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Opportunity and Value in Private Credit

The middle market is a prime source – and the potential may continue to grow.

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There always has been and remains excess spread in private debt opportunities in the middle market – but many institutional investors find it difficult to access the middle market.

“You can’t flip a switch and succeed,” says Andrew Edgell, Senior Managing Director & Global Head of Credit Investments, at CPP Investments, one of the world’s largest pension funds. “You need the proper infrastructure to get it right. That said, we see tremendous opportunity in the mid-market space – where deal sizes are slightly smaller and the business is a lot more human resource intensive.”

CPP Investments taps into the potential of mid-market exposure in private credit through private debt credit manager Antares Capital, a market leader for more than 25 years. CPP Investments invested in Antares in 2015.

“We partner with Antares to access the middle market, and see huge value in originating and underwriting of loans,” Edgell says. “Because the deal sizes are smaller, we see better pricing and terms than we would on the broadly syndicated market. For example, middle market direct loans have offered up to 200 basis point premium versus broadly syndicated loans since 2013.1 We’ve worked with Antares in several scenarios in which they originated the deal, developed the relationships over time, invested in the senior capital, and syndicated parts of the capital structure. We have provided junior capital, been there when the sponsor has sold the business to another sponsor, or even went public. That symbiotic relationship with Antares allows us to play holistically in the capital structure over time. We think there’s a lot more opportunity to come in the mid-market as a result, and in private debt overall.”

A changing middle market

The definition of middle market has expanded as the market has matured and become a more attractive asset class. There was a time when investors would get covenants on every mid-market deal, but cov-lite has become increasingly common, particularly at the upper end of the middle market size range.

“There are ways we strive to mitigate the risk associated with the loss of covenants, but it’s becoming more difficult to harvest yield premium unless you are well positioned as a lending leader,” says Edgell.

The mid-market has upsized over the years, too, with more players – not a lot, but more – willing to write the bigger checks. The U.S. has seen over $50 billion in unitranche loans sized at $1 billion or larger since September 2019, for example.2 Direct lender deal sizes have been growing along with the portfolio companies they’ve been financing for years, but only the biggest players have the hold-size capability to play at the highest end of the middle market.

“Even outside the mid-market, direct lenders are taking a share of the broadly syndicated large deals normally led by banks – and still getting premium spread because direct lending can be easier to execute. There is no [credit] rating or roadshow, and no flex – and there is confidentiality,” Edgell says.

Wider opportunity set

At CPP Investments, the credit investment business is highly diversified, providing debt-financing solutions across the entire capital structure. About 80% of its strategies are private, and a large chunk of that is corporate leveraged buyout [LBO] finance.

“Private debt and private credit include many different sleeves, of course, but the main part of our business is LBO finance,” says Edgell. “Because we’re one of the world’s largest private equity LPs, we’ve been able to create some incumbency in many capital structures and be there for multiple iterations of the company’s lifecycle. This is very attractive for identifying credit opportunities as we look to grow our AUM. Also, from an underwriting and risk management perspective, it puts us in a position to better understand company management teams and see how their strategies play out.”

Edgell and his team tend to be fast followers of sponsor-backed debt because, as he puts it, “sponsors tend to invest in better businesses, so we get behind their diligence. They bring a lot of industry expertise to the table. They tend to organize themselves around industry sectors.”

In his experience, Edgell has found this especially true with partners his team is familiar with through the pension fund’s private equity funds and direct private equity business. That translates into confidence that the business has already been vetted when a deal comes in the door from a private equity sponsor. Sponsors also stepped up in terms of financial and agile management support at the height of the pandemic.

A huge driver of growth in the credit markets is private equity sponsors. There’s over $1.1 trillion of PE dry powder according to recent numbers from Preqin, and similarly cited direct lending numbers are about 20% of that amount. Even with all that dry powder, there’s likely not enough debt 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 opportunity in the corporate credit markets,” he says. “Seeing a big opportunity, however, doesn’t stop us from trying to diversify the portfolio and target other pockets of opportunity. And that’s ultimately how we drive long-term value for CPP Investments’ contributors and beneficiaries.”

1 Refinitiv LPC

2 “Direct Lending Deals,” Q3 2021