Hello, and welcome to the Credit Edge, a weekly markets podcast. My name is James Crumbie. I'm a senior editor at Bloomberg. This week, we're very pleased to welcome Camille McLeod Salmon at Fidelity International in London. How are you, Camille?
Very well, Thank you.
Thank you so much for joining us today. We're excited to dig into your market views and to get your outlook. We're also delighted to welcome back Bloomberg's very own Lisa Lee, who covers credit markets from London. Great to see you again, Lisa.
Great to be here again, James.
And from Bloomberg Intelligence. Excellent to see Aidan Cheslin. Welcome back, Aidans.
Great.
So let's start with you, Camille. It's great to see you on the Credit Edge. I know you want to talk about collateralized loan obligations. We'll get into that, but let's start with a big picture. When we talk to global portfolio managers at the moment, they do like the sound of Europe for the potential diversification and also because it looks relatively cheap. Of course, they skew to the bigger US market, and as we've discussed recently on this
show it's getting expensive in the US. There's a lot of demand for not a lot of supply, so investors are definitely looking for options elsewhere, but maybe Europe's cheap for a reason. These economies seem more challenged in the US, where we may be headed for a soft landing rather than a recession, although a lot of the policy easing bets are being unwhelmed as we speak, because the data
on the economy just keeps coming in strong. So you know, Europe in relative terms seem to have a lot of issues, including inflation, which is tying policy makers hands when it comes to stimulus. But what is the macro outlook from where you sit? Camille? Am I being too pessimistic?
So I think let's start with kind of outlook for Europe and kind of what's been happening. So if you look at if you look at one of the big mowers in the market, it's the fact that we it's clear that we have reached kind of terminal rates and that we expect a decline this year. And we can
talk about May versus March. I think there's probably people more eloquent and educated about that than I. And we can also talk about how many rate cuts four versus five, But it's clear that there there will be rate cuts, and that impacts our market in a number of ways. So firstly impacts the direct funding for our for our issuers. And then so as rates rise, that means that the cost of borrowing, sorry, as the rates decline, the cost of borrowing also declined. So that's a helpful tail wind.
So what has been aheadwind now tearing into tailwind. We don't expect rates to reach zero percent, but clearly we've already seen since the end of last year that those interest costs have come down. And then leading on to that, it's if you look at you we have a maturity
all that we're approaching. So if you look at maturities in twenty five, twenty six, and twenty seven in credit, we have two hundred and thirty six billion of maturities that we need to amend or deal with, and that as a curve is lower and those funding costs are cheaper. That actually means those A and e's are easier to get down and are more affordable, and that stretch that you have to make is less. And then it also impacts M and A. So when we look at the
m and A environment. Actually, the bid off for spread that had existed is largely, in my opinion, a function of the rate problem. So if you're a seller and you expect rates to decline, then you're better off waiting and putting off that cell decision. And if you're a buyer, you can't really price in rate cuts. And I think that certainty that we're getting is allowing that bid ask spread hopefully to decline, plus some other factors that are
happening in the sponsored space as well. And then also, like the US, lower rates has also meant that the search for meal means that we've seen tightening in the European market as well in terms of spread. So we've seen the wave of repricings that have come across the US, but we still think it looks relatively attractive. So I think for a number of reasons, Europe's an interesting diversification play, and that rate shift continues to make it an interesting
diversit patient pay and relative it looks attractive. The US is large and liquid, but I think if you compare triple c's in each market, you've got nine percent triple c's in the US versus three percent in Europe, and also default rates are expected to be higher in the US than in U Europe. And I would also say that recovery rates give the creditor on creditor violence and the lost bitigation transactions that you're seeing in the US
that haven't yet transported to Europe. And I think the clubbiness of the European market holds that by a little bit, although that's something that we continue to focus on. Makes europe An important diversification or important diversify if you're able to invest globally.
So there's a lot to unpack there.
Community.
You've thrown us a lot of things. I just kind of wanted to back up a bit in terms of obviously the rates coming down are good for the borrowers who have been kind of struggling with with you know, the very big jump in rates, so their funding costs shot up at the same time the economy has kind of slowed down, their earnings suffered, and you know, fundamentally
that's good. And as you say, for deal makers, it's good, But what about for the investors, because you know, they got into floating rate because there was a lot of side in that. Now that that whole tray is reversing, isn't it?
