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September 2018 | PDI US Report 1

EDITORIAL COMMENTPRIVATE DEBT INVESTOR: US REPORT 2018

ISSN 2051-8439

This time last year, there was no lack of optimism among US private debt managers. Fundraising was at record levels and momen-tum strong. But there was also caution. Looser deal terms and an increasingly crowded market provided a stark reminder that the cycle would eventually turn, and the party would end.

Fast forward to today and those voices of caution are louder. The fundraising peak is well and truly behind us. Capital com-mitments in the first half of 2018 ($61.5 bil-lion), while strong, are a shadow of what they were in the first half of 2017 ($111.9 billion). Meanwhile, the issues surrounding covenants and competition are as pressing as ever. But the optimism, it appears, has not dissipated.

Industry participants (see roundtable on p. 20) have likened the market to the being in the Goldilocks zone. Yes, borrower-friendly terms are an issue, but deal structures are still more investor friendly than they were in the prelude to the crisis. Dealflow is also strong. There are certainly more players in the market and a lot more dry powder to deploy, but the consensus is that the opportunity – particularly in the US mid-market – remains largely underexploited.

The market is also sanguine about fundrais-ing levels. This year is not so much a slump but a return to normality after a migration of institutional capital into newly established private credit strategies. The main takeaway is that the market has matured substantially from

a decade ago, track records are longer and more LPs are still making their way to the asset class.

These investors are also more sophisticated and understand the asset class better. They are more selective in how they seek private debt exposure, be it through niche strategies or larger platforms. The flight to quality will favour man-agers who are both pro-active and selective.

For now, the optimism is justified. There is little debate whether the US private debt market will survive an eventual downturn, the question is how it will react. After all – to borrow the Goldilocks analogy – the bears will be coming back, eventually.

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PDI US Report | September 20182

ANALYSIS

TWO-MINUTE YEAR

SAID AND DONE

PRIVATE DEBT INVESTOR: PDI US REPORT

CONTENTS

4 The US private debt market in 4 charts

From fundraising to deal-making, PDI paints a data portrait of the US private debt market

12 The right tactics for a core market

A sharp increase in market participants in the mid-market is pressuring loan pricing and

covenants, so where does value sit in the sector?

18 Six things we learned about BDCs in 2018

Favoured for their relative liquidity, versatility and tax efficiency, business development corporations are an increasingly prominent feature of the private debt market

6 In case you missed it… From banner fundraises to new

strategies, PDI looks back at the most-read US stories online

from the past 12 months

40 ‘There’s enough to worry about, but we’re not doomed’

Hopes, fears and warnings. What the industry’s leading figures had to say about US private debt over the past 12 months

8 Why it pays to be picky In a competitive US private debt

market, maintaining discipline can be a challenge. Garrett Ryan, head of capital markets at Twin Brook Capital Partners, explains the value of being selective

16 How to look beyond the numbers

Capital inflows and new entrants to the market have made investing conditions tougher, but Brent Humphries, president at AB Private Credit Investors – the direct lending platform of global asset manager AllianceBernstein – says opportunities can still be found

28 The lighter side of cannibalism

More US private fund managers are taking minority stakes in their industry peers. There are benefits for buyer and seller alike

FEATURES20 A Goldilocks moment

for private credit Even at this stage in the cycle,

industry experts say conditions in the US private debt market are just right for LPs seeking to fill that sweet spot in their portfolio

26 Foot off the gas Fundraising for North America-

focused vehicles this year seems unlikely to exceed 2017’s totals

31 The pull back The National Center for the Middle

Market reports that average revenue growth of US mid-market

companies dipped to 7.4% in 2Q 2018, but remains above the historical average of 6.8%

32 Where does the capital call home?

A look at the most active private debt LPs in the US over the past five years reveals plenty of southern hospitality for fund managers

38 Hitting the open road Funds in market data show a

concentrated market where senior debt is declining in prominence

ROUNDTABLE

DATA

NEED A DIRECT LENDER THAT STANDS OUT?

Learn more about NXT Capital’s Middle Market Private Debt Funds at www.nxtcapital.com or call Linda Chaffin at 312.450.8082


OVERVIEW

The US private debt market in four charts

ANALYSIS

Last year was a record-breaker for the private debt indus-try. North America-focused funds – a group comprising vehicles largely focused on the US – accounted for a third of all activity, with $74 billion raised. This was close to the $78 billion gathered by multi-regional funds. North Ameri-can funds only surpassed regionally agnostic vehicles four times in the past decade – the last time was in 2015.

In the first half of 2018, North America-focused fund-raising reached $20.1 billion, overshadowed by the $30.3 billion raised by multi-regional vehicles and $20.5 billion gathered for Europe. The only time Europe-focused fund-raising surpassed that of North America was in 2012. Then, as now, this was largely due to a handful of giant fundraises. North America-focused funds still account nearly half of all fund closes globally in 2018 – 37 out of 81.

Our 2017 annual report tells us distress debt fundraising has been on the rise globally. The main driver has been the comparatively immature European market. North American private debt, by contrast, has seen distressed debt strategies dwindle in the years following the financial crisis.

There are two interpretations for this. The first is that we are seeing evidence of a more mature market. Lenders and borrowers are better insulated against volatility, which means fewer distress opportunities. During the crisis, distressed-focused vehicles accounted for nearly a third of all fundrais-ing – $11 billion of a total $35.5 billion in 2008. In 2017 they accounted for less than 10 percent – or $6.8 billion of a total $71.2 billion. Secondly, it is worth remembering that this market is cyclical. The strategy is likely to rebound as the cycle turns. Given that North America-focused distressed debt vehicles account for a quarter of all capital targeted by funds in market, this shift could be imminent.

1. AFTER THE PEAK

2. DISTRESS IN DECLINE – FOR NOW

THE THIRD WHEEL

SIGNS OF MATURITY

North America-focused funds have not dominated capital raising in 2018, but the region still accounts for most funds closed

Distressed debt fundraising has dwindled in a mature US market, but for how long?

Source: PDI

Source: PDI

250

200

150

100

50

0

Cap

ital r

aise

d ($

bn)

2008

n Multi-Regional

n Distressed n Non-Distressed

n North America n Europe n Asia-Pacific

n Middle East/Africa n Latin America

20122010 2014 20172009 2013 20162011 2015 YTD 2018

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%2008 20122010 2014 20172009 2013 20162011 2015 YTD

2018


ANALYSISANALYSIS

We have seen several headline-grabbing fund closes in recent years. The most recent were GSO Capital Solu-tions Fund III ($7.12 billion) and Broad Street Real Estate Credit Partners III ($4.2 billion), both of which closed in the first half of 2018. Anecdotally, many in the market have described an increasing bifurcation of the industry. Private debt has become more polarised as larger generalist funds consolidate and expand their reach, leaving niche players to fill the gaps.

The phenomenon has been seen in other alternative asset classes too. It comes as little surprise then that the average fund sizes have been drifting upwards over the past decade. The number may have waxed and waned on occasion, but overall it is an upward trend. A new high of $628 million was set in 2017, while this year has been a close second so far.

From record-breaking fundraises to creeping EBITDA multiples, there have been plenty of warning signs that we may be headed for another downturn. Perhaps one of the starker omens in the private debt industry has been the growing proliferation of covenant-lite loans. Covenants act as warning signals alerting lenders that all may not be going entirely to plan in a business they are backing. However, in a borrower-friendly market, these protections have become looser as managers compete for deals.

According to information provider LCD, cov-lite transactions now account for around three-quarters of outstanding US leveraged loan volume, up from about half in 2014, and one third pre-crisis. While the point has been made that these deals have not defaulted any more frequently than loans with traditional covenants, the amount of cov-lite loans is unprecedented. However, many in the industry will be keen to point out that loose terms have mostly been a feature of the upper mid-market. US managers are increasingly eager to emphasise their focus on the traditional – or core – mid-market where protections are stronger.

3. GIANT COUNTRY

4. DEAL PRESSURE

ADVANTAGES OF SCALE

BORROWER FRIENDLY

A new watermark for large US private debt funds was set in 2017

Looser terms have now become a dominant feature of the US leveraged loan market

Source: PDI

Source: LCD, an offering of S&P Global Market Intelligence

700

600

500

400

300

200

100

0

80%

75%

70%

65%

60%

55%

50%

Ave

rag

e fu

nd s

ize

($m

)

Average fund size

Covenant-lite share of outstanding US leverage loans

2008

Jan 14 Jan 16Jan 15 Jan 17 Jan 18

20122010 2014 20172009 2013 20162011 2015 YTD 2018


FEATURE

US TIMELINE

TWO-MINUTE YEAR

In case you missed it… From banner fundraises to new strategies, PDI looks back at the most-read US stories online from the past year

Cerberus launches San Francisco office

GSO announces direct lending unit

Cerberus Capital Management expanded its mid-market lending operations into northern California with the opening of an office in San Francisco. The firm hired Scott Johnston as a managing director and Kurt Peterson as a vice-president – both formerly of White Oak Global Advisors. Johnston will oversee sourcing, underwriting and managing investments in northern California and the Pacific north-west. Peterson will assist Johnston in this effort.

Blackstone’s GSO Capital Partners revealed plans to launch a new direct lending business. The move ended GSO’s sub-advisory relationship with FS Investments, which will be picked up by KKR and EIG. The new unit will enable the firm to gain more control of its activities in the private debt space, the firm said.

NOV 2017 DEC 2017

Anchorage launches $1.25bn distressed fund

Monroe sets $1.5bn hard-cap for debut special sits fund

Monroe Capital is seeking $1 billion for its debut special situations vehicle: Monroe Capital Special Situations Opportunistic Credit Fund. The Chicago-based firm set a $1.5 billion hard-cap. The fund will invest in firms in transition, such as a merger or initial public offering. It will focus on asset-backed credit, target returns in the low- to mid-teens and not make distressed investments.

Barings collects $1.85bn for North America senior debt

KKR closes credit opps fund on $2.2bn

Barings held a close on its debut North American-focused senior credit fund, more than doubling its $750 million target. The Charlotte-based firm, which oversees $299 billion, raised $1.85 billion over eight months for its Barings North American Private Loan Fund. Commitments came from 45 investors across 13 different companies. The vehicle invests in floating-rate senior secured loans in mid-market companies.

