LevFin Insights is working with the organizers of Private Credit Industry Conference on Direct Lending and Middle Market Finance for pre-event coverage. The conference, hosted by DealCatalyst and the LSTA, will take place in Fort Lauderdale, Fla., on May 9-10.
The agenda for the conference is available at https://events.dealcatalyst.io/DirectLending2024/agenda
The event brings together direct lending investment professionals, institutional allocators, advisors and more to reflect on the fast-paced evolution and growth of private credit, the importance of portfolio management, ESG and numerous other topics.
In the below interview, LevFin Insights sat down with Brendan McGovern of 26North Partners to discuss private credit investor constituencies, the growth of the asset class beyond direct lending and how banks and private credit managers may have more touchpoints – opportunity to drive business for each other – than initially thought. He will be speaking on the Innovations in Private Credit Across the Asset Spectrum panel on May 9.
Private credit has grown immensely in recent years, and one recent focus has been the retail channel. How has that evolved?
Historically, if an investor wanted exposure to private credit assets, the access point was through a private fund that was only available to certain accredited investors and not retail investors. BDC structures have broken down barriers that previously prevented retail participation in private credit.
BDCs are regulated by the Investment Company Act of 1940 and provide strong investor protections, making them appropriate for retail clients. The first BDCs were all public companies, and if investors wanted to get exposure to the asset class and later get their capital back, they could buy and sell their BDC shares on a liquid, tradable exchange.
But what investors found is that market volatility could sometimes result in the stock trading below net asset value. So, what we’ve seen take place is the advent of a newer flavor of BDC that are perpetually private but do offer investors a modicum of liquidity on a quarterly basis through a tender process. Both public and private BDCs continue to be easily accessed by retail investors who are interested in the private credit value proposition.
Insurance companies also have unique needs in their investments, as commingled fund investments can result in inefficient capital management. How have they invested in private credit?
We’ve seen insurance companies move away from investing through funds because of capital inefficiency, and we’ve seen them move away from separately managed accounts due to operational inefficiencies.
Rated note structures are becoming increasingly popular for insurance companies looking for access to the asset class. Through these structures the asset manager does the hard work and heavy lifting of originating a portfolio of loans through an SPV that’s owned by one or more insurance companies.
Once the portfolio achieves the needed diversification, the manager can go to a ratings agency, and basically tranche out the exposure back to the insurance company. Through this process the insurance company can effectively recreate the underlying economics of owning the whole loans, but through a more capital efficient exposure on its balance sheets. Also, since the insurance company doesn’t own the whole loans on its balance sheet, it doesn’t have to manage corporate actions such as fundings and amendments, which creates operational benefits.
Has the rise of direct lending made it easier for institutional investors to embrace other strategies?
The expansion of direct lending has paved the way for new asset classes to also see a shift away from public markets to private markets access points. Asset-backed finance comes to mind for me. There’s been a high-functioning, public ABS market for decades.
But today what we’re seeing is, just like we saw in corporate credit, asset managers are disintermediating what was a bank-led origination model. Asset managers have captive and growing capital designed to hold the risk long term, which allows private originations to grow.
Banks and direct lenders compete for deals, but is the relationship more mutually beneficial than people might think?
I think it is. On the one hand, it’s definitely true that a deal placed to a direct lender is a lost fee opportunity for the leveraged finance department of an investment bank. But I think that simple observation ignores a number of different fee opportunities that get created for banks because of the existence of the private financing.
For example, that private direct lending deal may have facilitated an M&A transaction and fee that would not otherwise have happened because the syndicated market couldn’t finance the deal. Also, it’s likely that a bank had a role in raising either the LP capital or the leverage for the direct lender’s portfolio, which also resulted in a new revenue opportunity for that bank.
So, I think that the different direct lending driven opportunities that banks benefit from creates a more symbiotic relationship between the parties than you might otherwise have believed.
Andrew Hedlund
Managing Editor
LevFin Insights
