# Intro To Private Credit Csk5C

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[00:00:00.560] Hi, friends. Welcome back to another episode of Peer Connections, the podcast series brought
[00:00:08.440] to you by the Global Peer Financing Association, also known as GPFA. These podcasts offer our
[00:00:13.380] GPFA members and global beneficial owner friends a forum for information sharing and discussion
[00:00:18.180] on topics most important to them. And we hope you, our listeners, appreciate the insights,
[00:00:22.780] best practices, and transparency offered from our members and industry friends about securities,
[00:00:26.960] finance, or related investment areas. Now let's get into the episode.
[00:00:35.970] Hi, listeners. Welcome back to another episode of GPFA's Peer Connections for the Global Peer
[00:00:40.730] Financing Association. We're excited today to bring to you this episode, which is an episode
[00:00:45.590] from one of our discussion groups. So GPFA runs a number of discussion groups on a wide range of
[00:00:51.050] topics where members can come together to explore conversation and best practice. And within the
[00:00:55.590] last year, the GPFA formed a new discussion group on the private credit markets. In today's episode,
[00:01:01.110] We tune in to a recent meeting that the Private Credit Discussion Group held in Toronto, where we had speakers presenting an introductory overview on the private credit market space.
[00:01:12.130] We want to thank our hosts and sponsor for the event, Osler, Hoskin, and Harcott, and also our expert speakers from HOOP, the Healthcare of Ontario Pension Plan, and CalSTRS, the California State Teachers Retirement System.
[00:01:26.570] Thank you again to those that joined in person for this meeting, as well as tuned in virtually at the time. And thank you to our listeners today for spending the moment with us. Now, over to our episode.
[00:01:38.350] Thank you all for coming. Thank you for attending. I am Lisa Mantel. I'm a partner here at Osler and one of the founding contributors to the GPFA. I'm joined today by a great panel. We have here Jason Pearlstein. Jason is a longtime investor. He's also an alumni of Osler, so we go back.
[00:01:55.350] I used to work for Lisa. That's what she's trying to say.
[00:01:58.850] And here on my left, we have Liz Berberakis, who is my partner in our financial services group.
[00:02:05.270] And joining by phone here, we have Christian Altier, who is at CalSTRS. So thanks all for
[00:02:11.990] joining. So our topic today, private credit. So this is something that's been very topical. It's
[00:02:17.930] in the media a lot. It's in the business news a lot. We're hoping that this will really be
[00:02:22.250] somewhat of an introductory session. So why don't we just start with what is private credit? So
[00:02:27.790] Jason, why don't we start with you? Yeah, I think the what is private credit is not complicated.
[00:02:33.550] What's nuanced is the execution and the investing in private credit. So what is private credit?
[00:02:39.710] It's loans that are not held by banks effectively or syndicated by banks. So most people know what
[00:02:47.650] alone is, take a big step back. So basically, every company and every asset that is large and
[00:02:54.910] purchased by the private equity community is financed with a combination of credit and equity.
[00:03:02.250] Equity, you invest in for the upside, but you don't have a fixed return. Credit, the opposite,
[00:03:08.850] you have the fixed return, but you don't have the upside unless you do some structuring,
[00:03:13.870] which you can also somewhat do in private credit. But generally, you have a fixed return. And the
[00:03:19.030] main risk is the risk that your borrower does not or cannot pay you back when your loan matures.
[00:03:26.370] So that's really simple. What is more nuanced and interesting and topical is what there is to do
[00:03:34.650] these days in private credit. Private credit used to be, and it's been around forever in the sense
[00:03:40.710] of private loans. Private credit historically has financed some of the private equity bio community
[00:03:46.870] and some distressed debt. What has grown very, very significantly recently is the scope of
[00:03:53.450] private credit. Private credit now finances M&A activity. It finances assets. You can do it in
[00:04:01.250] what's called investment grade, which is very high quality borrowers with some lower return.
