The climate for lenders in the credit market is now the most favorable, at least since the global financial crisis, said European credit manager David Allen, London-based managing partner and CIO at AlbaCore Capital Group.
Mr. Allen said there is now a favorable supply-and-demand backdrop for credit managers with banks continuing to hesitate to underwrite new deals.
"Additionally, higher coupons and yields, lender-friendly terms, and a more positive economic outlook than previously feared have put credit in a position to potentially generate equity-like returns over the coming years," he said in an email.
AlbaCore has about $9.5 billion in assets under management and has invested more than $25.6 billion for global pension funds, sovereign wealth funds, consultants, insurance companies, family offices and endowments since 2016.
Many recent opportunities his firm has evaluated have priced senior-secured risk at or above 10% yields, well above long-term equity returns.
"We are, perhaps, entering a new period for this generation of investors, where rates aren't pegged at zero and borrowers' (equity) and lenders' (credit) negotiating positions are more equally matched," he noted.
Mr. Allen said he believes rates will remain elevated across developed markets — at 3% to 4% — for the next several years. "Consequently, yields will also likely stay elevated, and our view is that the current lending environment presents one of the most attractive, broad market opportunities for credit in 30 years."
In market conditions like this, he noted, lenders have historically been able to extract higher premiums and more stringent terms, "trends we are benefiting from firsthand."
Indeed, if rates and yields remain elevated for the next several years, Mr. Allen sees this new environment with a "mix of optimism and caution."
AlbaCore sees subinvestment-grade credit as attractive, yielding about 8% in the eurozone across the market, with numerous opportunities to make investments in non-distressed names yielding in excess of 10% in the eurozone, with "room for tightening and stabilization over the next 24-36 months as the global economy recovers from the post-COVID shocks dealt by inflation, higher rates and trends in deglobalization."
However, he also expects default rates to rise, albeit from extremely low levels, and "remain higher than in the recent past over the coming years, which translates to an increase in distressed exchanges, defaults and lender activism."
Going forward, he indicated, credit selection will be critical, and a "deep understanding of deal structures, companies, sectors and regional fundamentals and sponsor behavior and incentives will be necessary to avoid pitfalls as companies run into difficulties or are no longer supported by sponsors."
Defaults are at the center of AlbaCore's institutional clients' and partners' greatest worries in the current climate, as default rates have been creeping up slowly, he said. Credit agency forecasts have also risen, "with Moody's 12-month baseline June 2022 forecast for Europe at 3.2% and U.S. at 4.2%, rising to 3.9% and 5.4%, respectively, as of the end of February 2024," Mr. Allen added.
In comparing European credit markets to U.S. credit markets, Mr. Allen said the European subinvestment-grade market is less levered than the U.S. market and European credit spreads are wider.
"The European market is more fragmented and dislocation tends to hit Europe harder as there are less players here to price risk," he said. "As long as the market remains choppy, we feel that there are better opportunities in Europe than the U.S."
