Private credit
Private credit: A case for senior loans
Here’s three reasons why we believe now may be a compelling entry point and opportunity for long-term investors in private credit and senior secured bank loans.
The core middle market presents a large and fragmented opportunity set and attractive competitive dynamics vs. the upper middle market
Potential total return advantages include high current income relative to liquid markets with lower volatility
Sourcing and due diligence expertise is essential for success in this space due to the idiosyncratic nature of investment opportunities, while ESG experience can also differentiate lenders
We define the core middle market as companies with between $100 million–$750 million in enterprise value and generating annual revenues between $10 million−$1 billion. The universe of companies in this segment is highly fragmented and represents a wide range of sectors and industries.
Relative to the lower middle market, companies in the core middle market have more robust infrastructure and governance and therefore tend to be less exposed to negative idiosyncratic events. Relative to the upper middle market, the core middle market is more fragmented and features a friendlier competitive environment.
|
Lower middle market |
Core middle market |
Upper middle market |
---|---|---|---|
Company enterprise value |
< $100 million |
$100 million–$750 million |
$750 million–$3.0 billion |
Company debt facility |
< $50 million |
$50 million–$400 million |
$400 million–$1.5 billion |
Company exposure to negative idiosyncratic risks |
High |
Medium |
Low |
Company infrastructure and governance |
Limited |
Developed |
Advanced |
Competitive landscape for deals |
Highly fragmented Strategy specific |
Fragmented Less competitive due to club transaction focus |
More concentrated Highly competitive AUM growth focus |
Participants |
Small BDCs, small loan managers, and junior capital providers |
Stand-alone credit platforms and medium-sized BDCs |
Largest diversified credit platforms, regional/investment banks, large BDCs, and CLOs |
Large, fragmented market with attractive characteristics
The U.S. middle market is a large and diverse ecosystem that represents virtually every industry, including business services, industrials, healthcare, consumer, and financial services.
Middle market senior secured loans offer structural advantages that have the potential to meaningfully mitigate downside risk.
Prepayment protection: Middle market loans often provide mechanisms such as call protection to compensate lenders for prepayment, limiting reinvestment risk.
Terms in the core middle market are generally more attractive relative to the upper middle market, which is a more competitive space due to the larger size of deals and availability of traditional capital financing for many deals. For example, maintenance covenants continue to persist in the core middle market while there has been erosion in the ability to obtain meaningful maintenance covenants in the upper middle market.
Why are these covenants significant? They can help lenders:
We believe success in middle market direct lending requires two core areas of expertise: sourcing and due diligence.
Sourcing capabilities
The core middle market is extremely relationship-driven. Origination in the middle market requires strong connectivity and direct relationships with a broad base of private equity sponsors, networks of advisors, service providers, and management teams. Sponsors continuously seek to receive financing from lending professionals and platforms with whom they have had extensive experience—relationships driven by longevity, reputation, and trust. Credit platforms that offer borrowers a range of capital sources and are staffed with professionals who maintain close relationships with sponsors and issuers are particularly well-positioned.
Due diligence expertise
Middle market underwriting requires bottom up, fundamental diligence to comprehensively evaluate the health of the borrower. Unlike traditional debt strategies, middle market loan portfolios tend to be comprised of illiquid positions, meaning that a lender is likely to maintain an investment until repayment. A comprehensive evaluation of the issuer is needed to understand the sustainability of the business model and any potential issues that could impact the borrower’s ability to service its debt obligations. Sector knowledge is required to review an issuer’s performance, risks, and sector-specific concerns. Private credit platforms that possess sector-specific expertise and extensive industry relationships tend to be favored by deal sponsors as they can effectively and efficiently underwrite transactions.
Our Direct Lending team has decades of experience in sourcing, underwriting, and executing senior secured loans in the core middle market. Our capabilities have made us a trusted partner in the space.
Source: National Center for the Middle Market, as of December 2022.
Source: Cliffwater 2022 Q3 Report on U.S. Direct Lending
Private credit: A case for senior loans
Here’s three reasons why we believe now may be a compelling entry point and opportunity for long-term investors in private credit and senior secured bank loans.
Current market dislocations in private credit: Distressed debt
Rising interest rates and higher inflation set the stage for distressed investors to focus on solid, operationally sound companies in stable industries.
Current market dislocations in private credit: Direct lending
Direct lending has three components to yield: base rate, an upfront fee, and a spread component. On the supply side, there are over 200,000 middle market companies with a consistent demand.
This link takes you to a site not affiliated with Invesco. The site is for informational purposes only. Invesco does not guarantee nor take any responsibility for any of the content.