[00:04:05.430] You can do it in less high quality borrowers with some higher return. You can do it in senior
[00:04:10.390] format, meaning you're first, you can do it in junior format and be in second. So there's so
[00:04:16.270] much to do in private credit, which makes it really interesting and topical and growing and
[00:04:22.770] sort of the genesis of why we're all here today. Great. Christian, how about you? Anything to add
[00:04:28.170] on that? Obviously, private credit is very different in the different markets. We're here
[00:04:32.470] in Canada. I would say that this is a burgeoning market here, sort of in its infancy. The US really
[00:04:38.350] seems to be the leader in this. But Christian, you tell us, what's your perspective from the U.S.?
[00:04:43.530] Yeah, I would just echo Jason's comments in terms of just the private credit investment universe is
[00:04:48.750] just really vast. This is from our seats spanning across corporate and non-corporate, ranging from
[00:04:53.910] senior to junior, and then you get into structured finance. In the U.S., definitely a very large,
[00:04:58.790] mature private credit ecosystem, still dominated by corporate direct lending, and then direct
[00:05:04.390] lending activity is still very much sponsored buyouts and M&A. When I say sponsored, think of
[00:05:09.730] companies essentially owned by private equity firms that have a fund around that. But that
[00:05:13.830] sponsored direct lending space, it's becoming, no surprise, a very crowded space. And what we're
[00:05:18.350] seeing is many specialized direct lending lenders out there increasingly pursuing kind of more
[00:05:23.710] non-sponsored deals. So think of your management buyouts, family-owned businesses, even your
[00:05:28.850] independent sponsored transactions. So think an institutional owner or buyer does not necessarily
[00:05:33.810] a PE fund behind that. And we're seeing more non-sponsored deals as a way to look for more
[00:05:39.190] proprietary deal flow or differentiated opportunities. One of the main allures to
[00:05:45.330] non-sponsored transactions is that you can typically strike up a much stronger lender
[00:05:50.190] document with better pricing and protections than otherwise would with a sponsored transaction.
[00:05:56.130] It's kind of holding all else equal. And when you think about it, when you're negotiating
[00:06:00.030] directly with a PE firm, very financially sophisticated. And I'm not implying that
[00:06:05.330] that's not the case for non-sponsored, but the PE firm, right, highly focused on pricing and
[00:06:10.450] leverage, right, when they're getting their cost in place may not be necessarily the case for a
[00:06:15.850] non-sponsored borrower. Now, one of the main challenges for this non-sponsored space really
[00:06:20.830] comes down to sourcing and the deal flow. As you can imagine, it's much more resource intensive.
[00:06:26.650] You're having to source your deals outside of your Rolodex of sponsored networks that kind of all have their own respective pipeline activity going on.
[00:06:35.890] And I think that might also be another reason why we're starting to see a growing number of these kind of bank private credit partnerships on the rise, because those, especially if they're done right, can be highly synergistic for both parties.
[00:06:47.970] We know why the banks are doing it, right?
[00:06:49.490] They want to be able to offer a wider product suite to their clients while still within their ecosystem, which they can accomplish via these partnerships.
[00:06:57.630] And then the direct lenders, in turn, now have access to the financing needs of the bank's fund base.
[00:07:03.490] That's very interesting and very relevant to our Canadian market.
[00:07:06.890] I think, as we all know here in this room, that the Canadian market is really dominated by the Canadian banks, particularly the Schedule I banks.
[00:07:14.010] And we've been hearing from some pension plans that are interested in doing these types of joint ventures with the banks, getting together, offering them.
[00:07:22.530] Obviously, pension plans can't offer things like deposit services, other bank products.
[00:07:26.910] But this is maybe something we'll see in Canada where you get together with Royal Bank or maybe one of the U.S. banks and offer different products and not necessarily the loan.
[00:07:37.910] Liz, anything to add to that, like from a Canadian perspective?
[00:07:40.490] I think all of those forms are sort of at various stages of their maturity in Canada. Certainly, we're primarily dominated by the direct lending space right now. But there is various forms that are building fund investment, the JV structure. There's certainly a lot of interest in the JV structure that is burgeoning right now. I don't know that we've seen a particularly active market yet, but there's a lot of talk about it. So it's certainly somewhere that people are looking.