KKR announced the final closing of its KKR Private Credit Opportunities II fund on $2.24 billion. PCOP II is more than twice the size of its predecessor, KKR Mezzanine Partners I, which had $1 billion in capital commitments and completed its investment period in March 2015. PCOP II will focus on private corporate debt and mezzanine lending, financial assets, hard assets and structured credit.

Anchorage Capital Group entered the market with its sixth closed-end distressed debt fund. The New York-based special situations investment firm is seeking $1.25 billion for Anchorage Illiquid Opportunities VI. The fund is targeting small and medium-sized companies, investing up and down the capital structure through myriad strategies.

JAN 2018


FEATURE

FEB 2018 MAR 2018 JUN 2018

Ares becomes first listed manager to convert to a C-corporation

PIMCO raises $150m for Bravo III

GSO becomes biggest contributor to Blackstone AUM

Apollo debuts debt-equity vehicle

Oaktree raises $720m for senior debt

KKR closes credit opps fund on $2.2bn

Ares Management elected to become a C-corporation, abandoning its partnership status. The LA-based alternatives manager expects its capital structure to be more liquid as a result. According to an investor presentation released alongside its fourth-quarter earnings, its shares may be a more attractive currency of consideration for strategic transactions.

Newport Beach, California-based PIMCO is targeting between $3 billion and $4 billion for its third fund: PIMCO Bank Recapitalization and Value Opportunities Fund III, with a $5 billion hard-cap. The fund is focused on residential and commercial real estate and speciality finance. The BRAVO vehicle’s predecessors, Fund I and Fund II, held final closes on $2.35 billion and $5.5 billion, respectively.

GSO Capital Partners, Blackstone’s credit arm, saw total assets under management reach $138.1 billion by the end of 2018, up from $93.3 billion two years ago. The large increase came from the addition of $22.5 billion from Blackstone Insurance Solutions and $10.8 billion from energy investment firm Harvest Fund Advisors. Blackstone’s total AUM rose to $434.1 billion, an 18 percent increase over the same period.

Apollo Global Management launched its debt-and-equity hybrid vehicle, seeking $3 billion. The New York-based alternatives giant’s Apollo Hybrid Value Fund will mainly target companies in North America and Europe with enterprise values of $750 million to $2.5 billion. Apollo will target senior and subordinated loans; non-control investments in distressed businesses; and structured equity.

Oaktree Middle Market Direct Lending Fund raised $720 million for its senior debt-focused vehicle that will invest in senior loans. The fund began deploying capital in April after holding a first close. On a second-quarter earnings call, Oaktree executives pointed to direct lending as an area of growth for Oaktree over the next few years.

JUL 2018


Since its inception in 2014, Twin Brook Capital Partners – the lending arm of Angelo Gordon

– has been providing cashflow-based financing in the form of senior secured loans to the mid-market private equity community. To date, the company has closed more than 1,100 transactions with 200 different mid-market private equity firms. The firm has offered finance for everything from leveraged buyouts and recapitalisations, to add-on acquisi-tions and growth capital, among others. The companies that Twin Brook works with typically have an EBITDA between

$3 million and $50 million. A larger pro-portion of these are companies with $25 million of EBITDA and below.

Q What do you consider the primary

challenge for a mid-market lender in

this competitive market?

The primary challenge that any lending firm has in a “hot” credit environment is that there are far more sub-optimal transactions that come to market. When leverage markets are awash with money, private equity firms are eager to deploy capital and purchase price multiples are at an all-time high, weaker borrowers stand a much better chance of trading or getting financed.

The outcome of this is that we need to say “no” more often to our sponsors or possibly deploy resources triaging deals that we would not normally spend time

FEATURE

US DEALS

Why it pays to be pickyConor Blake

“GIVEN WHERE WE ARE IN THE CYCLE RIGHT NOW, WE BELIEVE IT’S THE COMPANIES THAT SHOWED STRONG RESILIENCE THROUGH THE GREAT RECESSION – OR EXHIBITED STRONG, COUNTER-CYCLICAL ATTRIBUTES – THAT ARE THE MOST ATTRACTIVE”

In a competitive US private debt market, maintaining discipline can be a challenge. Garrett Ryan, head of capital markets at Twin Brook Capital Partners, explains the value of being selective


on. The flood of weaker deals can put pressure on resources and underwriting bandwidth.

Q How do you think deal structures have

changed in the context of a competi-

tive market?

The answer somewhat depends on what part of the lending market you target, but the obvious changes are around pricing and leverage, which clearly have moved in issuers’ favour. In some cases, lender protections such as such financial covenants and various negative covenants have also been weakened in recent years. The absolute acceptance of covenant-lite transactions in the broadly syndicated market – which includes companies with more than $40 million of EBITDA – is more normalised than it was in 2007-08.

The emergence of covenant-wide transactions – with companies that have more than $25 million of EBITDA – in the last 12-18 months is also alarming. The lower middle market – less than $25 million of EBITDA – is somewhat immune from these structures but there is always some level of pressure for spon-sors to push larger precedent deal terms throughout the middle market.

Q What kinds of US companies – in terms

of sector, size and needs – are most

attractive to private debt lenders right now?

Given where we are in the cycle right now, we believe it’s the companies that showed strong resilience through the Great Recession – or exhibited strong, counter-cyclical attributes – that are the most attractive. Having the right financial sponsor associated with these borrowers is also important, not just for their expertise, but their willingness to support the company with follow-on

capital, if necessary. The size of the company is less clear in its importance because larger borrowers come with very loose credit protections and little or no financial covenants, versus smaller companies who have more traditional protections in place but lack the scale of their larger competitors. Industry verti-cals – whether it’s software and technol-ogy, healthcare or financial services – are sectors that come to mind that provide lenders comfort, particularly in light of where we are in the cycle.

Q Does the amount of dry powder in

the market concern you? How can

the industry best mitigate the impact of it?

I think it concerns everyone in the market as it creates structuring pressure on lend-ers, but we believe execution, structure flexibility and long-term relationships are the key decision-making factors for bor-rowers. The winners and losers in private credit will be determined by the depth of the lending team’s experience, the strength of a lender’s origination func-tion and the role the lender plays in a transaction.

If you have a well-established direct originations function – instead of rely-ing on buying other lenders’ deals – we believe that bodes well for long-term success. If your role in these transac-tions is to act as an administrative agent, that should also be helpful in the long term for your strategy. This is because you are able to deepen the relationship with a sponsor, build a larger and diverse portfolio of credits, have more control over the credit agreement and generate more capital market income than your competitors.

Q Does the competitiveness of the deal

market dictate one preferred financ-

ing structure over another?

In a market that demands speed from

FEATURE

US DEALS

“THE WINNERS AND LOSERS IN PRIVATE CREDIT WILL BE DETERMINED BY THE DEPTH OF THE LENDING TEAM’S EXPERIENCE, THE STRENGTH OF A LENDER’S ORIGINATION FUNCTION AND THE ROLE THE LENDER PLAYS IN A TRANSACTION”

1:6Twin Brook’s preferred

ratio of account managers to borrowers

$3m-$50mTypical EBITDA range of mid-market companies


US DEALS

FEATURE

buyers who need to minimise lender processes on their side, unitranches have become a popular alternative to more traditional two-party debt struc-tures. However, sponsors will often opt for senior-subordinated debt structures because they have good relationships across both senior and junior debt pro-viders and are comfortable coordinating multiple tranches in the debt structure. These days, sponsors will typically ask lenders for term sheets highlighting both options. Ultimately, it comes down to certainty, speed, flexibility and price.

Q What role do the banks play in the

current debt market? Are US private

debt lenders more likely to see them as

competition or as partners?

In the middle market, commercial banks are struggling to maintain relevance in the sponsored lending world. The regu-lations are a significant time drag on their ability to screen, underwrite and process a transaction. Despite the new administration, the relaxation of Dodd Frank and the overall tone of less reg-ulatory oversight, banks still maintain that getting transactions done is fraught with restrictions. Separately from the regulations, the banks are having a dif-ficult time competing on hold sizes, lack of product offering, unitranches, amortisation terms, etc.

Moreover, it’s the overall lack of con-viction that most banks have around the space. Finance companies are set up with the sponsor at the centre of their reason to exist. For banks, middle market sponsored finance is not what gets them excited. Their focus is selling treasury management, foreign exchange and other non-interest-bearing prod-ucts. Credit is important to them, of course, but their risk tolerance is really geared towards larger double B

or investment grade rated companies where they can sell their traditional banking products.

Q How do you think private debt lend-

ers can best prepare for a turn in the

credit cycle?

Without a doubt, we believe it comes down to the size and experience of the professional staff that a lender employs. When the cycle hits it’s all about band-width. If an account manager has 15-20 names he or she is responsible for, and just one of them goes sideways, that’s an increased time constraint on that individual. During a cycle that portfolio may have two-thirds of those 20 names in triage for an individual account

manager. That is not sustainable. How-ever, lenders that have invested heavily in personnel to manage through the downturn should come out with better outcomes. Twin Brook has a profes-sional staff of more than 45 people and plans to add another seven by year end. Our preferred ratio of account manag-ers to borrowers is 1:6.

Q What is you biggest source of opti-

mism in the US private debt market

right now?

Despite the fact that the market is somewhat frothy today with price and structure clearly in favour of borrow-ers, the bright spot for lenders is that we believe there are no indicators that we are near a recession. In the event a cycle occurs, the US economy is likely more insulated from the severity of the shocks that occurred in 2008-2009. Also, dealflow continues to be strong. The first half of 2018 showed a significant increase in M&A volume over previous periods and the number of opportunities in all segments of the market continues to be robust. Despite the amount of liquidity in the market, we believe there are ample opportuni-ties for experienced lenders to deploy capital. n

“WHEN THE CYCLE HITS IT’S ALL ABOUT BANDWIDTH. IF AN ACCOUNT MANAGER HAS 15-20 NAMES HE OR SHE IS RESPONSIBLE FOR, AND JUST ONE OF THEM GOES SIDEWAYS, THAT’S AN INCREASED TIME CONSTRAINT ON THAT INDIVIDUAL”

Garrett Ryan is the head of capital markets for Twin

Brook’s middle market direct lending loan business.

Ryan has extensive knowledge of mid-market

leveraged finance, institutional and high yield debt,

and asset based lending. Prior to joining Angelo

Gordon in 2017, he spent eight years at Fifth Third

Bank as the head of healthcare debt capital markets.

