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9Questions is our Q&A series featuring key decision-makers in the corporate credit markets — get in touch if you know who we should be talking to!

Jonathan Butler is a managing director and heads the European leveraged finance team at PGIM Fixed Income, as well as co-heading the global high yield strategy. Before joining PGIM in 2005, he was responsible for establishing and managing NIBC’s third-party CLO asset management franchise, and held roles at Chemical Bank (now JP Morgan Chase) and Industrial Bank of Japan (now Mizuho).

9fin sits down with him to discuss the fresh wind in the syndicated market’s sails so far in 2023 after primary droughts, and to scan the horizon for choppy waters.

1. The credit markets have rallied hard in recent months. To what extent is that justified based on earnings performance? Is risk being priced appropriately?

We’ve seen a shift in recent years as investors look more at all-in yield. The combination of rising interest rates and widening credit spreads in 2022 made the all-in income from leveraged finance — across leveraged loans, high yield bonds and private credit — more appealing to investors. While spreads have since contracted, the all-in yield is still compelling for certain types of investors and leveraged finance is clearly a safer asset class than equities. Part of the rally is driven by people reallocating away from other asset classes, like equities, and into fixed income generally, with some of this reallocation coming into leveraged finance.

2. The new issue market feels like it's in full swing again. Is that fair to say? Can you set that recovery in context?

Yes — I think the markets are pretty fully open again now. There has been a lack of new issuance across the whole credit spectrum in the last two years, but we’re now back to relatively tight credit spreads again — they’re back to the levels we saw before Covid and before the Russia-Ukraine war. There have been inflows, a pickup in demand from clients and a lack of supply, which have all led to the rally we have seen.

3. What’s the outlook for, say, a CCC refi nowadays?

The outlook really depends on whether a business is a good triple-C or a bad triple-C. The businesses that are designed with a capital structure around having a triple-C rating should find it fairly straightforward to refinance in the market. The bad triple-Cs, with a capital structure that wasn’t intended for this market, are likely to struggle to refinance in today’s environment and are likely to easily fall into the distressed category. All in all, it depends whether you’re in the haves or have-nots camp as to whether a business can be refinanced.

4. PGIM Fixed Income is particularly active in the high yield market for a CLO. How has the recovery in high yield differed from that in loans? Is risk appetite different across markets?

The high yield market has rallied considerably and in line with other capital markets while the CLO market has not recovered in the same way. CLO liabilities have remained fairly wide with CLO arbitrage being generally weaker. This has hurt CLO formation and caused loan spreads to be relatively wider than high yield spreads.

In terms of risk appetite, the shrinkage of the high yield market over the last two years has led to a very strong technical in the asset class while loans continue to trade wider than high yield bonds.

5. What's the relative value play across high yield and loans at the moment?

High yield spreads are at close to the tightest levels than they have been over the last 15 years since the global financial crisis. It’s important to look at the relative value of each issuer and determine whether we like the loan issuer or the bond issuer, or a bond or loan from the same issuer based on its option adjusted spread (OAS).

6. What are your expectations for the return of M&A-backed supply?

There are sponsors that are increasingly able and willing to sell and a lot of dry capital waiting to be invested, so I think we are coming out of the cyclical lows of the M&A cycle. While things are moving slowly, there is more convergence between buyers and sellers around valuation expectations, which should lead to more processes completing. I’d therefore expect to see more M&A activity this year, which should drive portfolio rotation in terms of businesses coming out of portfolios but also lead to new issuance as well.

7. Even with a fairly hot market, there’s a hefty election calendar in 2024 and geopolitical tensions simmering in the background — what impact do you think these macro pressures could have on our markets this year?

There’s definitely increased geopolitical risk — we’re seeing greater divergence between democracies and authoritarian countries. The globalisation trend that has characterised the past 30 years has also stopped and is arguably now reversing, and this naturally brings tensions. Whether these tensions translate into a big knock-on effect on the global economy is the great unknown. There’s been more and more noise over the past year but spreads have tightened and equity markets have gone up a lot, so the markets seem confident that things will smooth out.

However, I do think we’re looking at a world where inflation will be higher for longer. One of the main pillars of globalisation was the movement of manufacturing to lower cost of production countries — if this reverses, it will be inflationary. Increasing global spending on defence and addressing climate change is also inflationary, so I think the era of ultra-low inflation and interest rates we’ve seen over the last 15 years has probably come to an end.

8. Private credit funds chipped away at syndicated markets’ supply in recent years, but now that the BSL market has regained ground, what’s the near-term future for large caps deals that could straddle both pools of capital?

We’ve seen private credit gain significant market share over the past two years, but this was partly a result of underwriting appetite of banks drying up, so its main rival was not really functioning. We’re now seeing a period of normalisation — banks are underwriting again and the BSL market performed very strongly in 2023, with spreads now a lot tighter than they were 12 to 18 months ago. Private credit is therefore having to move in line with the broader markets and is becoming just another leveraged lending product, alongside high yield bonds and leveraged loans.

Traditionally, private credit was really a mid-market lending alternative, but as the capacity of funds has grown, it has moved into larger businesses. We’re now seeing companies that have traditionally been issuers to the leveraged loan markets or high yield bond markets starting to move into the private credit world. There were a few big transactions last year that really underlined this point, at around the $5 billion mark.

9. Even away from markets, we hear you’re a man used to choppy waters?

I have spent the majority of my life living near water and spend a lot of my spare time doing many kinds of water sports, especially sailing. There are many parallels between sailing and financial markets — especially the notion that you have to be ready for any and all circumstances. Sailing is about preparation, navigation, teamwork and endurance. You need to be fast and effective but you also need to be smooth to get from one point to another. It’s important to plan and be organised, but also be nimble enough to respond when something goes wrong like bad weather coming either unexpectedly or expectedly.

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9Questions — Jonathan Butler, PGIM — The turning tide

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