[00:08:05.270] And I agree on the bank partnership concept is a very interesting idea because we've also
[00:08:09.290] seen the banks forming their own sort of private credit groups, which it sort of remains to
[00:08:13.770] be seen what corner of the market those are meant to structure and how those differ from
[00:08:17.270] traditional bank loans.
[00:08:18.870] But the JV interest with other private credit sources seems like the natural stepping stone.
[00:08:23.710] So interesting to see how that would play out in the Canadian bank market as well.
[00:08:27.790] For sure.
[00:08:28.230] Interesting to follow this.
[00:08:29.990] Krishna, I have one follow-up question for you just on the non-sponsored deals.
[00:08:34.070] Do you think eventually those will become sophisticated as well?
[00:08:37.830] I mean, I think in this room we all definitely understand and know why it's so difficult to negotiate against the sponsored deals because the key firms say we've done this deal a hundred times and these are the terms and you sort of just take it.
[00:08:52.230] Do you think that this will happen in the non-sponsored space as well as things progress?
[00:08:57.290] The law is a capital competition, right?
[00:08:59.030] We've seen it on the sponsor's side, and honestly, it happened a lot quicker than I anticipated.
[00:09:05.490] But, you know, I think the main thing that a non-sponsor has to go on, I mean, it's not as easy to scale that piece.
[00:09:11.270] So, yes, I think it'll come for them down the road, but certainly at a much slower rate than we've seen on the sponsor's side.
[00:09:17.430] Here's another question from a Canadian perspective.
[00:09:20.250] Again, speaking to many of the plans, how are the deals sourced if you're not partnering with the U.S.?
[00:09:26.250] Like, what do you think is the best way to source these deals?
[00:09:29.050] Is it sort of going to some of the banks and saying, hey, maybe that's not a borrower for
[00:09:34.010] you, you know, schedule one bank.
[00:09:35.990] But what are you doing at the plans?
[00:09:38.230] Is this just word of mouth?
[00:09:40.020] For us and for U.S. pension plans in general, our primary means of doing private credit
[00:09:44.580] is via fund investment structures.
[00:09:46.660] And so with these fund investments can often be supplemented by co-investments to help
[00:09:50.440] average down the effective fee load.
[00:09:52.120] But investing in funds is kind of how we do it.
[00:09:54.220] So in terms of how these private credit managers that have funds to this non-sponsored space,
[00:09:59.020] how they're addressing this market, I'd say it's a combination of all the above in terms
[00:10:03.300] of leveraging their banking relationships, other intermediaries.
[00:10:06.960] In many cases, they can be within a PE shop where the private equity part of the business
[00:10:11.560] are sourcing deals.
[00:10:12.600] And to the extent that they lose out on a deal or don't pursue a deal for whatever reason,
[00:10:15.840] it may still be a good fit on the credit side.
[00:10:18.280] And they can kind of struggle between kind of sponsored and non-sponsored situations
[00:10:21.640] within their sectors that they're targeting.
[00:10:23.760] Right.
[00:10:23.840] understood. Yeah, it's the same in Canada. And I think a lot of other investors globally is that
[00:10:28.620] there's some model, which is to partner fund investments with the experts sort of on the
[00:10:33.220] ground originating, and then try to co-invest alongside them in some direct flow as well
[00:10:39.100] through having actual teams that have real expertise in the asset class internally to be
[00:10:44.820] able to do that efficiently. And one thing I find, this is one of the few things bolded in my notes
[00:10:50.300] here, but it's so true. I think across and in private markets, but from my experience being
[00:10:55.040] in private credit, it really is a team sport and it needs to be a team sport. If you're going to
[00:11:00.060] venture out and do things like co-investments, et cetera, where you're trying to do it in a more
[00:11:04.100] dynamic way. I have colleagues here from all across the organization, from legal and tax and
[00:11:09.300] from operations, et cetera, et cetera. And if you're going to do that as an investor,
[00:11:13.980] You have to do that because you can't solely rely on the manager for everything.
[00:11:20.000] You have to, as an organization, have the team around it to execute, which is part of the challenge and also part of the fun in actually doing it.
[00:11:29.540] And Jason, tell us, what do you see in terms of trends in private credit?
[00:11:33.040] I know you'll talk about this, but one of my favorites is this ABL fame, mostly because when I started my career over 20 years ago, that was a major source of financing in Canada.