Prior to that, Ryan was with the finance company,

CapitalSource, and LaSalle Bank. He has 18 years of

experience in capital markets and earned his finance

degree from University College Dublin and got his

MBA from the Kellogg School of Management.

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BESTSELLER


The US mid-market has seen an inflow of both capital and new players in the last two to three

years and, according to Ted Koenig, CEO of sector specialist Monroe Capital, the result is a much busier sector.

“The US mid-market is crowded and active; those are the two key words,” he says over the phone from his Chicago office.

“There are lots of private equity firms vying for transactions in a competitive landscape. There have been a lot of new players coming into the market recently which are putting money to work, and to a certain extent, driving heat in the market.”

It’s easy to see why Koenig views the market as hot. Debt/EBITDA ratios and

leverage multiples on the underlying pri-vate equity transactions have been creep-ing upwards of late. Figures from market information provider Leverage Commen-tary & Data show that the former are roughly 20 percent higher than in 2015.

On the loan side of the equation, cov-enants have been disappearing and add-backs are also on the rise. Another mid-market fund manager notes that, rather than being a cause for concern, these developments are the invisible growing pains of an asset class than has moved further into the mainstream.

“Low yields drive alternative invest-ment and what you are seeing right now in the US private debt mid-market is in line with this theme,” he says. “Rock-bot-tom rates have driven capital formation,

which has in turn led to weaker terms and more opportunities, and options, for borrowers.”

Weaker terms mean sharper pric-ing. Koenig says deals that were pricing at LIBOR plus 600-650 basis points 12 months ago are now coming to the market at LIBOR plus 525bps. This means tighter pricing has absorbed the impact of the US rate rise that occurred in the interim.

Declining prices and weakening cov-enants have led to a significant repricing of the risk premium within the asset class. This makes it hard to find value but not impossible, says Koenig. The chief execu-tive says his shop has been seeking above market returns in the non-sponsored segment.

US MID-MARKET

A sharp increase in market participants in the mid-market is pressuring loan pricing and covenants, so where does value sit in the sector? Aaron Woolner reports

The right tactics for a core market

ANALYSIS


“We have been able to create alpha in the non-financial sponsored transactions. It is important to generate yield and create alpha, as opposed to being a beta player, in the market these days. We arrange financing for management teams who buy companies all the time, as well as deals driven by a pri-vate equity sponsor.”

Koenig says Monroe has invested more than a billion dollars in 2018, a third going to non-sponsored deals. He says in these types of deals his firm’s extensive existing network gives it an advantage over new entrants to the market.

“Our edge comes in sourcing the under-lying assets, which we do on a proprietary basis. We have been doing this for 17 years, unlike firms which have come-and-gone from the market.”

As well as a source of alpha, Koenig says this approach also means Monroe isn’t forced to search for new opportunities among firms with weaker credit. “Firms get problems when they go down the credit quality curve. It’s possible to make excep-tions to pricing, but when you start doing the same for leverage and credit quality, then that’s not a sustainable, long-term strategy.”

TRADITIONAL APPROACH

The direct sourcing approach may appeal to Monroe, but according to John Martin, co-chief executive of Chicago-based Antares Capital, there is still value in sticking to the tried-and-tested strate-gies despite new entrants.

“Our traditional approach of provid-ing senior secured loans to private equity sponsors is one that we have followed for the last 25 years, and has worked very well for us. We just continue to expand the private equity-sponsored universe that we actively call upon and that is where we get effectively all of our business oppor-tunities.

“Antares has longstanding relationships

with private equity sponsors with whom we have done multiple transactions with. When these sponsors are looking to finance their acquisitions generally they would prefer this to be led by a firm that they have done a lot of business with over the years.”

Martin recognises the challenge from the number of new entrants and the increased flow of capital into the sector, particularly from large institutional inves-tors. On the other hand, he notes that while it is “more crowded than it was”, the US mid-market private debt market is far from overcrowded.

Indeed, Martin welcomes new players, pointing out that the commercial banks have largely withdrawn from the sector. Meanwhile, global investors are waking up to the potential of the asset class.

“Investors around the world have realised that the private debt sector is somewhere they need and want to allocate more of their capital. So, we have seen tremendous flows from pension funds, insurance companies and sovereign wealth funds into this area and it is definitely more crowded as new managers have opened-up shop.”

COVENANT MYSTERY

Another recent trend is the spread of the covenant-lite structures that were previously the preserve of the syndicated loan market catering to larger firms. But according to Ruth Yang, managing director at LCD, the opacity of mid-market deals makes establishing meaningful data on loan covenants in the sector very difficult.

Drawing on anecdotal experience, New York-based Yang says managers in the sector appear to be relatively sanguine on the issue of covenants.

“I have had a number of recent con-versations with direct lenders and they maintain that in the core mid-market cov-enant lite is not as prevalent as has been

ANALYSIS

“IT IS IMPORTANT TO GENERATE YIELD AND CREATE ALPHA, AS OPPOSED TO BEING A BETA PLAYER, IN THE MARKET THESE DAYS”Ted Koenig

CREEPING RATIOS In a heated market, debt/EBITDA ratios among borrowers with less than $50m in earnings are at a post-crisis peak

6

5

4

3

2

1

020072006 2011 20152009 2013 20172008 2012 20162010 2014 2018

* Reflects broadly syndicated loan marketSource: LCD, S&P Global Market Intelligence

Deb

t/EB

ITD

A


ANALYSIS

suggested. What concerns them instead is the issue of add-backs: costs, or future earnings which are “added back” into the EBITDA to make an acquisition more attractive on an earnings basis.

Yang notes that while data from LCD is more granular in the broadly syndi-cated market, the mid-market does tend to broadly follow its larger loan peer, and the trend is concerning. LCD has analysed data around synergy-related add-backs – the amount of savings a sponsor expects to make from the deal and the percentage of deals with synergy-related add-backs in the EBITDA.

Figures for the latter have shot-up markedly hitting 54 percent for the first half of 2018 – way ahead of the post-GFC low of 13 percent in 2009, and more than the double the 24 percent of transactions in 2006, a year ahead of the crisis. The result, Yang says, is confusion for investors.

“We are hearing of cases where the multiples the company is projecting might sound reasonable – it could be less than six times EBITDA, which appears to be the fine line that everyone worries about it – but with the add-backs, the final mul-tiple is much higher. And that’s where the concern is. Once you strip away all those adjustments the underlying numbers may not be great.”

ADD-BACKS ADD UP

This concern is shared by our unnamed mid-market fund manager. He says the increase in add-backs makes it difficult for investors to compare firms on a borrower-by-borrower basis.

“EBITDA is the basis for purchase price multiples and leverage, and if you miscon-strue that, the whole transaction is kind of up in the air,” he says. “If half of a company’s EBITDA is add-backs, and they are wrong, then you could have material problems in the recovery rate.”

The potential for the mid-market sector to have a serious issue with recov-ery rates following the peak of the next cycle is clearly of concern, but according to Yang, this is where the good news starts. Her team has done an analysis of recovery rates for mid-market loans, with the data skewed towards firms with an EBITDA of $30 million-$50 million and she says this cohort typically outperforms larger corporates.

According to Yang, the simpler capital

structures among the mid-market makes recovery much more straightforward and should provide the sector with some addi-tional protection during the next down-turn in the credit cycle.

“We believe the middle market out-performs broadly syndicated on a recovery basis, because the middle market capital structures have far fewer layers to them compared with larger corporates in other credit classes. Middle market lenders have few capital classes and tend to be better aligned in their goals, and this goal will be to get the company out of bankruptcy as quickly as possible.”

Lenders to the mid-market can draw some comfort from this but according to Koenig one thing is clear – the juxtapo-sition of investor interest in alternative assets classes and cheap capital means now is a good time to be a borrower.

“The scales have been tipped in favour of the borrower as opposed to the lenders in terms of the sheer capital, as well as the downward pressure from the covenant-lite, fixed income sector.” n

US MID-MARKET

ADJUSTMENT BUREAUThe share of transactions with synergy-related EBITDA add-backs has soared for M&A-related deals in 2018

6

5

4

3

2

1

0

* Reflects broadly syndicated loan marketSource: LCD, S&P Global Market Intelligence

%*

“WE ARE HEARING OF CASES WHERE THE MULTIPLES THE COMPANY IS PROJECTING MIGHT SOUND REASONABLE, BUT WITH THE ADD-BACKS, THE FINAL MULTIPLE IS MUCH HIGHER. AND THAT’S WHERE THE CONCERN IS” Ruth Yang

20072006 2011 20152009

M&A-related deals All Deals

2013 20172008 2012 20162010 2014 2018

NEWSTARFIN.COM

BOSTON CHICAGO NORWALK NEW YORK CITY

SPONSOR RELATIONSHIPS

Long-term relationships with top-tier private equity firms allow for selectivity and generation of repeat

business

$13.8billion

Invested principal

621 Transactions

250 Private equity sponsors

EXPERIENCE

Founded in 2004, NewStar is one of the few middle

market direct lenders with experience through full

market cycles

10 years

Tenure of the senior management team

18 years

Avg. industry experience of the investment team

$6.6billion

In third party assets*

CONSERVATIVE APPROACH

Aims to create a portfolio that balances current income and downside

protection

Primarily first lien senior debt

Highly diversified

Low historic credit losses

All data as of June 30, 2018.*$1.9 billion assets under advisement.$13.8 billion of invested principal across 621 transactions refers to loans originated by NewStar Financial’s Leveraged Finance team since its inception in July 2004.

$13.8 billion of invested prin-cipal across 621 transaction refers to predominantly middle market loans originated by NewStar Financial’s Leveraged Finance team business line since its inception in July 2004

NewStar_PDI_Full-Page-Ad.indd 1 7/27/2018 10:28:45 AM


Q How has the market environment for

private credit changed in the last 12

months?

This time last year, it felt as if we were in the last stage of the credit cycle. The market was characterised by robust capital inflows along with several new entrants, which led to heightened market competi-tion. Unsurprisingly, this pressured trans-actions along a variety of dimensions, such as higher leverage multiples and tighter pricing. Most concerning to us has been the deterioration of underlying documentation terms – a development that could have a negative impact on recovery rates during a downturn.

Today these factors continue to be prev-alent and have worsened in some cases. No one can predict with perfection when a market turn will occur, but managers need to be conscious of the long-dated nature of the current economic recovery. It feels a bit like the calm before a storm, but only time will tell whether we are nearing the end of this particularly expansionary credit cycle.