So we still we still think that rates are not going to go back to zero, So in terms of current income in in European loans, it's still attractive. In loans. You also benefit from an inverted CUB. So if you look at the curve, European loans are generally based off three months of your arrival, so you're getting like one point three point three percent above where you are if you look at the five year point on the curve, so you're still getting a little bit of juice priced
into the loan market. We are seeing repricing, so you're seeing loans that kind of were four seventy five come at kind of four hundred the spicey of those or a better quality of those pricing at three seventy five. But if you look at new issue in the loan space, you're still at kind of plus fourty five four fifty for B two, and I think you're shaking out four fifty four to seventy five plus your arrival for a B three, which I think for for clean new issue
looks pretty interesting. So I still think from a carry perspective, loans continue to be offer interesting value Camille.
From your seat, you see quite a huge array of borrowers. And when you look at them, are there margins still holding up or are you seeing a lag effect of central rate hikes and some margin compression and starting to see borrowers starting to wobble in terms of their earnings.
It's a great question. So Fidelities just publish their global analyst survey and we have around twenty thousand meetings across equities, fixed income, and private credit each year with our companies, and we take time to aggregate and look at what our companies are telling us. So if you look at what our companies are telling us, they're saying that actually management teams are becoming more relaxed about inflation costs apart
from labor. Labor continues to be the sticky element. Think in some sectors and some geographies that labour stickiness will continue, but actually labor costs outside of that actually starting to normalize. And for the first time since the pandemic, more of our analysts are saying, actually they think the costs for their borrowers or costs for issuers are declining more than increasing.
And so when you look across all your borrowers One thing I learned about Europe is that the district and the countries really matter. Are you seeing any disparities and differences across borrowers from Germany versus Spain or in all the areas of Europe? Or is it sort of in March step as the economic forecast is changing.
I mentioned labour costs being tighter in some areas, and that's one case that you can see if you go from geography to geophy. So if you look at healthcare, for example, that's one thing that's particularly sticky across across your So some of the sectors are still dealing with those higher wage costs. It's quite positive in terms of what I've been saying, And you mentioned the lagged impact
on rates. One thing I would caveat is that even though the market's feeling quite buoyant at the moment and it's pising through two expected cuts, if you look at what our analysts are saying right now in terms of what we're experienced on the ground, the mood a little
bit more somber. So forty eight percent of our analysts and the Global survey have said actually they feel like their industries are in a slowdown and for a very slim number actually in recession, and we've seen that for the chemicals industry, where we've had well over a year and a half of the stocking. You started to see it in building materials as well. And so each geography
deals with different challenges. And I'm sure we're talking about later, but in your really idiosyncratic res is a key driver, and understanding different patterns and trends is really important too.
What about the default rate, Camille, I mean, everyone was very fearful last year about a big spike in defaults in leverage finance, but particularly on the loan side, because the floating rate nature and because those brewers seem to be under more pressure. But it never happened, and if you bet against it you would have made a lot of money. Were we just kicking the can? Is it all going to show up this year? And you mentioned that massive maturity war? Is that the trigger for it?
I mean, are you worried now about defaults?
It speaks in part to your first question. So last year we were we were having questions about the transmission and mechanism in Europe clearly being more effective than in the US, and concerns about the European economy and what that means for loans, and loans returned thirteen and a half percent last year, So clearly I think the important economy is quite important. But on the loan side, what you really need to focus on is borrower's ability to
repay or to service debt. And so when we looked at across our book, actually interest coverage ratios across our book, and I think that's probably quite reflective for the market as well. Eighty five percent of our issuers have greater than two times interest coverage, and that's because going into twenty two, actually cushions interest coverage ratio cushions were quite high.