[00:11:42.540] And now to see that come back, I think is really very interesting. So tell us what you see.
[00:11:47.800] Yeah, I think ABLS, which stands for asset based lending is a big one. The reason kind of goes back
[00:11:52.560] to the history of how this all came to be and how we got here, which is, again, private loans have
[00:11:58.480] been around for decades. That's not new. What happened was the cycle of it, which is through
[00:12:03.640] the great financial crisis, there became a lot of increased regulation on the US banks, which were
[00:12:09.980] the primary lender of loans. But that credit continued. Who was issuing and making those
[00:12:17.340] loans and giving the credit is the private alternative firm community, which is the fund
[00:12:21.880] partners that Christian referenced. As that played out through the decade of the 2010s,
[00:12:27.480] that regulation continued. The private alternative firms grew. And as they grew,
[00:12:32.020] they were able to finance, make loans to larger and larger deals that only the banks could
[00:12:37.680] historically, to the point where today, the private alternative or private credit community
[00:12:43.520] can finance pools of consumer loans or acquisitions of actual lenders themselves to credit in the US,
[00:12:52.940] etc. And so it's the combination of the environment that pushed arguably intentionally,
[00:12:59.080] or I don't even know if that's arguable, the financing into the private alternative community,
[00:13:03.180] and the growth of that community that now leads to that growth in the asset-based lending space,
[00:13:10.720] which historically was dominated by the bank. So that's what's growing that. And it goes back to
[00:13:14.980] one of the first comments I made, which is how dynamic and how nuanced it is to be investing in
[00:13:19.920] private credit, which really is an umbrella term for a number of different private debt options to
[00:13:26.180] invest in. Liz, same question. Trends here. What do you think? I think there is certainly a lot
[00:13:32.240] of ABL interest on this side of the border as well. I think for similar, although slightly
[00:13:36.460] different reasons, of course, we've seen that regulatory story play out differently here. We
[00:13:40.920] didn't have sort of a run away from the banks in the same way that we saw in the U.S. that Jason
[00:13:45.420] described. As Lisa mentioned, you still got one of the biggest challenges, which was sort of preview
[00:13:49.560] the second piece of this, is the dominance of the big six Canadian banks in the Canadian market.
[00:13:54.360] But I think, so you've got the trend toward ABL. Part of that, and interestingly, is I think there
[00:13:59.460] is sort of a space in the Canadian market that is currently being taken advantage of by U.S.-based
[00:14:04.460] private lenders that are lending to Canadian companies that the banks don't see as either
[00:14:08.540] creditworthy or the terms are not accessible to those borrowers that well-established or even
[00:14:13.940] some of the smaller U.S. private lenders are taking advantage of investing up north in those
[00:14:18.500] companies. So there's that that we're seeing happening. That's particularly true in the ABL
[00:14:22.240] space. So there's opportunities for Canadian-based private credit sources to take a piece of that
[00:14:27.640] market and to look at that a little bit more closely. I think saying the thing that nobody
[00:14:32.260] has quite said yet, but in terms of our current political geopolitical climate, in terms of the
[00:14:37.240] volatility in the market, all of that sets a stage. I mean, this is perfect, very fertile ground for
[00:14:42.500] the growth of private credit. This is exactly why it lends value add to borrowers in particular,
[00:14:47.800] because you have the ability to be a little bit more agile in terms of your terms. You aren't
[00:14:52.140] beholden in the same way as the banks are to certain regulations. And so you can have that
[00:14:56.760] play out in terms of companies wanting faster funds to come into them quicker. So you've got
[00:15:01.340] that opportunity on both sides of the border, particularly in Canada. I would also add to that
[00:15:05.940] that there's obviously a push right now, formally and informally for Canadian investment in Canadian
[00:15:11.540] companies. So there is likely to be Canadian government pressure on big Canadian investors
[00:15:16.180] to explore those kinds of investment and private credit is an obvious space to take advantage of
[00:15:21.520] that impetus. One trend I do think we have to mention, Christian, I'm going to toss this one
[00:15:25.240] over to you. But when you talk about trend in private credit, because this one I think is the
[00:15:29.260] most current trend, which is developing live and kind of unclear, I think how this shakes out is
[00:15:35.120] emerging now of the private and the public credit markets, in some sense, with large borrowers
[00:15:42.640] having options now to go public or private or a mix thereof. Sometimes in market dislocations,
[00:15:49.560] the public markets might be the first to shut down and the privates can step in, etc, etc. So
[00:15:54.980] So Christian, putting you on the spot there,
[00:15:56.880] if you have any thoughts.