Q What changes to the documentation are

you most concerned about?

The definition of EBITDA in the middle market has become subject to intense nego-tiation. For example, in many cases there are no limits on the portion of EBITDA that can be comprised of add-backs. There is also a general lack of accountability on the part of management to document and substantiate these add-backs, which is equally concerning. This will likely lead to increased payment defaults in the future as adjusted EBITDA per the loan agreement

and actual, realised EBITDA may differ considerably.

Our second documentation concern relates to provisions that enable borrowers to extract collateral value from the bor-rower group to gain increased negotiating power in a restructuring. The first notable example of this situation occurred with US clothing retailer, J Crew, where mate-rial intellectual property – ie, the brand – was transferred out of the business into an unrestricted subsidiary of the borrower, which extracted value from what the lend-ers believed to be a key part of their secu-rity package.

More recently, a similar situation involv-ing PetSmart has created concern among lenders. In this case, the borrower took advantage of weak documentation terms

to transfer collateral value (in the form of the equity of its most valuable subsidiary, Chewy) outside of the borrower group into both an unrestricted subsidiary of the bor-rower and a non-loan party subsidiary of the sponsor. In both cases, the transfer of a valuable portion of collateral will likely lead to higher losses.

Both cases are still in litigation so the outcome is unclear, but it is troubling for the market that we are seeing these actions being taken by borrowers.

Q What tools can a private credit manager

use to differentiate itself in such a hot

market?

I believe there are two key skill sets that a credit manager needs to be successful, particularly in the current market environ-ment but also over the long term. The first is having strong fundamental investment skills. Being good at assessing, mitigating and pricing risk at a fundamental level will always be a key success factor in the asset class, but this alone is not enough to excel. The second key skill set is business building and management execution.

The unique aspect of the private credit asset class requires managers to build an operating business, rather than simply buying and selling securities in the market. Successful private debt managers will therefore have strong business building skills which create differentiation. I believe that business model design and platform edge is as important as fundamental invest-ing skills in terms of enabling managers to outperform in a challenging market environment.

FEATURE

DEAL SOURCING

Capital inflows and new entrants to the market have made investing conditions tougher, but Brent Humphries, president at AB Private Credit Investors – the direct lending platform of global asset manager AllianceBernstein – says opportunities can still be found

Brent Humphries

How to look beyond the numbers


For us, creating platform edge spans all aspects of the business, including hiring and retaining top-tier talent, developing unique direct sourcing networks and creating a strong credit culture. A strong credit cul-ture encourages rigorous debate and results in consistent decision-making.

We also take a strategic approach to funding our business from an equity and portfolio financing perspective. For instance, we favour perpetual fund vehi-cles and prioritise distribution channels where we have a competitive advantage. We also dynamically manage investment capacity to meet the market opportunity while contractually matching the duration of investor commitments to the underlying loan assets. Raising equity capital in this manner has enabled us to create a scalable and low-cost financing capability, emphasis-ing fully-committed and long-dated middle market CLOs.

Q Technology now represents the largest

industry sector for leverage loans; does

this concern you?

Growth in the software sector is driving this trend, and it does cause concerns. Soft-ware loans have performed extremely well over the years from a creditor perspective, which creates a sense of complacency in the market. Today, many lenders have the view that you can do no wrong in software, but we don’t believe this is the case. There are many newly established software lending efforts that we see bending or completely disregarding time-tested frameworks for financing these companies.

For example, many companies offering software-as-a-service (SaaS) raise financing on a debt-to-recurring revenue basis, but this is only one metric and it can become a blunt instrument if it isn’t applied cor-rectly. Specifically, not all recurring revenue is created equal. Sponsors commonly ask us

what our comfort level is in terms of our maximum debt-to-recurring revenue for a SaaS business. We explain that we don’t have any hard and fast limits. Rather, the amounts we will lend depend on many fac-tors, such as the company’s top-line growth rate, stickiness of the revenue base, pro-jected lifetime value of the customer rela-tive to the customer acquisition cost and,

finally, the marginal profitability of each dollar of revenue.

Q But this isn’t the first time a growth sector

in the private debt market has stretched

its multiples . What is different about the current

set of tech firms?

Historically, lenders lent to profitable soft-ware firms based on an EBITDA multiple that was reduced for capitalised R&D costs. The R&D adjustment results in EBITDA and operating cashflow being virtually the same. In the past, you may have seen soft-ware firms that are leveraged on this basis at 6x to 7x EBITDA, reflecting 50-60 percent loan to value, for example.

We now see competitors, particularly new entrants to the software sector, lend-ing to these businesses on a multiple of EBITDA, without considering the ongoing need to invest in R&D. This could result in an actual debt to operating cashflow of 9x to 10x. This is just one example of market

excess, where rules that have historically applied to this sector begin to break down.

Q Are you actively positioning your port-

folio for a downturn given the extended

nature of this economic recovery?

It is very challenging to time when a cycle will turn, and one is likely to get it wrong more than they get it right. We have a phi-losophy of being active and selective in all market environments. I would emphasise being highly selective in this environment. We are not looking to make a land grab for market share. Rather, we seek individual opportunities where we can provide a cus-tomised and differentiated solution to our sponsor relationships.

We also focus on driving diversity across the portfolio to manage risk, including with respect to sector and single name concentra-tion limits. Our portfolio is also overweight senior secured loans, including traditional first-lien loans and unitranche instruments.

Q Given the concerns over a potential

downturn, how optimistic are you over

the long-term market outlook?

We are cautious in the near term, but we also think that this is a viable and strong asset class that can outperform in tougher markets, certainly on a relative basis.

We also feel good about private credit’s ability to create attractive risk-adjusted returns over the long term, although recov-ery rates will likely be lower than in previ-ous cycles. Returns through the cycle are therefore likely to be lower than before as well. This doesn’t mean industry returns will be unattractive compared to other asset classes. We still believe the industry will produce good relative returns through the cycle and believe the best managers will outperform.

Simply put, the key to success is asset selection and avoiding losses. n

FEATURE

“WE FEEL GOOD ABOUT PRIVATE CREDIT’S ABILITY TO CREATE ATTRACTIVE RISK-ADJUSTED RETURNS OVER THE LONG TERM, ALTHOUGH RECOVERY RATES WILL LIKELY BE LOWER THAN IN PREVIOUS CYCLES”


ANALYSIS

BDCS

Favoured for their relative liquidity, versatility and tax efficiency, business development corporations are an increasingly prominent feature of the private debt market. Andrew Hedlund looks at the lessons we learned in the past six months

6 things we learned about BDCs in 2018

1. HOW CREDIT QUALITY IS DETERIORATING Multiple BDCs have had troubled credits pop up into their portfolio. Management teams have acknowledged problematic loans in their books and faced tough questions from analysts and shareholders on their earnings calls.

Covenant-lite deals continue to proliferate, which has many credit managers and investors concerned. While many BDCs invest in companies outside the broadly syndicated loan market, one dominant theme in recent years has been borrower-friendly terms moving down market.

Earlier this year, two investment bankers told PDI that each had seen more covenant-lite deals coming through the restructuring groups at their firms. According to the two sources, it is now getting harder to rescue value once lenders reach the negotiating table.

2. WHY BDCs COULD BE INCREASING THEIR LEVERAGE One of the biggest changes to hit the industry in some time was the budget approved by the US Congress in March. The package – signed off by President Donald Trump – includes a last-minute provision that allows BDCs to increase their leverage from a 1:1 debt-to-equity ratio to 2:1.

Managers have taken diverging approaches. Some, like Goldman Sachs BDC, put the issue to a shareholder vote and lowered fees. Other firms, like Ares and Apollo Investment Corporation, won approval from their board of directors and cut their fees. Other firms, like TCG BDC, have sought approval from both their board and shareholders but kept their fees the same.

Certainly, it will take a while for BDCs to lever up – at least for those who choose to – but inves-tors can certainly expect a different landscape. This will be particularly true if some BDCs pursue a strategy of using the extra leverage to invest in lower-risk assets and still meet their return targets.

3. WHY IT DOESN’T ALWAYS TAKE AN IPO TO GET A PUBLIC BDC Barings got its own public BDC earlier this year when it paid $85 million for the management contract of Triangle Capital Corporation. Triangle simultaneously sold its loan portfolio to Benefit Street Partners for $982 million.

The latter sale will give new owners Barings a cash reserve of $606 million, net of debt, to put to work with new investments. Barings will make an additional $100 million commitment. In total, the BDC will have more than $700 million to build out a fresh loan portfolio, unen-cumbered by the problem credits that remained in Triangle’s book. Barings also managed to bag ex-Wells Fargo managing director and BDC guru Jonathan Bock. Bock is set to be the vehicle’s new chief financial officer.

The BDC also set up one of the more shareholder-friendly fee structures: a 1 percent manage-ment fee that steps up to 1.4 percent in 2020. The firm is charging a full 20 percent incentive fee with an 8 percent hurdle rate and a three-year look-back option that will kick in by 2020.


ANALYSIS

4. HOW TO BUILD ONE OF THE WORLD’S LARGEST BDCs KKR and FS formed the world’s second largest BDCs after merg-ing their two publicly traded vehicles, Corporate Capital Trust and FS Investment Corporation. FSIC was the surviving entity. The deal was announced in December 2017. New York-based KKR and Philadelphia-based FS joined in April when the latter parted ways with its former sub-advisor, GSO Capital Partners. KKR and FS became joint advisors to KKR’s two BDCs (one public, one private) and FS’s four BDCs (one public, three private) focused on corporate credit.

The combined entity will have $8.34 billion in total assets and will be second only to Ares Capital Corporation, which has $12.7 billion in total assets. The new vehicle will charge a 1.5

percent management fee and a 20 percent incentive fee over a 7 percent hurdle rate. As of March, it will have some 221 portfolio companies. Most of its portfolio – about 70 percent – will consist of senior debt. KKR and FS have touted the ability to take down larger hold-sizes as one benefit of their partnership.

5. HOW TO MAKE A COMEBACK Months after parting ways with FS Investments, GSO Capital Partners is nearing an initial close on a new direct lending platform. The platform will comprise separately managed accounts for institutional investors along with a BDC that will target retail investors. Blackstone’s credit arm set a $10 billion target for equity and debt contributions. Such a haul would immediately place GSO among the largest BDCs. Looking at GSO’s final closes of a $6.5 billion mezzanine fund last autumn and a $7 billion distressed debt fund this spring, the big surprise would be GSO not meeting that goal.

