1. Banks are facing big losses on LBOs that were underwritten before the market gapped wider. Do you think these deals represent a buying opportunity for investors?

Buyout transactions underwritten before significant volatility hit the leveraged finance market may represent a buying opportunity for loan and high yield investors, however, lenders must remain vigilant and focus on credit quality rather than just steep discounts given the uncertainty surrounding the economic outlook. In addition to increased economics, the current environment also provides lenders with the opportunity to push back on borrower-friendly documentation and secure better covenant protections.

2. Private credit has played a big role in some of these buyout syndications. Does that make life easier or harder for investors in the broadly syndicated markets?

In some respects, the increased role of private credit in LBOs has helped fill a void for sponsors where demand from the broadly syndicated markets may be constrained given the lack of interest from traditional buyer bases. As an example, this can be seen within the second lien loan market where over the last several years there has been an increase in the number of loans preplaced with mid and large sized private credit platforms. That said, private credit has also created additional competition within certain segments of the broadly syndicated markets, more specifically there has been a convergence within the middle- market space which has led to fewer broadly syndicated mid-market transactions.

3. What do you think are the two most important drivers of the volatility and uncertainty in markets today?

Currently, the most significant drivers of volatility within the markets are the path of inflation and the Federal Reserve’s response. Both of which are having a direct impact on credit fundamentals. Inflationary pressures driven by supply shocks, tight labor markets and high commodity costs are pressuring margins and that coupled with tougher comps is leading to increased volatility in corporate earnings. In addition, the Fed’s aggressive monetary tightening policy is designed to dampen demand and raise the cost of debt, thereby further pressuring cash flows, particularly for highly leveraged credits.

4. Defaults and distress are expected to increase over the coming months. What are you doing to prepare for this?

With default rates almost certainly increasing going forward it remains profoundly important to employ careful credit selection. Focusing on credits with strong liquidity, solid free cash flow and long debt maturity profiles should help mitigate pressures felt by rising rates and slowing consumer demand. We are also shifting focus away from goods and more toward services including those within industries that typically exhibit more recession resilient characteristics. As dispersion among credits has increased, it is allowing us to target selective idiosyncratic opportunities.

5. Which areas of the economy do you think are at particular risk from the recessionary environment we are entering?

We believe that consumer-related areas of the market are most at risk, as households are being pressured by higher food and energy costs and will likely pull back on discretionary spending. Looking at the most recent University of Michigan survey, consumer sentiment has dropped to a record low. Furthermore, companies that lack pricing power to help mitigate inflationary pressures and/or the ability to effectively deal with supply chain issues will likely see margins and cash flows compress further in a recessionary environment.

6. Do you think the tight labor market is going to continue being an issue for companies over the next few months, or is that pressure easing?

Given a starting point of ultra-low unemployment, our expectations are that labor markets stay somewhat tight over the next few months and remain a near-term headwind. Recent jobless claims data, however, is suggesting some early signs of easing, and there has been some anecdotal evidence that job cuts have begun in certain industries as management teams prepare for a weaker economic outlook. Clearly, if the US economy were to enter a recession, we would expect labor pressure to ease more meaningfully.

7. What do you think is the most important indicator or piece of market data credit investors should be watching right now?

Credit investors should be focused on inflationary indicators, not only CPI and PCE but also surveys that provide color into consumer expectations. Spreads for leveraged finance assets have widened, in part, over increasing fear that monetary policy will slow growth and may lead to a recession. Higher prices for goods and the Fed’s response are putting pressure on credit fundamentals. Rising interest rate expectations are also influencing market technicals. Leveraged loans’ floating rate nature has led to strong return performance relative to other asset classes for the year. However, we believe that once the Fed approaches a more neutral rate monetary policy, we could see the high yield market benefit from related tailwinds.

8. What changes, if any, have you noticed in the culture of your workplace now that people have been back in the office for a few months?

Although we adapted quickly during the pandemic to a work-from-home environment, being able to collaborate in person once again with colleagues and clients is proving invaluable. That said, our use of a hybrid model is also allowing people greater flexibility to maintain a healthy work-life balance.

9. If you could pick anywhere in the world to visit right now, regardless of cost or practical limitations, where would you go and why?

I’ve always gravitated more towards tropical beach vacations versus those focused on sightseeing, and Bora Bora has long been at the top of my wish list. Not to sound too much like a travel brochure, but the idea of staying in a bungalow perched over tropical water where I can see fish swimming beneath my feet sounds pretty amazing. Hopefully one day I will make it there.