So we've seen them declining from twenty two to twenty three and our forecasts into twenty four, and actually our forecast was done at the back end of last year, so the alleviation and rates gives us a bit more cushion over our forecasts than we had anticipated. So actually, in terms of affordability, our issuers are able to afford higher rates, and even if you look at the fifteen percent,
there are sub two times. Some of those deals were the hung LBO deals that were coming into twenty two, where we know that they have higher interest costs such as six tricks, but we think the company's defensive enough that that could service a higher level of interest. So
in terms of in terms of internal liquidity, that looks good. Also, we looked at OURCF draw downs across our book and if you look at RCF draw downs, fifty six percent of our issues haven't even drawn down on their RCF facilities. And ourcfs in this latest vintage tend to be larger, and they were larger, so private equity could shoe buy and build strategies without having to come back to the syndicate. So actually available liquidity to our borrowers is also good,
So internal cash generation good. Available liquidity is good, which means they can tread water. And last year, interestingly enough, even though we sort volumes under pressure, our issuers were able to push through price increases more than kind of the price increases they were saying they were seeing. So the EBITDA for most of our companies either stayed the same or increased, and that was because they had that pricing power. I think to the question Lisa asked earlier,
are we worried about that pricing power going into next year? Definitely, I mentioned earlier that our analysts were saying that they think more are saying that they think costs will decrease versus cost increasing. But that also means that their ability to pass on a cross we would question and it totally we We've spoken to issues at the start of the year and they say they think they can preserve margins through productivity gains, and I think that's yet to be seen.
I think how much of the trouble though, Camille, do you think was pushed into private credit or amended and extended and pretended a way that you know that will eventually crop up again that we you know, we haven't quite seen the end of these problems.
Yeah, I think it's really interesting. So if you look at the amend and extends that were done post two thousand an eight to pass to find out for crisis, you will then helped buy a zero rate environment. So the question is what will that look like now? And certainly, as we discussed that the start lower funding costs are helping that situation, and so will a resumption of M and A. That will also help that situation because you can sell the company and put a new a new
cap structure on it. I look at private credit really and high yield and leverage loans, and often people try to segregate them, but I think we should look at credit as solution providers. And actually, as we go into A and E's where maybe it's a good company, but the capital stack was put in a place where rates with zero, well, actually you might need those private credits to provide part cash, part pick or even all part
pick financing. And I think that gives a chance for again, the sponsors take a long time if they think actually, technically there should be an increased in valuation. I think what's clear though, is private credit will not finance companies outside sectors or companies that are not good, and so
it's important to understand enterprise valuations. And also it's quite healthy that there are some companies that you know, have been able to survive in a zero rate environment, and it will become difficult for them to continue on without
a restructuring of the balance sheet. If you look, we're largely through twenty five refinance in terms of A and E's, and the twenty fives that are left are either deals that are up for sales, or they're on the block, or they're about to IPO or they are companies that actually you need to think about a wholesale restructuring.
So moving on to Clos Camille definitely feels like twenty twenty four a different mood in the market. Yes, people are getting deals done last year, but this year has been a big shift in like triplea tightening and you guys got a deal that sort of reset helped reset the market for where it will price. And already some analysts are predicting up increasing the prediction for COLO issues. So can you speak a little bit to what's made the market feel so much better in twenty twenty four
and how much can how much? How long can this last?
I think that in that search field, COLO liabilities, as other asset classes, have rallied in So at the end of last year we were kind of at one seventy and now we're testing in Europe inside one point fifty and I think that is just part of the market tightening. So even though it has tightened again, I would look at it on a relative basis. On a relative basis,
we still think that CLO's liabilities look attractive. Also, if you are taking the view that actually we tighten in from here actually, what you're doing is buying assets at kind of one fifty and you're locking that in for one and a half two years for that spread level.
So how low can triple as go? Come? We all right, now, can you one forty even lower?
What's the expectation you mentioned the potential supply. I think one thing that's kind of putting a stopper on that is that asset the ability to source assets. But we know that there are a number of clos waiting to come to market, so that that puts an upper pressure
on on triple A spreads and liability spreads. And then also I would say that we've got the reset wave coming which will also again put new issuanto market, so that will help keep it a tightening on triple A spreads and liability spreads in general.
I maybe I can jump in there, what kind of I'm interested, what kind of sectors you've got your eye on at the moment, What are your kind of likes and dislikes.