6. WHO IS THE NEW KID ON THE BLOCK? BC Partners has filed papers to launch a BDC. The London-headquar-tered private equity firm, which also operates out of New York, is hoping to break into the direct lending space with BC Partners Lending Corporation, which will invest in companies with $10 million-$100 million of EBITDA. The vehicle will be externally managed by BC Partners Advisors. The BDC will charge a 15 percent incentive fee over a 6 percent hurdle and a 1 percent manage-ment fee on gross assets. It will invest in senior secured debt, both first lien and second lien, along with unitranche loans, unsecured debt, equity and structured products.

The BDC plans to leverage BC’s private equity platform to source deals. It also plans to provide managerial assistance by tapping the private equity business’s opera-tions team along with the knowledge base of its senior advisors and network of chief executives. BC Partners Credit managing partner Ted Goldthorpe will be the chief executive and president of the BDC. Previously, he was president at Apollo Global Management’s BDC, Apollo Investment Corporation.


ROUNDTABLE

MARKET INSIGHTS

Even at this stage in the cycle, industry experts say conditions in the US private debt market are just right for LPs seeking to fill that sweet spot in their portfolio

A Goldilocks moment for private credit


A decade after the global financial crisis, a group of US private debt lenders and advisors remains optimistic. While it is apparent to all we are near the end of the current cycle,

there is also the sense that the market has come a long way in 10 years. After a record-breaking year in 2017 – with $205.98 billion raised – it could be argued that gathering capital from new inves-tors is getting harder. This is not the case, however. The formation of larger private debt platforms is helping new investors find their way to the asset class. That’s good news for credit managers vying for new LP allocations. To get the full prognosis on the US private debt market, PDI sat down with NXT Capital’s John Finnerty, NewStar’s Pat McAuliffe, Adams Street Partners’ Bill Sacher, Churchill AM’s Randy Schwimmer, as well as Bill Brady and Matt Murphy of Paul Hastings.

Q More than halfway through 2018, what does the loan market look

like?

Randy Schwimmer: It feels like the proverbial Goldilocks market, despite issuer-friendly terms that credit managers are concerned about, covenant-lite and so forth. For investors, middle-market senior loan yields have improved thanks in part to higher LIBOR rates. Leverage remains on the high side, relative to historic levels.

Still, as an equity-to-capital matter, structures are significantly more investor-friendly than they were pre-crisis, and middle-market dealflow has been quite strong for us all year. So, the loan market continues to be not too hot, not too cold, but just about right.

Pat McAuliffe: The club middle market hasn’t dramatically changed, but there have been incremental changes to leverage, pricing and covenant structure. So, I guess one way of answering your question is things haven’t gotten better from a lender’s standpoint. They’ve gotten continually weaker.

Matt Murphy: Because of the low default rate that we’ve seen, the trust that people have in borrowers may be misguided. You see a lot of unique structures being put into place, or agreed to, that may not have been tested in a down market. And I think until they’re tested, parties will continue to push the envelope.

Q The market for sponsored deals continues to remain competitive.

How has this affected the auction process?

Bill Brady: From our perspective the really competitive auctions that we’ve been a part of in the middle market are companies with EBITDA as low as $20 million. In these competitive deals the key is to be commercial but with a laser focus on the critical issues that could seriously impair recovery.

John Finnerty: In the sponsor world, relationships that private

ROUNDTABLE

From left: John Finnerty, Bill Sacher, Randy Schwimmer, Bill Brady, Pat McAuliffe and Matt Murphy


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credit managers have with private equity firms do serve as a barrier to entry. While there’s a lot of new pockets of money raised, I think it’s going to be a struggle to get in.

Q What is the unitranche loans market like?

JF: Right now, senior-stretch and unitranche are the most prolific products out there. Historically, the structure has been reserved for the more stable cash-flowing businesses. Currently, we are start-ing to see it offered more broadly and even on cyclical businesses.

Bill Sacher: Without disagreeing with that, in the last six months we have seen a surprising number of traditional senior debt-junior debt structures – mostly senior first lien and second lien – and I think it’s been a pricing issue for the spon-sors, where a traditional bifurcated struc-ture has turned out to be cheaper.

MM: We spend a lot of time trying to figure out how the agreement amongst lenders (AAL) in a unitranche will play out in a down cycle – in a Chapter 11 case. Will the agreement be honoured by the bankruptcy court? Which lenders will be entitled to post-petition interest? Which lenders are entitled to provide debtor-in-possession financing, agree to a sale or credit bid at such a sale?

These terms have been more heavily tested in the true first lien-second lien scenario embodied in the inter-creditor agreement and less so in the unitranche AAL environment, which creates the need for a thoughtful analysis of these issues when structuring an AAL.

PM: The synthetic unitranche with the AAL, prevalent in 2016, has now moved to the dollar-one unitranche. A lot of the capital raised has been devoted to the uni-tranche product. It’s an attractive financing option for many sponsors.

Q Are there any factors that might mitigate

the severity of any imminent downturn?

BS: One of the potential contributors to a softer landing – and I think it still may be the bright spot in capital structures – is the amount of equity going in today’s deals. They’re running between 40 and 50 per-cent. In our portfolio, right now, there is 55 percent equity underneath the debt stack. If you compare the last time debt levels peaked in 2007, equity as a percentage back then was a fraction of what it is today.

Some of that incremental equity is making up for the record-breaking valu-ations, and if valuations drop, the addi-tional equity will act as a cushion. Sponsors are paying double-digit multiples for the underlying businesses, and even with lever-age at 6x, that gap’s going to get filled with

something, and that something is equity.

JF: It’ll be interesting to see behaviour in the next cycle. Sponsors do have signifi-cant money invested and have paid very full multiples. Given where covenants are set, 8-10x, when these companies default the equity is going to be significantly under-water, which begs the question: are spon-sors going to put more money in, or are they going to require the debt to convert [into equity]?

I believe some sponsors are going to struggle with their path to a recovery and decline investing more money, or they will invest new dollars subject to a material restructure of the debt.

Q What does the restructuring process

look like?

BS: Unlike a bank, which would have a separate restructuring team, I think, for most of us, the deal team that did the deal would remain involved.

RS: That’s the difference between the middle market and the broadly syndicated loan market. As a buy-and-hold lender, our portfolio management and underwriting teams take into account the possibility of a credit going sideways. Unlike the liquid market, we don’t trade out of loans. The same team manages the credit from begin-ning to end. Our senior management team

MARKET INSIGHTS

“RISK FACTORS PUT A VERY LARGE PREMIUM ON LENDERS BEING EXTREMELY PROACTIVE ONCE THE DEFAULT OCCURS. THE NUMBER ONE MISTAKE THAT I SEE MADE IS THE LENDER GROUP TAKING A MORE REACTIVE APPROACH”

Bill Brady, Paul Hastings, partner and head of alternative lender and private credit practice, member of special situations group

• Advises private lenders on an array of healthy and distressed debt structures in the form of unitranche, first lien, second lien, mezzanine and other loans in connection with acquisition financings, recapitalisations, refinancings and other transactions

• Practice spans multiple regions, including US, Europe and Latin America• Provides counsel on closing initial transaction and restructurings


ROUNDTABLE

has workout experience. They know the key is working closely with the sponsor to maximise value for everyone.

BS: Over the last 16 years, and through the worst recession we’ve seen in generations, I have invested in close to 200 transactions and have had only one non-consensual workout. Every other one was consensual.

BB: Risk factors put a very large pre-mium on lenders being extremely proactive once the default occurs. The number one mistake that I see made is the lender group taking a more reactive approach to the sponsor as opposed to

a proactive approach. We’ve haven’t had many [restructurings] that are non-con-sensual, but we’ve had at least a dozen where it was only consensual because we took those steps to prepare 100 percent for enforcement.

JF: Restructures are always a negotiation. As a lender you need to understand the bid, ask and your full range of options. Under-standing all your options and demonstrat-ing a willingness to pursue each option is your best path to a consensual agreement.

Q How do you execute a restructuring if

one of the parties is resistant?

MM: It depends on the party in interest. We try not to table-pound as much as simply point out how the documents are drafted and how they will be interpreted in a restructuring. We’ll have a discussion with all parties in interest and say: “Let’s talk, let’s focus our energies on the proac-tive, consensual resolutions. But, if that does not work or we run into a diffi-cult counterparty we will be prepared to execute on a strategy that’s going to maximise the returns for our clients.”

Q Early this year there was a lot of

volatility in the stock market. Have

these gyrations showed up in the loan

market?

RS: Volatility shows up a little bit in deal pricing at issuance. If broadly syndicated loan spreads gap out, the middle market tends to maintain the same illiquidity pre-mium. You can’t launch a middle-market loan on top of where liquid single-B-rated loans are getting done. One benefit of private credit is it’s not a correlated asset class. You generally don’t care where the Dow is trading. Supply/demand is more a driver of loan prices and spreads.

BS: We live in a more stable world.

JF: We see the impact more on the fund-raising side. You find more and more LPs shying away from the equity markets and moving to the debt markets.

“LPs ARE LOOKING FOR MORE AND MORE WAYS TO GET EXPOSURE TO PRIVATE CREDIT WITHOUT OVERLAPPING ON THE SAME DEALS. SO, GOING INTO SOME OF THESE NICHES REALLY HELPS EXPAND THEIR EXPOSURE”

“WE ARE CERTAINLY WELL INTO THIS CYCLE AND IT’S OUR OPINION THAT THE TIME TO GO INTO THE NICHE STRATEGIES WAS BEFORE SO MUCH CAPITAL HAD COME INTO THE MARKET. TODAY WE WOULD ENCOURAGE A FLIGHT TO QUALITY AND STAYING DOWN THE MIDDLE OF THE FAIRWAY”

John Finnerty, NXT Capital, senior managing director and group head of corporate finance

• Provides senior revolvers, terms loans, first out-last out structures, and unitranche loans to primarily private equity-backed mid-market companies

• Transaction types financed include leveraged buyouts, refinancings and add-on acquisitions• Borrowers generally have $5 million-$75 million of EBITDA

Pat McAuliffe, NewStar Financial, managing director and head of direct origination

• Finances senior revolvers, term loans, first out-last out structures, unitranche loans and equity co-investments

• Transaction types financed include leveraged buyouts, refinancings and add-on acquisitions

• Typical borrower is a private equity-backed single-B credit rating profile with operating cashflow of $15 million- $50 million of EBITDA


ROUNDTABLE

MARKET INSIGHTS

Q Is the mid-market opportunity big

enough to absorb the dry powder?

