Churchill Asset Management is a senior and unitranche mid-market lender with currently $2.9 billion in committed capital. The firm is part of Nuveen TIAA, a global asset manager with multiple asset classes and over $880 billion in assets. Brian Roelke, Randy Schwimmer and Ken Kencel explain why traditional middle market senior loans offer great value in today’s market.
We are in a low-interest-rate environment. But the Fed’s recent rate hikes are going into effect. Given this dynamic, what is driving investors towards private senior debt?
Roelke: My view is that the recent increase to short-term rates doesn’t seem to have impacted the perception that we are in a low-interest-rate environment. Obviously, if we look at the 10-year or 30-year rates, we are still close to all-time lows, and from an investors’ perspective, they are asking “where else are we able to derive yield other than Treasuries?” where historically there was a much higher ability to generate income.
Schwimmer: What’s driving interest in private debt has been the illiquidity premium between the highly liquid asset classes – fixed income and public equities – and alternative assets where Nuveen TIAA has been very active. That gap now has widened. Investors looking for that yield are seeking managers which have experience in that illiquid asset class.
Kencel: I do think we’re getting closer to an interesting cross-over point in the market. There is a recognition that in this lower-rate environment, that we have been in for some time now, in more and more of the pension funds and endowments that we’ve talked to are lowering their return targets. If you would go back five years ago, they were generally targeting, or certainly hoping to achieve, 8-10 percent. Now you are hearing, “well we hope to achieve 6-8 percent”. Traditional middle market senior loans offer an attractive alternative for these investors– with better pricing, more conservative structures and a floating rate to protect against rising rates.
Of the capital that has been raised in private credit, how much is for senior debt versus other strategies? And why?
Schwimmer: Close to $100 billion in private credit was raised last year, but 80 percent of that was for higher-risk investments, while only 20 percent was dedicated to senior secured debt, where Churchill plays. While there’s a perception of “all this capital going into the market”, it’s going into a very different risk category that’s essentially junior capital masquerading as senior debt.
Kencel: If you think of the capital structure in a typical company, 80 percent of the debt that is in that capital structure, in most cases, is actually more traditional senior debt. And only 20 percent of the capital might be junior debt or more subordinated debt or higher-yielding debt. So, you’ve got a bit of a mismatch, we think, in terms of the capital raised.
Roelke: As Randy just said, you have 80 percent of the capital raised targeting 20 percent of the balance sheet.
Kencel: Right. What we’ve seen is obviously a lot of capital coming into the space – call it $80 billion in terms of capital raised – and yet the actual need is primarily in the senior space.
What types of returns are senior debt investors able to garner?
Kencel: It’s interesting if you look at the spectrum of returns within private credit, generally. The most conservative and highest-quality traditional middle-market senior and unitranche loans are in that 6 to 8 percent range. And that’s the area where you see quality companies, with consistency and stability in business model, and top tier sponsors.
Schwimmer: We’re seeing in our deals today a good balance between investor and issuer-friendly terms. All-in yields have remained very stable, in the 6 to 7 percent range.
What kind of deal terms or structures are you seeing in the senior debt space?
Kencel: So, take us as a good example of the traditional mid-market lending area. Last year, we invested over $1 billion in mid-market senior loans. If you look at the credit quality profile of our borrowers, it has been extraordinarily stable. We’ve been hovering about 40 percent LTV in our businesses. Meanwhile, sponsors are paying up for companies; they are paying higher multiples. An average purchase price multiple for an average company is in excess of 10 to 12. Pricing has remained stable as well, and we have been hovering in that 6 to 7 percent yield the last couple of years now.
Roelke: And, I think that’s probably the biggest thing that I would point to that is showing a market in equilibrium. Whereas inflows and outflows in the broadly syndicated loan market lead to 100 basis point swings in a month in terms of their pricing, for example, here we have been at roughly 6.5 percent returns for five years.
What are some other edges that are critical for investing in the senior debt space these days?
Kencel: The ability to deliver capital in scale and to be an investor at $50-100 million today is a real advantage. There are not that many firms on the traditional senior lending side that can write a $75 million check. We can and we are one of a handful of firms that can do that.
Schwimmer: Another key is the alignment of interests between us and our private equity sponsors. With a non-sponsored company, that’s not necessarily the case. You may find a disparity between the owner, who created the business from scratch and wants to keep it going no matter what, and the lender that has a fiduciary responsibility to protect their loan. With the PE model, the sponsor and lenders are incentivised to work together. Anything that impacts the value of the sponsor’s equity may impact the lenders as well, and vice-versa.
Roelke: Diversification is critical in terms of driving long-term success because we are looking to minimise downside as opposed to maximising upside. Our average position size is only 1 or 2 percent of any individual vehicle.
Kencel: And we are very ‘industry focused’. We focus significantly on not just the cashflow, but the stability, the consistency of the underlying cash flow and how that company’s performed in a stressed environment. So, we are operating in industries that are generally not going to be subject to things like significant commodity volatility or regulatory changes that could change the overall industry dynamics dramatically in a relatively short period of time, areas like energy, chemicals, and retail, which are generally spaces we don’t focus on.
Playing well in the sandbox, not just with the sponsor but with the other lenders, is actually really important. If there is a workout or restructuring, if there are changes to be implemented, we are going to be constructive in trying to drive a solution that makes sense for the business and obviously works for our investors.
Ken Kencel is president and CEO of Churchill Asset Management. Brian Roelke is managing director and head of TIAA Private Capital. Randy Schwimmer is senior managing director and head of origination and capital markets for Churchill Asset Management.
This article is sponsored by TIAA Private Capital. It was published in the May 2017 issue of Private Debt Investor