loan] market, and in the second lien market – which in turn has had some impact on the unitranche market. But even spreads on unitranche remain higher than they were in 2019.
When you consider the improving economy and high-quality companies that have come to market, plus sponsors putting in significant equity and pricing at attractive levels, we think it’s a good time to strongly consider private credit opportunities.
Everyone is talking about inflation. What’s your view on how borrowers will perform in an environment of rising rates and debt service burden? Maybe a little inflation is not a bad thing?
Lindblad: I’d agree that a little inflation isn’t necessarily a bad thing, particularly if you’re a debt provider. If you provide debt to companies, a little inflation in moderate doses is preferable to deflation. We really don’t want to see high inflation, but modest inflation isn’t entirely bad. We’re seeing some inflationary impact right now, and that’s reflective of a U.S. economy that has picked up significant steam as it has reopened. Consumers have started to spend again, and that drives the economy.
Feels as if there may be a “but” coming . . .
Lindblad: True enough! From a credit perspective, we look at the raw material pressure in some sectors, labor pressure in others, and the availability of talent in a competitive hiring environment. Labor costs are increasing. We always have an eye on supply chain and product availability, and a focus on lending money to companies that are market leaders and have pricing power because of their relationships and value-add they provide customers. Yes, they’re experiencing some pressures, but they in turn can pass those costs on to their customers.
Amidst everything we’ve been talking about, how do you balance deployment and selectivity while maintaining creditor protections?
Lindblad: Credit selection is always key and critical to the success of our business. We manage that by having broad and deep sponsor relationships which generate significant deal flow from us. When you generate significant deal flow you can choose the best credits and be very selective. Right now, for example, we’re emphasizing companies with business models that are oriented around recurring revenue. In other words, where the products or consumer services are consumed on a regular basis.
What does that mean in the context of Covid?
Lindblad: We’re very mindful of lending money to companies and industries that have favorable demand drivers and growth potential. Sponsors will support high-quality businesses during short-term interruptions. We’re also seeing terms and conditions starting to become more flexible to the benefit of the borrower.
We’ve just been through a period where private credit endured a serious stress test and came out with flying colors on the other side. But concerns about risk are ongoing. Nevertheless, you feel conditions are favorable for deploying capital. Can you put that point of view into context?
Lindblad: Private credit did go through a significant stress test as it related to Covid. High- quality borrowers showed significant resilience – they bounced back. Some of those companies needed help, and sponsors were there to inject additional capital to support them and provide them with liquidity. Move the clock forward to today and the Delta variant is starting to pick up steam. That said, the U.S. economy is still open. And when we look at our portfolio, it continues to show improvement. Default rates are near all-time lows in our portfolio.
What has that meant for performance?
Lindblad: Even relative to 2019 pre-Covid, the portfolio has performed well, highlighting the fact that the U.S. economy is in a robust place. As you mentioned, there are always concerns about risk, whether it be the Delta variant something else. That said, we think the U.S. economy is on firm ground for the foreseeable future. As we think about private credit with a floating rate debt, even if the interest rates go up, our rates will go up along with that – it’s a nice hedge. And at the end of the day, sponsors have raised significant dollars. They’re putting more and more equity into transactions. We are seeing them buy higher quality companies. And with our portfolio – which has been well-vetted – they’re making additional acquisitions at a lower price that helps them to create value and enables us as a lender to deploy additional capital to high-quality companies that have been vetted.