RS: Investors ask us all the time: “Are we too late? Are there still opportunities in private credit?” The answers are no, and yes. You read headlines about this firm rais-ing $2 billion, or that manager raising $5 billion. Much of that is going to higher-yield strategies, not first-lien senior debt. Compare those numbers to the opportu-nity set of about $500 billion of middle-market new issue and $500 billion for the refinancing cliff over the next five years.

There are 7,000 middle-market com-panies owned by private equity firms in this country out of a total universe of, depending how you measure, 200,000 middle-market companies. Do the math. We’ve got a long way to go. I’m going to be working for a while longer.

Q Fundraising has dipped this year. Is that

something credit managers should be

concerned about?

JF: Yes, it’s been down, but last year was a record year. I think the amount this year is

more in line with 2014 or 2016 numbers. Maybe it’s back to a normalised level. It seems like a lot of money has moved out of the hedge fund strategies and moved into private credit strategies.

Q In recent years we have seen private

equity firms launch their own private

debt groups. Will this trend continue?

RS: The private equity industry has not been growing, in general, as fast as private credit. Adding private credit sleeves gives sponsors another option for their LPs. It also diversifies their overall business. But since the users of credit are other PE firms, there’s potential for conflict.

As far as other asset managers go, the performance of private credit through the downturn, and the exiting of regu-lated banks from the space, have created an attractive investment opportunity. That’s not going to change anytime soon.

PM: If [private equity firms] do a lot of work on a deal and lose it, and that deal is in the market, they say: “Hey let’s take the piece of the debt”. They’ve done a lot of work on it from a credit standpoint and an investment standpoint. I think they’re trying to leverage the work they’ve done and get something for it. And it’s a natural extension to do a debt fund.

BS: I’m noticing that the private credit

“YOU SEE A LOT OF UNIQUE STRUCTURES BEING PUT INTO PLACE, OR AGREED TO, THAT MAY NOT HAVE BEEN TESTED IN A DOWN MARKET. AND I THINK UNTIL THEY’RE TESTED, PARTIES WILL CONTINUE TO PUSH THE ENVELOPE”

Matt Murphy, Paul Hastings, partner in corporate practice and member of the restructuring practice and special situations group

• Advises clients on out-of-court and Chapter 11 bankruptcy restructurings, clients include borrowers, alternative lenders and institutional lenders

• Firm restructuring expertise spans all industries with a recent focus on retail, oil and gas, media and technology and healthcare

• Corporate practice advises on domestic and cross-border transactions in Asia, Europe, Latin America and the US

“SPONSORS ARE PAYING DOUBLE-DIGIT MULTIPLES FOR THE UNDERLYING BUSINESSES, AND EVEN WITH LEVERAGE AT 6x, THAT GAP’S GOING TO GET FILLED WITH SOMETHING, AND THAT SOMETHING IS EQUITY”

Bill Sacher, Adams Street Partners, partner and head of private credit

• Leads investment, portfolio construction and fundraising for private credit group• Firm finances first-lien and second-lien loans, mezzanine debt and unitranche loans• Targets private equity-backed companies


ROUNDTABLE

new entrants are beginning to specialise a little bit and leverage the unique capability that the private equity sponsor may have – slightly stressed deals or the healthcare industry, for example. They are less of the universal debt providers like most of us.

BB: In addition to the new entrants, what I’m seeing in the market related to that is existing US asset managers entering Europe and existing European asset man-agers entering the US market on the direct lending side. Many of our clients fit that description.

Q Many LPs have begun investing in pri-

vate credit in recent years. Have the

investors likely to move into the asset class

done so, or are there still new LPs to tap?

RS: Educating investors on the virtues of the asset class has been going on for almost two decades. I’d like to think our firm has had a major role in that. There are LPs who haven’t fully gotten the message yet. And there always seem to be new investors interested in the space. But it’s a long learn-ing process. It can take years. You have to be passionate, persistent and very patient.

PM: Their knowledge base has developed very rapidly. Not too long ago, you’d go into LP meetings – this is when LIBOR was 1 percent – and they’d say: “You’re telling me

a 6 percent to 6.5 percent return and the other guys are telling me from 8 percent to 8.5 percent return, I don’t understand the difference.”

We’d say: “OK, let’s walk back on that and go over what first lien senior secured actually means.” We don’t find that anymore. When we go in there, they ask: “OK, you have a workout – tell us the steps you take to protect your interests.” They ask us good, detailed and well-researched questions.

BS: I think probably the biggest dollars of demand [and one of the reasons why LPs find private credit attractive in the first place] is its use as a yield enhancement to the credit portfolio. In addition, given how late we are in the cycle and how high valu-ations have become, some private equity-oriented investors are turning to private credit as a safe way to play the cycle.

Q What types of questions are those LPs

asking?

PM: We get a lot of cycle questions: “What did it look like last time? What deals went sideways? What did you do with them? What industries were they in? How long did it take you to get your money back?”

Q Are LPs backing more niche strategies,

such as speciality finance?

JF: LPs – now that they understand the

asset class and they’ve invested in it – realise it is a good place to generate returns. So, yes, I believe they are looking for more and more ways to get exposure to private credit without overlapping on the same deals. So, going into some of these niches really helps expand their exposure.

PM: I guess, but I don’t know if it’s the right time. We are certainly well into this cycle and it’s our opinion that the time to go into the niche strategies was before so much capital had come into the market. Today we would encourage a flight to quality and staying down the middle of the fairway.

Q Fees are always something that are on

LPs’ minds. Have your firms felt more

pressure than usual to lower those rates?

JF: There is always pressure on fees. Inves-tors prefer lower. What you are seeing in the SMAs and funds, larger investors who are willing to write a large ticket have more negotiating leverage.

PM: I think it’s normal as the industry matures that there is going to be fee discus-sions. The same occurs with private equity. LPs want to pay less. But they also are vet-ting managers for credit skills, reputation, track record, etc, and recognise you get what you pay for. n

“STRUCTURES ARE SIGNIFICANTLY MORE INVESTOR-FRIENDLY THAN THEY WERE PRE-CRISIS, AND MIDDLE-MARKET DEALFLOW HAS BEEN QUITE STRONG FOR US ALL YEAR. SO, THE LOAN MARKET CONTINUES TO BE NOT TOO HOT, NOT TOO COLD, BUT JUST ABOUT RIGHT”

Randy Schwimmer, Churchill Asset Management, senior managing director

• Supervises origination and capital markets• Firm finances senior debt and unitranche facilities for private equity-backed companies• Founder and publisher of industry newsletter The Lead Left


FUNDRAISING

DATA

Foot off the gas Fundraising for North America-focused vehicles this year seems unlikely to exceed 2017’s totals

SLOWING GIANT

A SENIOR FOCUS

CONCENTRATED COMMITMENTS

North America still dominates fundraising but has fallen from previous peaks

Capital raising in the first half of this year was dominated by senior debt strategies

The 10 largest fundraises in 2017 and 2018 represent $16.8bn of capital raised

Cap

ital r

aise

d ($

bn)

Num

ber

of f

und

s cl

ose

d

80

70

60

50

40

30

20

10

0

100%

80%

60%

40%

20%

0%

140

120

100

80

60

40

20

02014

2014

n Subordinated/ Mezzanine debt

n Senior debt

n CLO

n Distressed debt

n Royalty financing

n Venture debt

n Unitranche

n Fund of private debt funds

20162015 2017 2018

YTD

2015

Capital raised ($bn) Number of funds closed

2016 2017 YTD 2018

SUBORDINATED/ MEZZANINE DEBT

SENIOR DEBT CLO “

DISTRESSED DEBT

Ares Private Credit Solutions ($3.40bn)

Berkshire Multifamily Debt Fund II ($1.25bn)

KTCU-TH Real Estate Joint Venture ($1.00bn)

Oaktree Middle Market Direct Lending Fund ($0.72bn)

Glendon Opportunities Fund II ($2.50bn)

Barings North American Private Loan Fund ($1.85bn)

Golub Capital Partners 11 ($2.32bn)

Antares CLO 2017-1 ($2.10bn)

BXMT 2017-FL1 (Blackstone Mortgage Trust) ($1.00bn)

Trinitas VI ($0.72bn)

We Invest in Relationships

www.churchillam.com / 430 Park Avenue 14th Floor. New York, NY 10022 / 212.478.9200

Leveraging the Scale and Scope

of Nuveen

Alignment of Interests

and Principles

Long-term Investment Philosophy

Highly Experienced Management and Team

Extensive Middle Market Relationships and Access

Churchill Asset Management is a leading provider of

senior and unitranche debt financing to middle market

companies, primarily those owned by private equity

investment firms. We currently manage over $4.4 billion

in committed capital and are part of Nuveen, the asset

management division of TIAA and one of the largest

global asset managers across multiple asset classes.


MINORITY STAKES

ANALYSIS

Three New York alternative asset managers – Blackstone Group, Dyal Capital and Goldman Sachs’

Petershill programme – have been on a feeding frenzy. Through a series of trans-actions, each have taken non-control positions in several other alternative investment firms and are on track to beat last year’s total for such deals.

The phenomenon is not new, but this extremely well-resourced group has helped drive a new spate of deal activity. Blackstone Strategic Capital

Holdings oversees more than $3.3 bil-lion in permanent capital. Dyal closed its $5.3 billion fund, Dyal Capital Partners III, last year and has already returned to market, seeking another $5 billion for its fourth fund. Goldman Sachs – the only one of the three willing to comment for this article – closed its latest Petershill fund in February at $2.5 billion.

“Demand is building from institu-tional investors,” says Jeff Hammer, man-aging director at advisor Houlihan Lokey and co-head of the firm’s illiquid financial

assets practice. “The predictability of the income stream from funds with long-term, locked-up money presents an attractive investment opportunity.”

Transactions tend to result in stakes of 10-33 percent, says one fund man-ager that sold an interest. The reason, the manager adds, is that Blackstone, Dyal and Goldman want to write cheques that “move the needle”.