So in terms of sectors called to our portfolios will typically always have those defensive businesses, so for example, tech, healthcare, business services, those businesses where you've got good visibility over revenues, strongly bit dar margins, good cash flow generation, and I
think that that leaning is probably increased. So if you look at those sectors relative to their ten year historic average and you're just for kind of triple season those sectors and distress names in that sectors, actually you're still getting some of the highest spreads that you've got relative tenure averages. And we think that as you enter into period where rates are declining, that will be obviously not going to zero, but that pressure that they faced into
a three will be diminishing. So we continue to like those sectors. And if we're wrong and actually in the next twelve months are not the uptick that our analysts are expecting or not the improvement in earnings that are expecting. If we're wrong about that, then you're in these defensive sectors. I would say that our sector leaning changes. It's amount. There's a sector influence to portfolio constructions changes over time.
So if you look at the end of twenty twenty two, we were looking at kind of the gas situation, and that had an impact on kind of what sectors we didn't did and didn't like. We'll also move sectors according to who can pass through inflation and who can take interest, who can take a higher level of interest costs. But if you look at it now, I think we're more positioning towards less it's less of a sector focus in our for a little more about idiosyncratic risks. The operating
environment for our borrows is becoming more complex. If you look at it, They've over the last five years, they've had to deal with COVID, they've had to deal with war, they had to deal with supply chain issues, rising rates. So and if we look forward, there's AI, there's a number of elections going on this year and the implications of that, working it through changing supply chains again, ESG regulations. There are a lot that our borrows need to deal with.
And making sure that each company understanding what that impact is on each of our companies as we look forward is quite important.
To go back to something we talked about earlier, which is default rates. They have remained so much lower than many were afraid of, but recoveries have not been very great. I think Europe's recovery has been better than the US because the US has what's called London and lender violence, where existing lenders do not treat each other very well and prime each other, and Europe doesn't quite have that.
But can you speak to how you look at recoveries and whether maybe whether you think that might come to wash upon these shores and what impact that might have.
Yeah, I think you'll definitely see a dispersion in recovery recovery rates, and you've already seen that. You've seen that in some of the cross border transactions. A couple that have happened in Europe, the creditor and creditor. That kind of flavor was tested in Europe and got a lot of pushback. I think no one wants to be the first one to put that across. As I mentioned, it's a more clubby market. So probably think about the US
as it was call it ten years ago. And so there's an impact to treating inland as badly as you continue to raise capital. But at the same time, we don't all it out. I think one of the things that is most distinct about the US is just these
funds that are actively looking. So in a default situation, you'll be thinking about, okay, recoveries, how how we make the best of it, But there are actually funds that are seeking out default situations and trying to prime lenders, and that asset priming and that need to create those transactions I think is quite disturbing, but it'd be naive to say that it would never come to Europe.
What about the innovation in clos, Camilla, I want to ask you about that. We're seeing more interests in private debt clos for example, not just middle market, but you know, the larger private debt deals. How do you feel about that and what other innovations do you expect this year?
Yeah, so the COLO market has been fairly innovative, I would say since twenty twenty two. So the fact is that we've had limited issuance over twenty two and twenty two three, and so the way you extract value from or the way leverage loans deliver total returns is different.
So if you look at in twenty twenty two and the arbitrage and colos or the value for the equity and clos really comes from the fact that prices in the leverage loan market were so low versus in a more normalized market where if you look at your liabilities, so you're financing a portfolio of assets with bonds, then your assets spreads also have to rise, but because we didn't have any nuissians in terms of assets to reset higher.
Actually it was the porter part and that led to colo structure changing, so not selling single B static issuance, changing of non calls. In terms of private deals, I think there's a real push to get private credit deals done. One of the big challenges apart from the rating agencies is getting the diversity of assets in Europe for that to happen. So I think the first ones to do it will be one of the established direct lenders with a large portfolio.
Can you expect that to happen this year?
I hear people who are pushing for it.
Okay, we'll watch out. In terms of what you see as opportunities can be in terms of relative value, what do you think is the best relative value right now across all the things you look at.
