There have always been and still are excessive spreads in private debt opportunities in the middle market – but many institutional investors struggle to access the middle market.
“You can’t flip a switch and be successful,” says Andrew Edgell, senior managing director and global head of credit investments at CPP Investments, one of the world’s largest pension funds. “You need the right infrastructure to do it right. That said, we see huge opportunities in the mid-market space – where deal sizes are slightly smaller and the business requires significantly more human resources.
CPP Investments leverages the potential for exposure to the private credit middle market through private credit manager Antares Capital, a market leader for over 25 years. CPP Investments invested in Antares in 2015.
“We are partnering with Antares to access the middle market and see tremendous value in originating and underwriting loans,” says Edgell. “Because transaction sizes are smaller, we are seeing better pricing and terms than we would in the heavily syndicated market. compared to heavily syndicated loans since 2013.1 We have worked with Antares in several scenarios where they originated the transaction, developed the relationships over time, invested in senior capital and syndicated parts of the capital structure. We provided junior capital, been there when the sponsor sold the business to another sponsor, or even went public. This symbiotic relationship with Antares allows us to holistically play into the capital structure over time. We think there is a lot more opportunity ahead in the middle market as a result, and in private debt in general.
A changing middle market
The definition of the middle market has broadened as the market has matured and become a more attractive asset class. There was a time when investors got commitments on every mid-market trade, but cov-lite has become increasingly common, especially at the upper end of the mid-market size range.
“We are working to mitigate the risk associated with the loss of covenants, but it becomes more difficult to reap a performance premium unless you are well positioned as a lending leader,” says Edgell.
The middle market has also grown over the years, with more players – not many, but more – ready to write the biggest checks. The United States has seen over $50 billion in unitranche loans of $1 billion or more since September 2019, for example.2 The size of deals with direct lenders has grown with the holding companies they have funded for years, but only the biggest players have the ability to play at the high end of the middle market.
“Even outside of the middle market, direct lenders take a slice of the large, heavily syndicated transactions normally conducted by banks – and still get a spread premium because direct lending can be easier to execute. There’s no [credit] evaluation or roadshow, and no flexibility – and there is confidentiality,” says Edgell.
Wider set of opportunities
At CPP Investments, the credit investment business is highly diversified and provides debt financing solutions for the entire capital structure. About 80% of its strategies are private, with a large portion being corporate leveraged buyouts [LBO] finance.
“Private debt and private credit have many different rounds, of course, but the main part of our business is LBO financing,” says Edgell. “Because we are one of the largest private equity LPs in the world, we have been able to create incumbents in many capital structures and be there for multiple iterations of the investment life cycle. business. This is great for identifying credit opportunities as we look to grow our assets under management. Plus, from an underwriting and risk management perspective, it gives us a better understanding of the direction of companies and see how their strategies are unfolding.
Edgell and his team tend to follow sponsor-backed debt quickly because, as he puts it, “sponsors tend to invest in better companies, so we back their due diligence. They bring a lot of industry expertise to the table. They tend to organize themselves around industrial sectors.
In his experience, Edgell has found this especially true with partners his team knows well through the pension fund’s private equity funds and direct private equity business. This translates into confidence that the company has already been vetted when a deal comes to the door of a private equity sponsor. Sponsors have also strengthened in terms of financial support and agile management at the height of the pandemic.
Private equity sponsors are a huge engine of growth in credit markets. There’s over $1.1 trillion in dry PE powder according to recent numbers from Preqin, and similarly cited direct lending numbers are about 20% of that. Even with all that dry powder, there probably isn’t enough loan capital available to meet demand.
Edgell likes what he sees in that regard, but he’s not overlooking other opportunities.
“At a high level, we see great opportunities in corporate credit markets,” he says. “However, seeing a big opportunity doesn’t stop us from trying to diversify the portfolio and target other pockets of opportunity. And this is how we produce long-term value for contributors and beneficiaries of RPC Investissements.
1 Refinitiv LPC
2 “Direct Lending Agreements”, Q3 2021