For the seller, meanwhile, a small stake of 3-5 percent is unlikely to have a big enough impact to make the deal

More US private fund managers are taking minority stakes in their industry peers. There are benefits for buyer and seller alike, writes Andrew Hedlund

The lighter side of cannibalism

MINORITY REPORTThe last 18 months: Who’s buying, who’s selling and what the money’s being used for

BLACKSTONEDYAL CAPITAL

PARTNERS

Leonard Green & Partners06 JulSuccession

Riverstone Holdings27 MayReinvest in firm

Energy Capital Partners 31 MayPartially pay retention bonuses

Vector Capital11 AprSpeed up growth of credit business

Cerberus Business Finance26-DecBuy out stakes held by GPs

Round Hill Capital3 JulExpand into new property types and geographic areas

HPS Investment Partners3 JulPursue strategic initiatives

Accel-KKR2 MayIncrease GP commitments, potential product expansion

Sound Point Capital4 AprProvide CLO risk retention capital

Rockpoint Group13 MarNot disclosed

Clearlake Capital Group29 MaySeed performing credit fund

Kohlberg & Co.23 MarIncrease GP commitments

Francisco Partners13 JulIncrease GP commitments

PAG26 MarNot disclosed

PRIVATE EQUITYCOMPANY

PRIVATE CREDITCOMPANY

REAL ESTATECOMPANY

SellerDate of transactionProceeds used for

GOLDMANSACHS

Atalaya Capital Mangaement28 JunIncrease GP commitments

TPG Sixth Street Partners11 AprProduct expansion, investor alignment

Source: PDI, company information

2017

2018

Deal-making can feel like a maze.

Let us help you navigate new paths to innovation and growth.

22 offices in the Americas, Europe, and AsiaOne global private debt practice

Paul Hastings LLP


ANALYSIS

MINORITY STAKES

worthwhile. Goldman Sachs’ Petershill didn’t start by targeting private fund managers. When it launched just before the global financial crisis, it was taking minority stakes in hedge funds, but has since expanded its book to include man-agers operating closed-end funds.

“Private equity offers stability with locked-in management fees,” says Hammer. “Hedge funds are more volatile as the value of their assets ebb and flow with market conditions, and so do their fees. That said, hot hedge fund managers can offer significant fee upside through performance in any given year.”

Hedge funds, on average, have posted lacklustre performance in recent years, returning 0.79 percent through June, according to Hedge Fund Research’s HFRI Fund Weighted Composite Index. One-year returns stood at 5.67 percent, while three- and five-year returns were 3.63 percent and 4.44 percent, respec-tively.

For its part, private equity has per-formed much better. Preliminary results for the first quarter were 2.96 percent, according to the Cambridge Associates Private Equity index. For the three months ending 31 December – the most recent period with final results – the asset class returned 5.07 percent. It had a 12-month return of 17.49 percent, and three- and five-year returns of 17.49 percent and 11.79 percent, respectively.

On the capital-raising side, hedge funds saw $30.3 billion of inflows in 2017 – the highest on record – though that does little to offset the $111.6 bil-lion in outflows the industry suffered in 2016, according to research firm eVest-ment.

PLAYING CATCH UP

By contrast, private credit and private equity fundraising has been in rude

health. PDI data show that private credit had a record-breaking fundraising year with $206 billion raised. Private equity raised $455.4 billion – the most since at least 2012.

The focus on closed-end capital is the result of illiquid managers playing “catch up” with firms overseeing open-ended vehicles, one industry source says: “There’s clearly different nuances partnering from a liquid manager and an illiquid manager.”

One manager that invests in the space posits that private equity funds have been more attractive than hedge funds.

“We would start with the premise that they’re just different asset classes,” the market participant says. “There’s

challenges in the [hedge fund] space, but there’s a lot of firms that have been very successful. The locked-up capital [of closed-end funds] just requires a higher valuation.”

INVESTOR ADVANTAGES

LPs have come to appreciate indirectly owning minority stakes in other alterna-tive asset managers because, for once, it allows them to receive a portion of private fund fees rather than pay the levies.

“[Through minority stakes in alterna-tive asset managers] the investors also see the fees they are paying to these managers,” says another fund manager who invests in the space.

“When you offer these LPs to sit on the same side of the table of the GPs, it can be a pretty compelling trade.”

In addition to the management fee and carried interest income streams, LPs will also see the gross return from the given fund manager’s GP commit-ments.

“[The phenomenon is] partially driven by LPs looking for deeper and deeper relationships on their GP side,” says Goldman managing director Christian von Schimmelmann. “They are encouraging private equity GPs to expand into credit, which requires capital.”

The investment proceeds are typi-cally used for one of three purposes: succession, larger general partner com-mitments to the firm’s funds or product expansion.

“Other reasons why people might do it in today’s environment – to the extent that there’s market dislocation – the winners will have substantial balance sheets with cash,” says one fund manager that sold a stake, noting that alternative investment firms historically have not had large balance sheets. n

“THE PREDICTABILITY OF THE INCOME STREAM FROM FUNDS WITH LONG-TERM, LOCKED-UP MONEY PRESENTS AN ATTRACTIVE INVESTMENT OPPORTUNITY” Jeff Hammer

16Number of deals

involving fund manager minority stakes tracked

in 2017-18Source: PDI


ANALYSISDATA

US MID-MARKET COMPANIES

The pull backAverage revenue growth of US mid-market companies dipped to 7.4% in 2Q 2018, but remains above the historical average of 6.8%, according to the National Center for the Middle Market

PRODUCTIVITY IN THE US MID-MARKET

REVENUE GROWTH IN THE US MID-MARKET

US MID-MARKET BY SECTOR

3

2.5

2

1.5

1

0.5

0

10

9

8

7

6

5

4

3

2

1

0

Q1 2016

Q1 2017

Q3 2016

Q3 2017

Q1 2018

Q2 2016

Q2 2017

Q4 2016

Q4 2017

Q2 2018

Q1 2016 Q1 2017Q3 2016 Q3 2017Q2 2016 Q2 2017Q4 2016 Q4 2017 Q1 2018 Q2 2018

Annual revenue of US mid-market companies

Mid-market companies that plan invest extra cash (67% last year)

Mid-market companies that report increased revenue in past 12 months (72% last year)

$10m-

$1bn

Business services 4%

Manufacturing 9%

Wholesale 16%

Retail 16%

Finance, insurance, real esate 9%

Construction 9%

Healthcare 11%

Others 29%

%

%

Source: National Center for the Middle Market

Source: National Center for the Middle Market

Source: National Center for the Middle Market Source: National Center for the Middle Market

71%75%


FEATUREDATA

Where does the capital call home?

University of Michigan | AUM: $11.81bn | PD allocation: Not disclosed | HQ: Ann Arbor

Florida State Board of Administration | AUM: $204.9bn | PD allocation: Not disclosed | HQ: Tallahassee

The University of Michigan is one of the largest universities in the US Midwest. In March 2017, the university announced that it intends to commit

a total of $185 million to two private debt platforms and a hedge fund. It also revealed plans to invest $75 million in a direct lending arm of Brevet

Capital Management, and to commit $60 million to Granite State Capital Partners, which specialises in illiquid bank loans.

The SBA manages funds on behalf of the Florida Retirement System Pension Plan, Florida Retirement System Investment Plan, Florida PRIME,

Florida Hurricane Catastrophe Fund and Lawton Chiles Endowment Fund. The SBA is governed by a three-member board of trustees. In Q3 2017,

it committed $150 million to Benefit Street Debt Fund IV, $150 million to CVI Credit Value Fund IV, $150 million to Glendon Opportunities Fund II

and $200 million to GSO Capital Solutions Fund III.

Fund commitments by vintage


Total commitments by strategy


Total commitments by regional focus


n Distressed

n Distressed

n Multi-region

n Multi-region

2014

2013 2014

No

of

com

mit

me

nts

No

of

com

mit

me

nts

4

76

10

9

10

6

11

6

6

1

2016

2016

2015

Figures may not add up to 100% due to rounding

2015

2017

2017

2018

2018

n Royalty financing

n Royalty financing

n Asia n Subordinated

n Subordinated

n North America

n North America

n Funds of funds

n Funds of funds

n Senior debt

n Senior debt

n Europe

n Europe

n CLO

n CLO

1%4%

3%2%

1

2

FUNDRAISING

A look at the most active private debt LPs in the US over the past five years reveals plenty of southern hospitality for fund managers

12

10

8

6

4

2

0

12

10

8

6

4

2

0

44%

48%

10%

11%

13%

25%

45%

48%

42%

38%

51%

10%8%


FEATUREDATA

Pennsylvania Public School Employees’ Retirement System | AUM: $56bn | PD allocation: $1.12bn | HQ: Harrisburg

Texas County and District Retirement System | AUM: $29.77bn | PD allocation: $3.86bn | HQ: Austin

PPSERS was set up in 1917 and serves over 600,000 individuals in Pennsylvania. In December 2017, the PPSERS’ board committed $150 million

to Almanac Realty Securities VIII, a real estate private placement fund managed by Almanac Realty Investors. In May 2018, the pension fund

confirmed commitments of $150 million to Trilantic Capital Partners VI (North America), $150 million to TPG Opportunities Partners IV, and $100

million LEM Multi Family Fund.

TCDRS was set up in 1968 as a not-for-profit public trust managing pension, disability and death benefit plans. While pooled assets are invested

collectively, each county and district is treated as an individual retirement plan. In May 2018, TCDRS made a $125 million commitment to Sound

Point Strategic Capital Fund and a $150 million commitment to Arbour Lane Credit Opportunity Fund. It also contributed $100 million to Taconic

Commercial Real Estate Dislocation Fund II in July.







n Distressed

n Distressed

n Multi-region

n Multi-region

2013

2013

2014

2014

No

of

com

mit

me

nts

No

of

com

mit

me

nts

4

3

7

4

7

4

5

3

3

6

1

7

2016

2016

2015

2015

2017

2017

2018

2018

n Unitranche

n Royalty financing

n Subordinated

n Subordinated

n North America

n North America n Unitranche

n Senior debt

n Senior debt

n Europe

n Europe

n Venture debt

1%3% 1%

2%2%

6%

2%

3

4

12

10

8

6

4

2

0

12

10

8

6

4

2

0

27%

48%

17%

21%

38%

38%

73%

56%

10%

40%

14%

n Asia

n Asia

1

24,6,10

9

7

8

35


FUNDRAISING

DATA

Teacher Retirement System of Texas | AUM: $151bn | PD allocation: $2.43bn | HQ: Austin

Teachers’ Retirement System of the State of Illinois | AUM: $51.55bn | PD allocation: Not disclosed | HQ: Springfield

Teachers’ Retirement System of Louisiana | AUM: $20.02bn | PD allocation: $1.2bn | HQ: Baton Rouge

The Teacher Retirement System of Texas was formed in 1937 to provide retirement benefits for employees of the public schools, colleges, and

universities supported by the State of Texas. In July last year, Jerry Albright was appointed to be the new chief investment officer. In April 2018,

Texas Teachers committed $200 million to Oaktree Special Situations Fund II. In June 2018, the pension fund committed $150 million to Square

Mile Credit Partners II.

