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News Analysis
‘Walk, don’t run’ to take advantage of software disruption, says KKR
by Shant Fabricatorian & Kathryn Gaw
Q&A Eddie O’Neill and Jeremiah Lane, co-heads of global leveraged credit at KKR, give their view on the headwinds and opportunities in CLOs
Creditflux: What are your views on the CLO market?
We’ve seen issuance slow a lot and we think it’s likely to continue to slow for true new deal formation. That’s a key development for adjusting the excess demand imbalance we’ve seen in the market and returning the arb to a more attractive level.
Jeremiah Lane: Right now, the arbitrage is thin. You’ve lost a lot of spread in the underlying loans. At the same time, when you look at defaults including LMEs — the right way to look at it in our opinion — defaults are high. That’s a hard combination in a highly levered product.
While we wait for that to happen, we’ve seen big dispersion in manager performance, and we expect the list of in-favour managers to continue to evolve.
There are some good businesses in software
Jeremiah Lane
Co-head of global leveraged credit
KKR
Eddie O’Neill: This year has obviously seen a lot of change. You’ve had volatility around software and conflict in the Middle East, and now a lot of dispersion in performance across sectors and European geographies.
You have to think about which country you’re taking risk in. Is it France? Is it Spain? How the economy performs is just as important as the sector.
You are seeing a significant tail in the market today, with probably 15% of the markets in Europe trading below 90. That’s changed significantly in the past two to three quarters.
Defaults and triple Cs are still relatively low, but we do expect to see additional defaults from headwinds in sectors like building materials and chemicals, as well as continued uncertainty around how AI will disrupt the software sector, which represents about 8% of the leveraged credit market in Europe.
So I do think you’re going to see more dispersion in pricing and performance, a longer tail of credits and a gradual pickup in the default rate.
Creditflux: What sectors are you currently looking at?
JL: Software is an interesting one, where the weakness in the security and loan prices is really more about concerns for what the future holds, as opposed to observed weakness in the financials of businesses.
We’ve been talking about it as ‘walk, don’t run’ in software. I absolutely think there are some good businesses in software that are not egregiously levered, that should be able to continue to access capital and should be able to refinance.
We’ve been buying [software]. Specifically, when we think about investing in this sector, we look for deeply embedded platforms that are mission critical and own workflows, revenue structures that are recurring, and business models that are insulated from AI and obsolescence risk. We also avoid ARR [annual recurring revenue] deals, which can be vulnerable to volatility.
We tend to stay away from commodities-driven issuers
Eddie O’ Neill
Co-head of global leveraged credit
KKR
Creditflux: What is your view on public versus private credit?
JL: We tend to think about credit as a continuum rather than a series of buckets. The key variable is liquidity and how much flexibility you want in a portfolio.
Private credit can make sense if you are comfortable locking up capital, but public markets give you the ability to move when dislocations create opportunity, and to deploy capital more quickly. Our approach has consistently been to invest across both, with the flexibility to shift as conditions change and in a way that aligns with an investor’s objectives.
For a long time, we had a successful playbook around providing amend-and-extend capital to select triple C-rated or other highly levered capital structures. In the past couple of years, we’ve had limited ability to participate in those transactions, because there’s been a strong tendency for them to pivot to private credit from leveraged credit.
As the two markets continue to evolve I think these types of transactions will naturally ebb and flow between leveraged credit and private credit. It’s likely we will see a shift in this balance where names will not be moving to private credit.
Creditflux: You are co-heads of global leveraged credit. What are the opportunities in Asia?
EON: Asian credit spreads have remained relatively contained, as the Asian developed market has no exposure to software and has become less dependent on energy imports.
We do like oil producers in Australia given the higher oil price. Renewables are holding up well in Asia. But we tend to avoid countries with strong dependence on energy imports, such as Sri Lanka and Pakistan.
