The private loan market is being revalued. Risks are becoming more expensive and coupons are shooting up. Positive for pension funds and insurers that stay put until maturity, but investors in this category also sometimes have distressed moments.
“Will there be gamechanger upon gamechanger? That’s a question that does keep me awake,” said Pieter D’Hoore of Neuberger Berman. “What scenarios should we take into account? What if the energy crisis continues for a very long time, what if China starts supporting Russia? The risk is small, but these are things you have to take into account in the long term. Meanwhile, the Fed and the ECB are far from finished.”
D’Hoore worked at ING and Delta Lloyd, among others, before becoming responsible for European private loans at Neuberger Berman four years ago. In this five trillion dollar universe, the asset manager manages 1.3 billion dollars from pension funds and insurers, through mainly mandates. In total, Neuberger Berman has 408 billion dollars under management.
In the first quarter of 2023, the asset managers will launch a second private loans fund, for institutional parties that have small assets available for a separate mandate, but do want to invest in European private loans with maturities of three to 10 years.
Risk of accidents
However, investing in this environment is difficult, agrees D’Hoore. “Pension funds and insurers, which are among our clients, often ‘only’ need to achieve a minimum return to meet their obligations. Thanks to high interest rates, this is easier now than three or five years ago. But the risk of accidents has also risen exponentially.”
To overcome that within “his” asset class, D’Hoore is extra strict on ratings. “And we continuously monitor how the companies we invest in are doing. If a company moves towards bankruptcy, we immediately reach for our covenants to terminate loans. Where others gamble, we absolutely do not. Not even now.”
The asset manager invests at all only in bilateral loans, granted by one of the 11 banks it works with on the basis of a strict legal framework. Such a loan is registered with the ECB. If the asset manager is interested, it can finance 90 per cent of the loan, for example, while the bank holds 10 per cent. It is always a co-investment.
This provides an extra safety clause, argues D’Hoore. “If something goes wrong, a company is obliged to alert the bank, which in turn alerts us. With direct lending, you don’t have that plus.”
In practice, it has never occurred to the asset manager that bankruptcy threatened and Neuberger asked for the money back. “But in the 10 years we’ve been doing this, we did have regular discussions with management. We are keen on that, we are not going to take risks. If a business model shocks in a certain scenario, we don’t do it. Even though we might then leave money on the table. We only buy senior loans, and these are often secured.”
Another maxim for investors, is that it will never lend to a company with more leverage than four times ebitda. ‘The golden rule is that you can earn more above that,’ says D’Hoore. ‘But your risk increases exponentially in the meantime. We prefer to look for the added value in a good coupon.’
Timing
Financial markets have already had a lot to digest recently. The prevailing view: this tough weather is not over just yet. D’Hoore: “Getting in last February was not good timing-wise, loans in 2023 seem more attractive. Unless something big happens, but it seems to me we will have taken the biggest hit by then. Everything has a bottom.”
Sector-wise, the investor avoids anything cyclical, tourism, and airlines, mainly because of the aftermath of the covid pandemic. “Still we are keen on that because we reckon that theme will reverberate for some time. So we prefer non-cyclical companies, which deliver price-elastic products. Retailers for example, people keep buying food.”
“From the banking network, we see a strong flow of new quality loans,” said D’Hoore. “Market conditions have changed significantly, making it harder for companies to raise funding in the primary bond markets. On average, these loans yield a coupon of more 200 basis points above public bonds, with a credit quality score of BBB.”
This interview originally appeared on InvestmentOfficer.nl.