The General Assembly of Illinois created the Teachers’ Retirement System of the State of Illinois in 1939 to provide retirement annuities,

disability benefits and other benefits for teachers, and beneficiaries. Within its private equity portfolio, the retirement system invests in

special situations which include distressed and mezzanine debt. In May 2018, the pension fund committed $50 million to Harvest Partners

Structured Capital Fund II.

TRSL provides pension fund services to over 150,000 members and is Louisiana’s largest state retirement system. In July 2017, the system

approved $75 million to Castlelake V. In May 2018, TRSL greenlit a $75 million commitment to Oaktree Special Situations Fund II. It committed up

to $75 million to Apollo Hybrid Value Fund the following month.







n Distressed

n Distressed

n Distressed

n Multi-region

n Multi-region

n Multi-region

n Royalty financing

n Royalty financing

n Asia n Subordinated

n Subordinated

n Subordinated

n North America

n North America

n North America

n Unitranchen Senior debt

n Senior debt

n Senior debt

n Europe

n Europe

n Europe

5%2% 5%

5%

4%

6

5

7

52%

33%

13%

31%

21%

26%

36%

60%

69%

33%

37%

59%

56%

45%

8%




2013

2013

2013

2014

2014

2014

No

of

com

mit

me

nts

No

of

com

mit

me

nts

No

of

com

mit

me

nts

4

5

5

8

5

4

4

5

4

1

6

3

2

2

2

4

1

4

2016

2016

2016

2015

2015

2015

2017

2017

2017

2018

2018

2018

12

10

8

6

4

2

0

12

10

8

6

4

2

0

12

10

8

6

4

2

0

With over four decades of investment experience, Adams Street Partners has a deep understanding of the broader private market landscape, and can access the most attractive opportunities while providing world-class client service.

Through our targeted offerings, customized accounts and our annual fund-of-funds program, our investment teams cover the full spectrum of private market strategies including:

Primary Fund Investments

Secondaries

Co-Investments

Venture Capital

Growth Equity

Private Credit

Experience. Integrity.Results.

adamsstreetpartners.com Beijing | Boston | Chicago | London | Menlo Park | Munich | New York | Seoul | Singapore | Tokyo


FUNDRAISING

DATA

Minnesota State Board of Investment | AUM: $93.5bn | PD allocation: $523bn | HQ: St Paul

New York State Common Retirement Fund | AUM: $207bn | PD allocation: Not disclosed | HQ: Albany

Texas Municipal Retirement System | AUM: $28.4bn | PD allocation: $4.67bn | Austin

The Minnesota State Board of Investment is the agency responsible for administering state funds and the assets of the state public pension

systems. SBI’s private debt portfolio is classified under yield-oriented alternative investments. The board commits to corporate, real estate and

infrastructure debt vehicles globally. In March 2018, the board approved commitments of $150 million to CVI Credit Value Fund IV and $200

million to TPG vehicles including TPG Opportunities Partners IX.

NYSCRF is the third largest pension fund in America. It is managed by the New York State Comptroller’s Office, which audits state agencies, public

authorities and all local governments in New York state. In May 2018, NYSCRF committed $150 million to the Värde Specialty Finance Fund, which

makes private equity investments in specialty finance lenders globally, with a focus on North America and Europe.

Texas Municipal Retirement System, established in 1947, provides retirement, disability, and death benefits for employees of participating Texas

municipalities. In June 2018, TMRS approved $600 million-worth of fund and manager commitments in its non-core fixed income portfolio: $250

million to AG Direct Lending Fund III, $150 million to HIG Whitehorse Trinity and $200 million to Värde Private Debt Opportunities Fund.







n Distressed

n Distressed

n Distressed

n Multi-region

n Multi-region

n Multi-region

n Venture debt

n Venture debt

n Asia

n Subordinated

n Subordinated

n Subordinated

n North America

n North America

n North America

n Senior debt

n Senior debt

n Senior debt

n Europe n MENA

n Europe

4%

1%

8%

3%

9

8

10

50%50%

41%

33%

11%

11%

56%

33%

45%

33%

57%

42%

43%

50%

17%

7%7%




2013

2013

2013

2014

2014

2014

No

of

com

mit

me

nts

No

of

com

mit

me

nts

No

of

com

mit

me

nts

3

1

6

5

3

2

7

6

2

3

4

3

2

2

2

1

2

2016

2016

2016

2015

2015

2015

2017

2017

2017

2018

2018

2018

12

10

8

6

4

2

0

12

10

8

6

4

2

0

12

10

8

6

4

2

0

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FUNDS IN MARKET

DATA

SENIOR TAKES A BACK SEAT

SHOWING BIG AMBITION

WHO IS KEEPING IT REAL? STRATEGIES IN BALANCE

Most capital targeted by the top 10 largest US private debt funds is in subordinated or distressed strategies

Of the funds that disclosed their target size, well over a third are aiming to raise more than $500m

More than a quarter of capital targeted by US funds in market will be focused on real estate and infrastructure

Distressed and senior debt are near-level pegging, while the largest share of capital is targeting subordinated debt

Hitting the open roadFunds in market data show a concentrated market where senior debt is declining in prominence

SUBORDINATED/ MEZZANINE DEBT

DISTRESSED DEBT SENIOR DEBT

CLO

3G Special Situations Fund V ($10bn)

TPG Sixth Street Adjacent Opportunities Partners ($5.5bn)

Apollo Hybrid Value Fund ($3bn)

Energy Investment Opportunities Fund – Goldman Sachs ($3bn)

York Structured Credit Opportunities Fund ($2bn)

AG Direct Lending Fund III – Twin Brook ($2bn)

Macquarie Infra-structure Partners IV ($3.5bn)

Levine Leichtman Capital Partners VI ($2.2bn)

Carlyle Credit Opportunities Fund ($2bn)

Related CRE Debt Fund ($2bn)

>$1bn

$500m-$1bn

$250m-$500m

$100m-$250m

$50m-$100m

<$50m

0 10 20 35 455 15 3025 40 50

*Of 262 funds in market, 93 have not disclosed their target

n Corporate

n Subordinated/ Mezzanine debt

n Senior debt

n Distressed debt

n CLO

n Venture debt n Othern Infrastructure

n Real Estate

22%

74%

4% 5%3%5%

28%

36%

26%

Number of funds

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SAID AND DONE

THE LAST WORD

‘There’s enough to worry about, but we’re not doomed’Hopes, fears and warnings. What the industry’s leading figures had to say about US private debt over the past 12 months

“The record amount of debt and leverage that US corporate borrowers are carrying is making many of them as vulnerable to downgrades and defaults as they were in the run-up to the 2007-08 global financial crisis” S&P Global Ratings report in November

“One of the most important lessons learned was the peril of leverage. Another general lesson that the crisis reinforced, once again, was the importance of matching assets to liabilities” Aoifinn Devitt, chief investment officer of Chicago Policemen’s Annuity and Benefit Fund, reflecting last November on the global financial crisis

“It wasn’t a big surprise to those of us in the sector that Donald Trump’s proposed changes

... haven’t yet come to fruition. In fact, it feels familiar; Barack Obama also came to office with an infrastructure expansion plan, which was swiftly side-lined” Dylan Foo, head of Americas infrastructure equity at AMP Capital, on infra-related disap-pointment in the US last November

“We expect this to be a year of continued consoli-dation and M&A in the BDC space – as BDCs that have lost all institutional confidence sell (or are forced to sell) their franchises to an entity that has not lost all institutional confidence”Jonathan Bock, at the time director and senior equity analyst at Wells Fargo, gives his prediction for the year ahead in February

“Over the long term, I think we’ll see some managers who struggle when credit condi-tions tighten, subsequently separating the good from the bad. It seems the dry powder issue will resolve itself as the industry con-solidates over time”Grant Haggard, partner, Twin Brook Capital Partners, shares his thoughts on dry powder in April

“Markedly stronger growth in loan volumes was seen in commercial and industrial, and commercial real estate” In May, the Dallas Fed became the latest in a number of Fed districts to report a jump in com-mercial and industrial lending that officials hope may herald an investment boom on the back of the recent cut in corporate taxes

“There’s enough to worry about, but the market’s not doomed” David Scudellari, head of principal debt and credit investments at Canada’s Public Sector Pen-sion Investment Board, when asked in September last year what he thinks about levels of competi-tion and pricing in private debt

“Our view has been that direct lending continues to be a relatively attractive asset class even though absolute levels of return [across all asset classes] are coming down” Steve Nesbitt, chief executive of LA-based Cliffwater, speaking the same month

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DEALS LEAD/CO-LEAD ARRANGER

COMMITMENTS ISSUED TO DATE

CLOSED TRANSACTIONSsince 4th quarter 2014 inception

$62,000,000$62,000,000$62,000,000

Administrative AgentAdd-On Acquisition

July 2018

UndisclosedUndisclosedUndisclosed

Administrative AgentJune 2018

$45,000,000$45,000,000$45,000,000$105,000,000$105,000,000$105,000,000 $87,000,000$87,000,000$87,000,000

$117,000,000$117,000,000$117,000,000UndisclosedUndisclosedUndisclosed

$105,000,000$105,000,000$105,000,000

UndisclosedUndisclosedUndisclosedUndisclosedUndisclosedUndisclosed


$105,000,000$105,000,000$105,000,000

Administrative AgentApril 2018



Administrative AgentMay 2018



Administrative AgentJune 2018


May 2018


April 2018


April 2018

90%


$6.5B

223

Documents

US REPORT BIG WHEELS KEEP ON TURNING · at record levels and momen - tum strong. But there was also caution. Looser deal ... 2 PDI US Report | September 2018 ANALYSIS TWO-MINUTE YEAR