[00:15:58.160] Yeah, that's exactly right.
[00:15:59.560] We like to call that face the private BSL market.
[00:16:03.480] I mean, it's grown tremendously,
[00:16:05.080] but it's exactly that.
[00:16:06.260] You have these large borrowers
[00:16:07.720] that basically have their voice.
[00:16:09.360] I like to describe this whole trend as like,
[00:16:11.280] obviously we've had that first wave
[00:16:12.720] of private credit growth play out over the last 10 years,
[00:16:15.300] largely in non-investment grade,
[00:16:17.860] mid-market direct lending,
[00:16:19.500] with the second wave appearing to be asset back,
[00:16:22.180] AVL or specialty finance, as we commonly prefer, with AVL being a very large part of that.
[00:16:26.860] And then we're also seeing a pretty strong growth outlook for private IG, what Jason was referring
[00:16:32.940] to, which could be seen as a strong complement or alternative to traditional fixed income,
[00:16:37.400] though I think most would probably see it more as a complement. Still have the illiquidity premium
[00:16:41.800] there, at least historically lower default rates and stronger lender protections. So essentially
[00:16:47.780] offers enhanced yields and diversification benefits while maintaining the risk profile
[00:16:52.260] that's still comparable to traditional investment grade bonds. I think the real question around that
[00:16:57.140] really comes down to liquidity. You know, as for us, fixed income, I think this is true for most
[00:17:01.840] of us. Fixed income kind of still serves that dual purpose role in terms of offering both yield and
[00:17:07.260] diversification, but also liquidity if and when needed. What are the challenges for private credit?
[00:17:12.780] Jason, what do you see? I was hoping you were going to go with why is private credit comes to
[00:17:16.280] talk okay we can go to that we can go to either one you know what i'll answer both those questions
[00:17:21.480] together just because it dovetails it's a good story from what christian just mentioned which
[00:17:26.380] is what happens so my favorite headline about private credit which won't go away has just
[00:17:31.360] changed a little bit is this concept if you google this you will see lots of this term is the golden
[00:17:37.460] age of private credit and so there's all this talk and headlines this catchy headline is my
[00:17:42.960] perception of how private credit became so topical because of this cash outage. Are we in the golden
[00:17:47.480] age of private credit? Are we still in the golden age of private credit? Was it the golden age of
[00:17:51.180] private credit? It's a fun topic to discuss. What I think people actually mean by this,
[00:17:55.920] which is what Christian just referred to, is what happened is you had three forces in 2022
[00:18:01.740] all converge to make what I think people mean by the golden age of private credit.
[00:18:06.460] And those three are large private alternative firms, the actual development of it through the
[00:18:12.900] regulation. So where it was known that private credit was a financing option. And the third
[00:18:17.120] thing that happened in 2022 was the rate hiking cycle of the central banks, which raised interest
[00:18:23.440] rates from near zero to 5%, 500 base points. And what that did is cause some financial plumbing
[00:18:30.540] issues in the US. Everyone probably rarely knows what I mean in 2022 into 2023. And what that did
[00:18:35.920] was shut down the broadly syndicated loan market that Christian referred to. It paused and was not
[00:18:41.560] having new financing for a number of months there. And so what happened was private alternative
[00:18:46.540] firms stepped in and made these loans for a premium interest rate, that's pricing that we
[00:18:51.760] talk about. And so you had these decent credits as a general statement, and the interest rate
[00:18:58.160] on these loans for a period of time in 2022 to 2023 was around 5% the floating base rate.