It's a pretty painful question given the repricings there were seeing. So if you've seen our analysts, it's hard. It's hard to reset sometimes. I think where there's value is as I say, current income in loans is really good. I think we're thinking high single digits total return if you you even take account for the lower default rates that you see in the market, and I think if you then look at the fact that active managers can one avoid those defaults and should outperform the market, and then
also trading should generate relative value. So our approach is really when we manage is rather than picking assets that we think are maybe more distressed and making call about whether there's a port pa, we think that you can make small gains over time that actually build and are accretive to the portfolio. So that's how our investment style is set up. So we're always looking at where we
think leverage is going over the next four quarters. So there's always small trades to be done in terms of names that we think maybe the market hasn't priced in that the next set of earnings might be a little bit weaker, or there's a rating trigger. It's a little bit hard in the market now because you can see names that probably will get a downgrade but are supported by a strong technical But I think as we move through the year there will be windows and you can be nimble nimble about it.
Are there any particular sectors or countries that are ripe for those opportunities right now?
So when we when we look at the tech sector. That is, if you look at the ten year historic average, they are trading at the upper end of the range. And has discussed before, once you get those card in interest rates, we think there's some tightness there. We also think in the chemical sector we are starting to see
some green shoots. I don't think we're at a point where we would going to the most challenged yet, but I do think definitely in the double B space as part of the tech stack that we've already been investing in because they can take a longer period of destocking. But I think there are more names now that could benefit from those early green shoots within the chemical sector.
When you mentioned double digit returns, you're talking about European loans specifically for this year.
European loans had thirteen and a half percent total return last year. We think it'd be more like high single digit this year, even when you take into account the defaults that we expect, so we expect defaults to remain contained.
Okay, what sort of rate on the defaults?
I think the raining agencies have said kind of three to four percent, and that includes director of stressed exchanges. It feels like that's probably a fair a fair assumption. But again I think the movement in rates, maybe at the margin we do a little bit better.
So over all, you sound quite upbeat, Camille, And you know, obviously we're a credit show. We tend to look we tend to be fairly pessimistic, and we're journalists too, so we're even more pessimistic. But what do you think are the biggest risks out there? What are the things that keep you up at night worrying? Is it defaults and bankruptcies or rates or is it something you know, geopolitical or something else that we haven't discussed. It's more troubling.
I think it's hard to h it's hard to know exactly what's going to happen in a year. If you look at typically in market dislocations, we think they are for interesting opportunities. So if you look at COVID, for example, there was no respect of ratings. Names would just shut down, so you could be in a travel company that was very, very low levered and suddenly their earnings got shut down
and they were and those spreads blew up. So in market dislocation, we always think that there's opportunity to trade, and we've actually been able to build value in periods of market dislocations. So what I would be worried about, or what we are focused on is and we've touched on it, this move that's it's in the US towards creditor on creditor of violence and the shift that you've had there that translating into Europe. And also we're worried about jump to default risk. So most of the names
in the leverage known market trade around part. So if you do get a company that's misses on earnings or get things wrong, once you lose a colo Bidge, you're pretty punished for that. So we're really focused on our analysts are really focused on understanding where our companies are going, being close to our sponsors and our borrowers to understand, you know, things that are not going to plan. Is that a quick blip or is that something more more serious where we need to trade out great stuff.
Camille McLeod Salmon at Fidelity International, thank you so much for being on the credit edge.
Thank you so much, Thank you for having me.
Also want to say a big thanks to Lisa Lee with Bloomberg News in London. Brilliant to see you again. Cheers and before we talk to Aidan Cheslin at Bloomberg Intalience is a bit more detailed about the telecoms. I'd just like to say read all of Lisa's great scoops on the Bloomberg terminal and of course at Bloomberg dot Com. So Aidan Chanslin at Bloomberg Intelligence, you cover telecoms based in London. I wanted to get an update on Altice, which is a huge global telecom's name with a lot
of debt. They've been through a lot of drama over the last few years. Some people said that they wouldn't make it, but we have seen some a movement in the bonds recently and are they mounting a big comeback here? What's the outlook.
I think what's happened is you've seen some movement at the shorter end of the curve where they've started to try and push them of their twenty twenty.
Five maturities out.
They've had more success on that at Altis International, where there's money sitting in escrow ready to repay the twenty twenty five bonds. Artists France, they've partially partially done that. They had a small loan that got done, but there's still a bit more work to do. I think the market is also speculating that they might get some disposals done which will again help the twenty twenty five maturities.
