Capital talk: Separate from the pack

Mitch Petrick is notorious for being media-shy, and his meeting with PDI lives up to that reputation.

As head of The Carlyle Group’s Global Markets Strategies platform (GMS), Petrick oversees roughly $35 billion in assets, including the firm’s leveraged finance, mezzanine and distressed businesses, according to his biography on Carlyle’s website.

Perched in his corner office 38 storeys above Madison Avenue, it takes a long time for an evident wariness of the press to give way to his enthusiasm for what he and his team have created at Carlyle, and even then, he’s reluctant to talk about some of the seven strategies that comprise the GMS platform.

When pressed on the firm’s mezzanine or the firm’s latest distressed fund, he declines to comment. The corporate mezzanine strategy hasn’t raised a new fund in six years and the firm’s latest distressed fund, Carlyle Strategic Partners III, closed on $703 million last year, well below the totals raised by its predecessor.

Petrick’s keen that the business isn’t seen as just another credit platform, and it quickly becomes clear that mezzanine and distressed strategies – cornerstones of most rivals’ credit operations – are not the sole focuses of Carlyle GMS.

“It’s kind of the way we were, and we’ve evolved so far from that,” he tells Private Debt Investor.

Prior to joining Carlyle in 2010, Petrick spent 20 years at Morgan Stanley, a period that included stints as the global head of the bank’s institutional sales and trading, corporate credit, non-investment grade, distressed investing and leveraged finance and restructurings businesses.

It’s an impressive background, and based on that experience, he has likely developed some very firm opinions on how the market for debt and credit-related products will continue to evolve. Conveying those opinions may not be so easy, however.

During the interview he pauses at times, scrutinizing slides from an investor presentation, carefully introducing statistics and phrasing seen in press releases and regulatory filings. “We have seven different strategies. We have 150 investment professionals and 61 active funds,” he says. “We took a bottom up, and a top-down, approach, looking at investment strategies where we felt we could have a competitive advantage.”

It’s only when he starts to explain the thesis behind GMS’ development that he begins to warm up.

Not just another credit business

Petrick doesn’t want to focus on the distressed and mezzanine segments because doing so would imply that GMS is just another credit platform, and he believes the launch of new products and business segments over the last four years has given GMS a more singular identity.

He wants to talk about some of the platform’s newer strategies – commodities, emerging market equities, long / short credit and the platform’s new business development company, Carlyle GMS Finance. Most importantly, he wants to talk about how each of those pieces fits within the platform as a whole, how it is positioned for further growth.

Although separate, the temptation to focus on any one of GMS’ entities misses the central thesis that ties its products together, he argues.

“Operational growth is all about execution. It’s very linear. Like our structured credit business, doing what you do, and then doing it better,” he says, moving one hand up and to the left, as if tracing an upward sloping curve on an invisible Cartesian plane.

“Transformational growth is [about] taking risks, starting new businesses. They’re non-linear in nature but the payoffs are greater,” he says. He is moving his other hand now, spreading his fingers wide to create an explosive, multi-directional visual to illustrate the difference.

“The reality, to have sustainable growth, you have to do both and you have to oscillate between the two,” he says. “History’s littered with examples. Look at Apple, Apple lived on this side. They were transformational. Now they’re getting more into execution, less transformational. But there are a lot of companies that couldn’t innovate and are now gone.”

He draws his hands together. This is the point he had been trying to convey all along. For years, certain elements of Carlyle’s GMS platform failed to merge those philosophies. His goal, for the last four years and moving forward, is to manufacture a platform that possesses elements of both, and can thus perform at any point in the market cycle.

“These aren’t funds. These are businesses. Those seven strategies are businesses. And if you run them as businesses it allows you to do this [merge operational and transformation growth],” he says. “As the opportunity set changes, our business has the opportunity to evolve and change as well. What I’ve always said is, we never want to be a ‘me-too’ business.

One of my hallmarks is, if I designed a strategy where if I have to sit down in front of an investor and I say, ‘Here’s mine, mine’s better than theirs, I’ve lost the game.”

Operational

The largest business operated through Carlyle’s GMS platform is also the one Petrick identified as taking the most operational approach to growth, and it seems to have moved along a similar upward trajectory.

In 2009, structured credit accounted for 82 percent of GMS’ $13 billion in assets under management, according to a November investor day presentation. And though that total has grown to $17.2 billion as of the end of the fourth quarter, its share of the platform’s total AUM fell with the arrival of new strategies and investment vehicles. As such, structured credit effectively served as a foundation upon which Petrick and his team built out GMS’ other product offerings.

It’s proven quite sturdy in that regard. Despite the risks commonly associated with the loans that comprise CLO assets, Carlyle’s limited default loss rate remained well below industry averages through the financial crisis, according to a firm presentation that cites LSTA data.

“The asset class actually proved to be pretty resilient. Roll that forward to where we are today, the investor base for both liabilities and equity is a much more diverse set of investors than what we’ve seen historically,” says Petrick. “Given the thirst for risk-adjusted returns and absolute returns, the appeal of the asset class continues to grow.”

Those themes created an excellent environment for the launch of new CLO vehicles. Low interest rates drove fund flows fund from retail investors into US leveraged loan markets, which in turn elevated CLO volumes. Carlyle GMS responded by closing six new CLOs with a combined $3.1 billion of assets, a total that includes the platform’s first two vehicles in Europe since the financial crisis.

Although many expect 2014 to be another robust year for CLO volumes, the sector also faces some challenges moving forward. More specifically, there is a distinct possibility US regulatory headwinds could arrive in the form of risk retention rules (mirroring recent moves in Europe) which could require CLO managers to retain a 5 percent interest in their vehicles. The end result could limit the ability of small and medium sized managers to issue new funds.

“Now we’re at a point where acquiring assets for these vehicles is more challenging, so to complete deals appropriately, the arbitrage has to work,” says Petrick. “Issuance has not been as robust: the amount of assets available at attractive prices, coupled with several AAA buyers on the sidelines due to uncertainly regarding risk retention and banks’ ability to own these assets, have made things a bit more challenging. These issues have to play themselves out before the market can return to what it was last year.

“The last time the market was challenged and issuance was way down, we went through a period of consolidation where managers with existing assets were faced with a trade-off of hoping the market would reopen, versus carrying the cost of an employee base with earning assets which were clearly going to run off over time. They could sell the present value of that earnings stream, and monetize it day one, by selling the business as a financial asset.”

Given the size of its structured credit portfolio – Creditflux Q4 league tables of CLO managers AUM ranked Carlyle second only to GSO Capital Partners – it is unlikely that Carlyle would face situations similar to the one Petrick describes. In that market environment, the firm’s sizeable balance sheet would more likely prompt it to acquire smaller managers’ CLO contracts, a practice the firm executed two years ago when it purchased €2.1 billion in European CLO assets from Highland Capital Management.

“Interestingly, the environment that we’re in today, if you look at some of the issues the industry is facing – if issuance does not pick up we may go through another wave of consolidation for those smaller managers who may not have the financial capacity to meet the new risk retention rules,” Petrick says.

In either case, given GMS’ track record for building structured credit AUM via financial transactions or new closes, it’s clear Petrick believes the structured credit business to be well positioned to continue along its steady growth trajectory in either environment.