[00:19:04.900] This is US centric. So SOFR, the US base rate was 5.3% at one point, and the spread was over 600
[00:19:12.300] basis points. So that is a double digit cash interest rate for a period of time, what people
[00:19:18.620] I think were referred to as the golden age. If you look at the long term return rate on public
[00:19:23.960] equities, it's not that high. And so you had senior parts of the capital stack, cash fixed
[00:19:30.400] interest rates, generating a higher return for a period of time. It's questionable whether this
[00:19:34.500] exist today, but it was yielding more. And so that I think is what was, whether we're still in
[00:19:40.680] or not is up for debate, the golden age of private credit in the sense that private credit had this
[00:19:45.480] outstanding for a period of time relative value to other asset classes. It became very, very clear
[00:19:50.360] at this time that that was the case. And that's what created sort of the flood of capital into
[00:19:54.780] the space. And now a few years later, the market's kind of shaking out in a way in terms of what's
[00:20:00.260] next. But to me, that answers the question, why has private credit become so topical? But also
[00:20:04.960] the challenge that Christian is referring to, which is because the growth has happened so quickly,
[00:20:09.840] the question now is the supply-demand dynamics in certain spaces is a topical focus now.
[00:20:15.900] And the supply-demand is definitely an issue for Canada, right? We only have so many borrowers,
[00:20:20.720] we have the Canadian banks dominating. So where is that going to come from? Liz,
[00:20:25.000] anything to add on challenges? I mean, challenges, this is depending on where
[00:20:28.940] you're sitting and what role you're playing, this could be a challenge or it could be sort of a
[00:20:32.560] trend comment is I know that there's different players in the Canadian market and across the
[00:20:36.440] US who are sort of becoming more and more interested in the private credit space. So I
[00:20:40.440] know we've got a strong pension investment audience here, but there's a lot being spoken
[00:20:45.280] about in terms of the increase of private wealth investment in the private credit markets. That's
[00:20:49.460] particularly through fund investment, but that opens the doors for other types of JV opportunities
[00:20:54.180] for the pension space as well, which are interesting. And we'll have to see how that
[00:20:58.080] sort of plays out over the course of time. As I say, you might see that as a challenge and where
[00:21:02.320] that takes the market or an opportunity, depending on what chair you're in. And I know that there's
[00:21:06.780] another sort of space where new players, at least in the Canadian market, have interest is sort of
[00:21:11.360] in the insurance space. And I know, Christian, we were speaking about a little bit earlier,
[00:21:15.260] you know, the growth of sort of the concept of the Evergreen Fund and investment in that space.
[00:21:19.580] And insurers are particularly active in that space for a number of different reasons. So how and
[00:21:24.920] whether that plays out in the Canadian industry will be interesting. But I think the big focus
[00:21:29.180] right now is developing the relationships either through the big six Canadian banks or, you know,
[00:21:33.880] somehow parallel to them to make sure that you're taking as much advantage as possible of the market
[00:21:39.280] opportunities that the current volatility present. Christian, anything to add on that?
[00:21:44.840] I agree with everything that's been said. I would maybe just add with regards to kind of the upper
[00:21:48.680] mid market again, it just continues to be very fluid between BSL and private credit, even when
[00:21:53.940] the BSLs are played, the advantages to their borrower are just very clear, right? You're
[00:21:58.760] dealing with a much smaller group of lenders. It's more relationship driven. Information is
[00:22:03.020] more private and protected. It's more customizable. They can move quicker. So you have greater
[00:22:07.500] certainty of close. I would argue that it may be a pretty common playbook these days, at least for
[00:22:12.400] a PE sponsor to get the deal initially with private credit, despite higher pricing, do some
[00:22:18.540] of the heavy lifting up running initial two years and then refi with public debt just a couple years
[00:22:22.680] later. Great. Thanks. It does sound like we might need a part two of this session. It's something
[00:22:27.600] we have a lot to talk about. It's a big topic. It is. So maybe we'll do that in a couple of months,
[00:22:32.100] but thank you everyone for joining us and stay tuned for our part two. Thank you, Christian,
[00:22:37.000] Jason, Liz. Thank you for joining us. Thanks everyone. Thanks everyone.
[00:22:44.020] Thanks for listening to another episode of Peer Connections by GPFA. We hope you found the
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