Private debt as an asset class continues to grow, whether it’s the ever-expanding number of alternative lenders and asset managers, the continued retrenchment of regulated lenders or more limited partners turning to the asset class as they look for higher yields.
Currently, many smaller investment shops focus on writing specific transaction types, be it by ranking of the debt or a preference for either sponsored or non-sponsored deals. Doing so may give that firm an excellent view of their sub-asset class, while larger asset managers, like TIAA, that play up and down the capital stack can offer a detailed, holistic view of private debt for each level of it.
PDI sat down with Brian Roelke, head of TIAA private capital, Jason Strife, head of private equity and junior debt, Laura Parrott, head of investment grade private placement origination, and Ken Kencel, chief executive officer and president of Churchill Asset Management (a majority-owned affiliate of TIAA) to discuss the future of private debt.
With almost $900 billion of assets under management, TIAA is a huge organisation. Can you explain the structure and roles each team plays?
Brian Roelke: We think it’s important to have the ability to invest across the private credit spectrum. We believe it’s important to have scale in those businesses in which we choose to invest and to align ourselves with very experienced, strong teams that have demonstrated strong track records of investing through the credit cycle, and that was one of the main factors behind our decision to align ourselves with the Churchill Asset Management team.
Ken Kencel: As the exclusive provider of middle-market senior and unitranche loans for TIAA, we benefit from the size and scale of the TIAA organisation – including the approximately $8 billion TIAA has committed to private equity investment firms, which are the exclusive focus of our business. Where TIAA has a strong appetite for the asset class, they will look to affiliate with a best-in-class investment team to commercialise that strategy by raising third-party capital from like-minded institutional investors. TIAA’s approach is quite unique in this regard and provides a significant level of alignment with our investors. It also provides us with increased scale for our investment activities.
Jason Strife: The mezzanine or junior debt strategy is most applicable to private equity-backed platforms with $10 million to $50 million in earnings before interest, taxes, depreciation and amortisation. These loans are invested as second lien or unsecured subordinated debt versus Laura’s world, which are going to be larger issuers.
Her portfolio has much larger, more stable assets with lower debt to capitalisation ratios. The junior debt portfolio has a different company profile – less scale, higher levels of leverage, but offset with a private equity investor controlling the equity account with a vested interest to de-leverage the balance sheet, support the company’s capital needs and ultimately create substantial equity value beneath our junior debt investment.
Laura Parrott: The stability within the private placement asset class is really the core. It is a bedrock of [TIAA’s private credit] investment platform because we believe it is a stable asset class, and we’ve seen attractive returns through the cycle. Private placements have call protection and are primarily fixed-rate opportunities. I think that’s the hallmark of the private placement group in addition to the diversification offered.
How has the private debt market and the sub-asset class changed in recent years?
BR: We’ve seen some of these trends growing in the last number of months, but as the check sizes of the private credit investors get larger due to increased amounts of assets that have been raised, clearly the deal sizes are increasing as well. [As private] credit investors have larger amounts of money to deploy, those solutions are available to larger companies than may have been the case previously.
JS: Ten years ago, unsecured subordinated debt or mezzanine was the primary financing alternative available to private equity firms seeking debt capital in the middle of the balance sheet, 40 to 70 percent of enterprise value-type financing. Today you have significantly more options in the marketplace, including a second lien market, both privately clubbed and syndicated, as well as stretch-senior and one-stop financing providers.
Secondly, there are more institutional investors like TIAA with very large balance sheets that are bringing one-stop shop capabilities to the marketplace whereby we have the ability to commit to private equity funds, establish a deep relationship as a limited partner, support the portfolio with direct equity co-investment and junior debt capital. In our case now we also support private equity funds with first lien capital through Churchill.
KK: Private credit has become very much a mainstream asset class. Whereas I might have met with investors 10 years ago and they were trying to decide where to put private debt or private credit or direct lending, today that decision has already been made. So most of the institutions I meet with today – the public pension plans, endowments, family offices or even high-net-worth individuals – I think they’ve all recognised that in this low (or even no) interest rate environment we have been in, private credit is an excellent way to generate strong current income (and excellent risk adjusted returns) as well as provide for increased diversity in their portfolios.
