The Obstacle Between Credit Funds and a Giant Pool of Money

Illustration by II

Illustration by II

And how some canny managers are getting around it.

Insurance companies are vying for yield, and asset managers are eager to provide it through alternatives such as private credit. There’s just one problem. Insurance regulators impose strict capital requirements that make popular debt strategies too expensive to own. Ever creative, certain asset managers think they’ve found a workaround: ratings agencies. For the first time, credit funds are asking for ratings.

“The trend is happening and is likely to continue,” says Rory Callagy, senior credit officer at Moody’s Investors Service, which does not currently rate private credit funds. “Asset managers view insurance companies as a big potential supply of new capital, and they’re trying to provide solutions.”

Insurance companies have always operated within tight rules limiting risk in their portfolios, as they’re on the hook for massive and unpredictable payouts. The firms’ general accounts tend to be 80 percent in fixed-income securities, but they still need to deliver returns. Bonds aren’t cutting it. Interest rates have been at historic lows for a decade, even after recent hikes.

Alternatives — and their potentially higher returns — appeal to insurance companies, given the environment.

But insurers can’t often pull products off the shelf. “You have to think about how they would impact risk-based capital charges,” notes Callagy. “Managers seem to be pursuing ratings as a way to address that factor.”

One such firm is Metropolitan Partners Group Management, which extends loans of $5 million to $50 million to small and midsize businesses with tangible assets to back them. The lender recently began applying to get its funds rated. Paul Lisiak, who founded Metropolitan in 2008, says the loans deliver fixed-income returns in the mid- to high teens. Those numbers are potentially attractive to insurers.


But insurance companies hesitated when the firm pitched them an opaque limited partnership fund, Lisiak says. “They told me, ‘I like the strong return profile, but that sits on my balance sheet as equity unless the instrument can be rated.’ ” Metropolitan ultimately offered managed accounts, a structure that allows insurance companies to invest in whole loans.

Metropolitan initially originated individual loans and worked with insurance companies to get agency ratings. Then the insurers would buy them one by one. But the review process for each private loan proved too onerous to be profitable long-term.

When the fund manager raised money from endowments and others for its fifth fund, it also secured an insurance company limited partner as a test case. Metropolitan is in the process of getting the new fund rated after receiving so-called “indicative” ratings for earlier funds. Once the concept is borne out, the firm plans a broad marketing push and to get future funds rated.

“We wanted to work with one group to focus and make sure we were addressing the true needs of an insurance client,” Lisiak says.

Fund ratings are aimed at insurance firms, but they also indirectly help other investors. A number of endowment CIOs told Lisiak that they didn’t need the rating, but it was helpful for comparing public market bond portfolios with private funds. If an illiquid private fund is rated BBB+ and expected to return 11 to 14 percent, and a liquid fund with the same rating earns 7.5 percent, an endowment’s board can easily see the 350-basis-point bonus for locking up its money.

Dan Pietrzak, co-head of KKR Private Credit, says the firm works with insurance companies that are strategic partners and want to hold individual loans in a separately managed account. “It’s a combination of not needing the leverage of traditional funds and the fact that holding an interest in a nonrated fund is inefficient and somewhat punitive,” he explains.

Smaller funds are most likely to go after ratings, at least initially, according to Lisiak. “The funds that are two to three times my size already have broken into the endowment and pension markets, so they may not be as attracted to this.”

Ratings agencies are getting on board, too.

“Private credit is an opportunity, and we want to package it in a way that makes it usable for insurance companies,” says Callagy from Moody’s.