Managing Director, Head of European Credit
Q: Relative to other major markets, what’s the risk-return outlook for credit in Europe this year and beyond?
A: European credit is generally pricing at a premium to North America on many of our key indices, particularly in sub-investment grade credit. This is due to a number of factors, notably higher input cost and labour inflation compared to North America, and heightened geopolitical risk driving caution. From a credit fundamentals perspective, sub-investment grade credit in Europe has a much higher proportion of floating-rate risk versus North America, where fixed-rate, high-yield borrowing is more prevalent. The base rate increases by central banks are impacting cash flows here more relative to North America because a higher proportion of debt issuances immediately become more expensive, which in turn drives corporate credit underperformance and wider required returns to compensate lenders for the perceived risks.
Q: How much are you talking about recession risk with sponsors and relationship partners?
A: Despite all the headlines, we haven’t had many conversations with our partners anchored on concerns around growth. Most sponsors who we talk to are focused on controlling the inflationary impacts on investment portfolio companies and managing cash flows. We engage a lot with sponsors on creating value in this environment, often through M&A. We’ve generally been pleased with the performance and resilience of the companies we are invested in, so recession risk is something we track closely but we have yet to see a broad, demand-driven impact across our portfolio.
Q: What’s the most notable issuance trend that your team is seeing?
A: The biggest trend we are seeing is a focus on amend-and-extend transactions, where a borrower seeks to work with its existing lender group to amend the terms of its borrowing and extend the maturity date. The aim of this is relatively simple: since spread premiums are currently high, and banks are cautious about committing to underwriting, it makes more sense to engage with existing lenders to effectively roll over debt at manageable premiums rather than issuing new debt at uncertain market terms. This also buys a borrower time to wait until the market normalizes when it can do a more traditional refinancing transaction.
Q: What does that amendment premium look like?
A: Typically, it would comprise several percentage points upfront as a fee, plus a slightly higher debt coupon or margin in exchange for the maturity extension. But it leaves all the other terms in place and keeps everything much simpler.
Q: Any other issuance trends?
A: With large leveraged buyouts slowing, many sponsors remain focused on growing portfolio companies through smaller M&A and are engaged in bolt-on acquisitions. This creates a need for debt financing in a smaller quantum – and to the points above, there’s little interest in taking on the risk of a full refinancing of a debt structure to accompany these bolt-on deals. So we’re seeing more of what are termed non-fungible loans, where a borrower issues another tranche that sits alongside the existing loans, but has different key economic terms compared to the original debt. This is an effective way to issue the financing required for M&A without a full refinancing of the capital structure.
Q: What kind of opportunities exist in an environment like this for a long-term investor like CPP Investments?
A: We see an opportunity over the next few years to utilize our balance sheet to bring solutions that help solve problems for borrowers. This takes us back to our DNA, where we benefit from the relationships that our Private Equity department has with sponsors across the market and allows us to be a partner of choice. Where these sponsors have situations that are perhaps more complicated — more bespoke and in need of particular solutions — that’s where we can be most valuable to our existing and future partners.