The banking fortress

If the global narrative is bank retrenchment advancing the cause of private debt, nobody told Canada, reports Andrew Hedlund

There seems to be two sides to the Canadian private credit market: a robust presence of sophisticated limited partners, some of which have a global direct investment platform, and a deal market where banks continue to have a major presence.

Large retirement funds such as the Canada Pension Plan Investment Board (CPPIB) and Caisse de dépôt et placement du Québec (CDPQ) have been some of the early players in the private credit space, playing the role of both capital allocators and deployers.

The size and scale of their operations dwarf many US general partners. Three years ago, CPPIB acquired GE Capital’s mid-market lending platform, Antares Capital, which lent $21 billion in 2017. Last summer, CDPQ partnered GE Aviation Services to create a $2 billion aircraft leasing and financing platform.

Smaller and medium-sized LPs are beginning to allocate to the asset class as well. In fact, when Northleaf Capital acquired a 16 percent stake in Antares in 2016, one of the end results was to allow Antares access to those types of LPs that may want to set up separate accounts for the asset class.

Then, there is the deal market.

“Most banks have a platform that provides higher-risk loans,” says Darrell Pinto, research director at the Canadian Venture Capital and Private Equity Association (CVCA). And if those financial institutions don’t have such a product, they are moving into it. Pinto notes CIBC’s recent purchase of Wellington Financial, a lender to venture capital-backed companies.

“It’s a sign of how banks are starting to engage in this space in a bigger way,” he adds. “Since the Canadian lending space is highly relationship-based, it’s easier in this environment to buy rather than trying to build a footprint in this space, which could take years.”

Steady increase

The Canadian private equity market has seen a steady increase in deals. The number of transactions, as opposed to their dollar value, are a better way to evaluate the market because one or two mega-deals can skew the overall picture, Pinto explains.

Many of those deals are less than $100 million, which don’t normally have a lender, he explains. Rather, the private equity firm will write a cheque covering the entire deal. Of the 603 private equity deals done in Canada last year, 429 were less than $100 million, according to CVCA’s data.

When lenders are involved, they are often banks.

“The private equity market has always been pretty well served by financing solutions provided by the Canadian banks,” says one credit fund manager. “It ends up being difficult for an institution to build a private credit portfolio based solely on the Canadian market.”

The source notes an increase in Canadian deals, but these account for only 5 percent of its overall deal flow. The US makes up the majority of the firm’s pipeline, while Europe constitutes 35 to 40 percent.

One Canadian general partner that has benefitted from Canadian LPs for private credit is Sagard Holdings. The Toronto-based outfit brought in Adam Vigna from CPPIB in October 2016 to build out a new credit platform.

The firm held the first closing of Sagard Credit Partners in January when it rounded up more than half of the capital required to hit its target, locking down $260 million toward a $500 million target.

The Toronto-based Healthcare of Ontario Pension Plan, Montreal-based family office BRK Capital, and another “large Canadian corporate pension plan” were among the first allocators to the fund, according to the announcement.

“We believe there is an underserved market in the US and Canada in the private credit space, particularly as it relates to the non-sponsored market,” Vigna tells PDI.

He says his firm sees a large portion of deals close to home. Of around 20 possible deals a month, at least half the transactions are in Canada, he says. The firm has closed on three deals, totalling around $100 million.

The fund is targeting a 10-12 percent unlevered net return and will write cheques of approximately $30 million to $40 million. A large amount of the capital in the debut fund will come from Canadian LPs, Vigna says, but Sagard will look to bring in US and European investors as well.

Not all private equity deals go to banks. One of Sagard’s initial investments went to a Canadian private equity firm, Calgary, Alberta-based Founders Advantage Capital, to which Sagard lent a $42 million senior secured credit facility.

Not about fixed income

Some Canadian LPs are using the asset class differently from their counterparts in the south. In the US, many pension funds have adopted private credit within their fixed-income portfolio, making it an alternative or complement to traditional bond funds. That’s not always the case in Canada.

“Sometimes [private credit is] a debt replacement, sometimes it’s an equity replacement,” says Janet Robovsky, a partner at Ellement, a Canadian pension investment firm. “The average discount rate [in Canada] is much lower than the US, so you don’t have to go as deep in the capital structure [to meet your return targets].”

Most discount rates in Canada are around 5.5 to 6 percent, she explains, which is due to stronger regulatory oversight in Canada than in the US. That means those with oversight of the Canadian pension funds ensure discount rates are more in line with market expectations.

The average discount rate for public pension plans in the US is 7.6 percent, according to data from the National Public Pension Coalition, a pro-public pension advocacy group. By comparison, private pension plans, which are governed by the Employee Retirement Income Security Act federal law, had a discount rate of 4.39 percent in 2016, according to analysis by trade publication Pensions & Investments.

Commingled funds targeting Canada specifically are relatively rare, so to build out a well-diversified private debt allocation LPs need to look beyond their borders, to funds that have a larger geographic investment mandate.

“There’s only a few that invest in Canada,” Robovsky says. “So, you tend to have to go outside [Canada] to build a diverse portfolio. I would say that the US would be a first point of call.”

The US may be a beneficiary of a still-nascent private credit deal market in Canada, but maybe one day GPs will say private credit is as Canadian as maple syrup.