How are institutions placing private credit in their portfolios?
BR: We’ve seen a lot of private credit investors deploying capital out of private equity or the alternative bucket. Some of the more forward-thinking institutions have created private credit buckets as a standalone asset allocation category, and others are deploying out of their fixed-income allocation. I’d say that seems to be the minority compared to those who deploy out of the private equity buckets. I think it can be more challenging for folks allocating out of their fixed-income bucket, given the fact that the nature of private credit investments does require a longer hold period in order to be successful. These are not investments that can be easily managed in liquid portfolios.
LP: Over the long term the investment-grade private placement asset class is attractive to institutions because of the stability it provides, and that’s because of the call protection we have, guaranteeing a long-tenured asset, in addition to the structural component. The financial covenants during a credit crisis or downturn in the cycle bring private placement investors to the table with credits earlier than other lenders and ultimately prove that this asset class has lower loss rates through cycles than public investments.
Do you think you will see more commingled funds in the future, or do you think that you will see more separately managed accounts?
KK: I would say the best managers in the private credit space have recognised that you need to be flexible and responsive to investors’ requirements when offering investment vehicles – some investors prefer leverage to enhance returns while others like to invest directly in the loans with no leverage, some like to invest offshore, while others prefer an onshore structure. Moreover, fees or reinvestment period can vary based on the size of an investor’s commitment and/or their liquidity needs. The most successful managers in the middle-market senior lending world understand this and have created an array of fund structures to meet investors’ needs, whether it’s separately managed accounts, commingled funds, middle-market CLOs or even a BDC – these vehicles will typically all invest in the same underlying middle market loan, but with a different “wrapper” if you will. We then allocate to funds based upon each vehicle’s committed capital.
What do you think is next in terms of opportunities and growth of the asset class?
LP: We anticipate seeing continued demand for private placement debt as this low-yield, low-rate environment continues, and we see new entrants in our market as investors try to gain access to these assets. One of the trends that we’re seeing is a real focus on building relationships within the market. Not with just the agent bank community, which brings a lot of products, but directly with the companies that we are invested in.
BR: There are a couple of other main factors to consider over the next few years. The likelihood of economic dislocation over the next four or five years would be pretty high. In that environment, a lot of private debt managers who were formed in the wake of the downturn and have been investing in today’s benign credit environment will have their processes and their investment practices really tested for the first time.
KK: We’ve had a proliferation of private credit managers over the last several years. I think managers with a strong track record that stay focused on their core strategy are the ones that will thrive over the next decade. We’ll inevitably have a downturn and I think that will result in a shakeout in the private credit space – and that’s where the top managers will increasingly distinguish themselves. In terms of the growth overall – clearly the growth will continue to be driven by the disintermediation of the banks and traditional lenders in favour of institutional investors and the firms that manage capital for them.
How do you compete and differentiate yourselves when the market is getting so competitive?
BR: We don’t really view it as ‘compete’ necessarily. We tend to work alongside a lot of lenders or investors in transactions in which we invest. We are known across the different TIAA private portfolios on deep, fundamental underwriting, a high level of selectivity and a large focus on both understanding the structural elements of the transaction and making sure the structures in which we are investing are appropriate for the individual investments over long periods of time.
KK: Agree very much with Brian. I would add that our market is very clubby – one where strong relationships with the other most active middle-market lenders are very important. As an example, we’ve completed over 100 investments alongside Antares Capital … and many deals with firms like Golub Capital and Madison Capital as well. These relationships are very important to us.
What will position you to be more successful in the future?
LP: We see [private debt] as a real relationship business where we have long-term relationships with these companies that we are invested in. And those relationships will be helpful if we have the opportunity to reinvest, but also if there’s a change in the credit profile and there needs to be some sort of negotiation. That’s a trend we are seeing becoming more important in the private placement world.
JS: Relationships are paramount, and this is a defining characteristic of middle-market sponsored finance – the market is very relationship-based. You don’t need to canvas the entire sponsor universe, you need to have a core group of relationships, and foster and develop those at a very deep level by providing a complete value proposition and first-rate execution.
This article is sponsored by TIAA Global Asset Management. It appeared in the Future of Private Debt supplement published with the October 2016 issue of Private Debt Investor.