Bridgepoint: ‘Q2 was our busiest quarter ever’

As public markets adjust and opportunistic credit comes alive, there are plenty of reasons to be excited about private debt, says Andrew Konopelski, managing partner at Bridgepoint Credit.

This article is sponsored by Bridgepoint Credit

How would you describe the current state of private credit markets across Europe? Where are the opportunities and challenges?

Andrew Konopelski
Andrew Konopelski

The credit markets right now are trying to find their balance. The public markets have been largely shut since March, leading to new issuance volumes being down 70 percent year-to-date in the leveraged loan and high-yield bond markets. This has created many different and interesting opportunities for private credit.

The clear trends in Europe have been a return of risk premiums, a return of base rates and a very large shift to private markets. Q2 was our busiest quarter ever because everything found its way to private markets: a large M&A pipeline, new credits and many European markets that to date have not favoured private credit all turned to it. For example, the Benelux region, the Nordics and Spain were more active last quarter and became increasingly positive towards private credit.

That uptick has not just been in direct lending. Opportunistic credit is proving to be a very good partner and able to deliver attractive financing solutions for sponsors in times like these. Europe doesn’t always price risk well in times of change and this is the first time that private markets have been of the size and maturity needed to step in and fill some of the more complex financing needs in the market. Private equity sponsors have been pleased with the result as it has enabled them to continue to complete their transactions, both primary deals and add-ons. Private markets have also been clearing bank risk, something we’ve seen through our CLO and direct lending businesses with the clearing price almost right on top of direct lending target returns.

Finally, one of the main trends has been the divergence between high-quality credits and those that have been more impacted by the invasion of Ukraine and macroeconomic challenges. You not only see this in pricing, but you also just see very little willingness to finance the most highly impacted or at-risk sectors.

What we have not seen is panic. Covid was a good opportunity for management teams and companies to stress test their processes and hone how they respond to difficult times. It seems to have given them a greater understanding of their businesses and as a result have been better prepared for the recent set of issues they are facing, making them more resilient in the process.

It has been an interesting year for European direct lenders – how have GPs responded to the testing macroeconomic environment?

It really depends on the state of your portfolio coming into this. It is too late to pivot or change strategy – in private markets if you don’t like your risk at this point, you don’t have many options to adjust your portfolio, especially in direct lending. However, if you came into 2022 feeling good about your portfolio, and didn’t have too many issues to deal with, then you are ready to step up and continue to do business. If your portfolio wasn’t well positioned, you may have other priorities, forcing you to pause on new deals and reflect on those missed opportunities.

We always say that if you only start to take action when you see a difficult market developing, you are already two years too late. Now is the time when you see the better businesses really outperform. They aren’t immune to pressures like wage inflation, but they do have a greater ability to pass through cost increases if their market position is strong.

If you know your own mind and stay true to your core investment strategy, know how to price risk, and are willing to be in the market, then you will find attractive opportunities that others won’t see. The point of private credit is to be consistent and always open to discussions. Sponsors will remember those that supported them in difficult times. The uncertainty of public markets being open or closed has definitely driven sponsors to the deliverability of private debt. Some of that flow may revert to public markets, but for many sponsors it will remain the primary financing route of choice.

Covid provided some real lessons for management teams, sponsors and credit investors alike. Being tested through cycles and managing stress is something your team needs to experience. It is easy to make money in a bull market but now is the time that will test the mettle.

What opportunities are there in special situations, and how can managers position themselves to take advantage of those?

We are finally seeing the market really develop there. It’s been a frustrating strategy at times to invest over the last half a dozen years, and a difficult place for many market participants to deliver consistent out-sized returns. At Bridgepoint we invest across corporate credit, from CLOs to direct lending to opportunistic credit, and we often work with the same companies. What we are seeing is a return to the perception of risk, and the proper pricing of it.

There are probably three areas providing interesting opportunities right now. First is the secondary market, which has been a tricky place to invest for opportunistic credit over the last few years during the bull market. The combination of lower global growth and rising interest rates has resulted in a steep fall in secondary market prices. This disruption is leading to a greater differentiation between credits. If you can understand those companies, what risks they face and how they will perform through a downturn, you can start to identify some very attractive and mispriced risk.

Then there is this primary gap that both of our private credit strategies across direct lending and opportunistic credit have been filling, providing acquisition capital and more creative capital solutions as public markets rebalance. Finally, as mentioned earlier, there is the opportunity to clear overhang from the banks’ balance sheets.

An opportunistic credit strategy provides solid upside returns together with downside protection, which we feel is particularly attractive in turbulent and more uncertain times as we are in today. Across the portfolio you can make private equity-like returns out of the opportunity across primary and secondary markets if you know what to look for. In private markets that really comes down to your ability to source deals, thoroughly diligence those opportunities by using your knowledge angles, then pricing and structuring that risk to deliver the right returns.

There is competition – a fair bit of capital raised during covid sat on the sidelines after the market rallied back so quickly. Many market participants anticipated the covid opportunity would last longer than it did and that markets would fall further than they did, causing LPs some frustration that it wasn’t put to work as they expected.

We believe the opportunity today is fundamentally different. It is not a short-lived dislocation but a series of macroeconomic headwinds that we are all trying to size up and understand. The one thing that seems pretty clear is that this is not going to be a quick fix. The coming downturn should provide a very attractive investment market for private credit for the coming quarters and years ahead.

What do you think the next year will bring for private debt in Europe?

The growth of private credit has only been going in one direction for some time now, in terms of size and market share. We expect that will continue and Bridgepoint Credit is very well positioned to continue to grow within it. This economic and geopolitical environment is another challenge that will test the market, but I expect the asset class will come through strongly thanks to the way lenders, such as ourselves, lend, and the ability to interact directly with management teams and sponsors to resolve issues quickly.

There will be some companies with cash needs that face inflationary pressures and issues with their revenue bases and end customers. But for most direct lenders, portfolios are going into this in robust health. The average company that we lend to has a 30 percent EBITDA margin, which implies these businesses are well positioned in their markets and have a reasonable degree of pricing power.

Rates are rising and will begin to have a meaningful impact. With floating rate instruments, that flows straight into returns, although we need to factor that into our underwriting and ensure companies are able to absorb the increased cost. But with an average of around 3x interest coverage ratios in our portfolios today, it indicates a solid cashflow buffer and the ability to absorb a bit of margin erosion.

We might price loans a bit differently today, terms might be a bit different, but I’m expecting more of the same, with a continued growth in market share and a proper opportunistic credit environment delivering good risk-adjusted returns over the next three to five years.

ESG

ESG is playing an increasingly important role in financing today. How are European managers responding?

ESG is one of those challenges that we are all incentivised to work on together, we are committed to helping each other and working through industry groups to share best practice. This is all about increasing awareness and improving responsible investing for all of us, so there is nothing proprietary or competitive about it.

Right now, I would say we are at the professionalisation stage of this: at Bridgepoint, we have just hired our first credit-focused ESG professional. While we continue to utilise our fairly extensive firm-wide resources and the ESG ambassadors that we have within our credit team, we hired Katie Cotterell as ESG manager to help get us to the next level in terms of our approach.

We are also in the measuring phase: we have the approach down, we have the investment style and we know what we want to talk about with companies and where we would like to see them headed. Now we are focusing on things like emissions and trying to measure those, because it is remarkable how few companies are doing that.