Loan Note: Concern over loan greenwashing; credit quality on the up

Investors raise the alarm over loan greenwashing. Plus: credit quality begins to recover and sovereigns target China. Here's today's brief for our valued subscribers only.

They said it

“In 2020, commitments to reach net zero emissions from businesses roughly doubled. The next step is now for impact investing to reach the shores of the fixed income market.”

Raphaël Thuin, head of capital markets strategies for Paris-based fund manager Tikehau Capital, on the launch of the firm’s Tikehau Impact Credit fund (see announcement here).

First look

Concerns over loan greenwashing
Investors appear to be split in half on the issue of whether the perks that borrowers receive from green loans and bonds are justified.

A survey from the European Leveraged Finance Association (see here), which quizzed 170 credit investors in Europe – 90 percent of which owned bonds or loans incorporating environmental, social and governance provisions – found that just over half (51 percent) believed that the structure and targets for sustainability-linked bonds were “robust and credible”. For green/social/sustainable bonds, the figure was 55 percent.

The main investor concern was that companies may be able to reap the benefits of “greenium”-style interest savings while avoiding meeting, or even testing, key performance indicators. They are able to do this by issuing instruments that are callable before the KPI target date.

Over a third of investors (37 percent) said between two and five years was an appropriate timeframe for a borrower to test KPIs, while 25 percent said less than two years (which would almost certainly fall within the non-call period). A further 30 percent said it should be case-by-case, with no absolute timeframe.

Of investors, 90 percent said it would not be appropriate to change ESG KPIs in the event that an issuance turns out to have strong demand.

Credit quality climbs towards pre-pandemic level
On the back of robust economic growth in many leading economies, including the US and China, business conditions have improved faster than expected – and this in turn is producing an upturn in credit quality.

According to a report from S&P Global Ratings (log-in required here), 77 percent of BBB debt monitored by the ratings agency is in sectors expected to return to 2019 credit quality in the near term (early to mid-2022), up from 47 percent in April.

Given the more positive trading conditions, the report estimates that $112 billion of BBB non-financial debt is now vulnerable to being downgraded to speculative grade over the next 12 months in the US and EMEA – a 70 percent decline compared with last year.

Sovereigns flock to China
China is seeing increased interest from sovereign investors and central banks, according to the ninth annual Global Sovereign Asset Management Study from Invesco.

The study found that, over the next five years, 40 percent of sovereigns plan to increase allocations to China, with three quarters of them attracted due to the prospect of good local returns and 57 percent seeing the country as an important portfolio diversifier. China is expected to be the beneficiary of both new allocations and capital being diverted from North American and European allocations.

Central banks have also continued increasing their allocations to Chinese assets as they diversify away from the US dollar. Central banks had average allocations of 2.3 percent to China at the end of last year versus 1.9 percent a year previously. More than half of central banks (57 percent) now hold renminbi assets compared with 40 percent in 2018.


Inflation? Bring it on
Taken from a new paper by Randy Schwimmer, co-head of senior lending at US fund manager Churchill Asset Management:

“Because senior private credit is a floating-rate instrument, investor demand for these loans should increase in a rising interest rate environment. Rising inflation rates are also supportive for middle-market lenders as price increases will generate more cashflow that businesses can use to de-lever.”

Bubble talk
We may be entering bubble territory in financial markets, according to a report from Paris-based fund manager, Tikehau Capital. One of the signs of this, it says, is the emergence of acronyms such as EBITDAC (earnings before interest, taxation, depreciation, amortisation and coronavirus). They suggest investors are “attempting to justify expected higher revenues and earnings despite a lack of certainty”.

Antares hires MD from Barings 
Chicago-based fund manager Antares Capital has appointed Jeffrey Stammen as managing director, head of investor coverage in asset management.

Stammen will report to Vivek Mathew, head of asset management and funding, and lead the company’s efforts to develop new relationships and raise capital from institutional investors. Stammen has nearly three decades of experience in private credit and was most recently managing director and regional sales head of North American institutional distribution at Barings.

LP watch

Institution: Texas County and District Retirement System
Headquarters: Austin, US
AUM: $38.1 billion
Allocation to alternatives: 50.9%

Texas County and District Retirement System has approved a revision to its existing investment policy following the pension’s June board meeting.

Highlights from the revised investment policy include:

The consideration of distressed debt investments in both the US and other regions. In the long-run, TCDRS expects the performance of the distressed debt component of the private credit portfolio to exceed that of the wider asset class by 3 percent.

TCDRS is considering private debt investments outside of the typical direct lending, preferred equity and senior and mezzanine debt origination the pension typically invests in. Other potential lending components under consideration include non-correlated funds as well as royalty streams and leasing.

TCDRS may also consider future co-investments alongside the pension’s existing managers, with this including the potential for both control and non-control positions with regards to investment discretion within the vehicle. Any potential co-investment must be consistent with the relevant manager’s strategy, focus and skill set. The pension fund is considering allocating to a maximum of 10 co-investments per year.

This revision to the policy was recommended to the board by chief investment officer Casey Wolf. Wolf took the reins as CIO in April 2018, having previously been managing director for TCDRS’s hedge fund and opportunistic credit portfolios.

TCDRS has a 29 percent target allocation to private debt that currently stands at 24.1 percent. In June 2021, the $38.1 billion pension approved a $175 million commitment to Arbour Lane Credit Opportunity Fund III alongside $25 million to Venture Lending & Leasing X.

As of the end of H1 2021, TCDRS had made commitments to eight direct lending funds, alongside three vehicles each focused on distressed debt and strategic credit out of its wider private debt portfolio.

Today’s letter was prepared by Andy Thomson with John Bakie and Robin Blumenthal.

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