You still have a huge dislocation obviously into the subordinated ponds, particularly about East France, and I think that's that's very much justified. They're very much a recovery pain.
So as we just talked about with Fidelity, I mean, there seems to be the sense of relief that you know, rates will come down and some of these struggling borrowers will end up, you know, getting access to cheaper finance that could even get them out of the hole. Is that the situation with our teas are they kind of seeing a pathway out here, and it is it helped by the macro and the rates outlook.
Well, the loan stuff they did last year before, some of it before the big rally we had in the end of the year was well into double digits yield wise, so they're certainly paying through the teeth to be able to extend. And you know, there's some medioscreted issues around the ongoing police and restigations that are still going on into alleged corruption there which I think are made probably with them specifically.
In the market's just a little bit more jittery.
So I think for them it's it's more about self help rather than the market bailing them out, if I'm completely honest. But you know, if the market does generally become a little bit easier to access, it can't do them any harm, and it can't do at their disposal prospects any harm. I think disposals potentially at how Tis International are probably one source of cash for them in
the mid term. There's limits to how much cash outis Internationals can out stream to help silos like out East France, but I think that's probably where you could more likely to see disposals, and there seems to be a bit more interest from potential buyers.
So they can actually reduce leverage and there's a path to that slightly.
Yeah, I say Artists International is a less levered part of present four and a half times around that we think it's going to be when they report you for results. You know, there's a talk of them selling most parts of that business, with the exception of Israel. I think probably the Portuguese part of the business that's been showing some nicely. Big dark growth seems one possible avenue to raise some disposal proceeds.
They probably need to repay quite a lot of debt within the.
International box before they could upstream material proceeds to help other parts of the structure. But everything is for sale in that business. And the more confidence that potential buyers have around the credit markets, improving macro conditions not being as bad as feared, I think brings that disposal that a little bit closer.
Is there selling off the Crown jewels because they need to get cash?
Yeah, that is a risk, but you know, Portugal is an asset that's been handed around quite a lot. It's a larger part of the business, is part of the business that's done well relatively speaking recently. I'm not sure whether mister Dragees sees it necessarily as a Crown joint compared to France.
I think saving France is probably top of the list.
And just to be clearfulur listeners that he is the billionaire owner of the company, right, yeah, okay? And are there any kind of read throughs for the sector. Is it very specific to this one company?
I think very.
Specific to this this particular company. As I say, I think amongst the tm T names I cover, I think probably they have the most acute short term refinancing requirements.
The support nature bonds are definitely going. The widest bonds.
Are high look at in my coverage genius, and I think you know the nature of telecoms is that you have an area like Portugal for example, dominated by by one big, big player, and you know, if you get a change in ownership of that one player and of redefines that market. One issue they do have though that I think is common to a lot of companies that have allowed leverage to go up to this kind of
five to six times area that you see. How to use France though, is the depressed equity valuations, particularly telecom space, have made it much more difficult for businesses to delever through disposals.
You know, most of the deals.
We've seen telecoms companies being sold, whether it's radophone selling in Spain or have you the kind of multiples we've seen around five five and a quarter times eve eve itde selling a business at five times ev ef it does doesn't really help you if your leverage or six times. So that's something you you know, when people start talking about disposals as a potential savior to highly indbted how your companies.
I think that's something you actually have to look out for, whether that's.
Realistic or whether it's just something that helps with liquidity and kicks the can further down just to end up having your business.
Aidan Chanslin at Bloomberg Intelligence, thank you so much for joining us.
My pleasure, James.
Check out all of Aiden's great research on the Bloomberg Terminal or contact him directly if you need more information. Thanks again to Camille mcleoud Salmon at Fidelity International and Lisa Lee from Bloomberg News. Read all of Lisa's great scoops on the Terminal and at Bloomberg dot com. And please do subscribe wherever you get your podcasts. We're on Apple, Spotify and all other podcast providers. Give us a review, tell your friends, or email me directly at jcromb eight
at Bloomberg dot net. I'm James Crombie. It's been a pleasure having you. See you next week on the Credit Edge.