June 2022 – Jess Larsen, Founder & CEO, Briarcliffe Credit Partners

Jess, it’s a real pleasure having you join us on Private Capital Call.

1. The Markets Today. Jess, you founded Briarcliffe in early 2021 as a shop exclusively dedicated to helping private credit managers raise capital. A little more than a year later, we are in a changed world. What has that meant for your business?

At the highest level, it’s a great time to be in private credit! Interest remains very strong and we’re seeing the large pensions and big institutional investors increasing allocation, which includes rotating capital from other asset classes into private credit. Fixed Income, which we often hear referred to as “no income,” is the biggest pool from which LPs are reallocating. But, we’re also seeing investors swap from private equity as the continued maturation of that market is netting lower returns, particularly driven by current equity pull back.

Against that backdrop, macroeconomic conditions are changing, as well. We just published The Private Credit Compass, which highlights how the diversity of private credit’s broader strategies make the asset class particularly durable through all economic cycles. As one strategy contracts, another grows. As McKinsey & Company notes, private credit is an asset class for all seasons. Additionally attractive to investors, the typically shorter private credit fund lifecycle of five to seven years provides more regular access to capital than the usual decade-long maturities in private equity.

2. Private Credit Defined. You define the industry within Briarcliffe’s “Four Pillars of Private Credit”. How do managers differ in what they are offering? Have investors changed their appetite for the asset class, and how? 

Private credit is a very broad asset class! Many people are familiar with direct lending, but that’s just one strategy in our Four Pillars, which include 1) Corporate Credit, 2) Structured Credit, 3) Specialty Finance, and 4) Real Assets Credit. As you know, direct lending has significant capital invested which is why we focus on niche, esoteric strategies in the wider universe. A good example of the evolving LP interest is with real assets strategies. They provide income and have unique downside protection from the assets. That can be with transportation strategies, equipment finance, etc. Several of these strategies are reaching 20%, 30%, 40% Net IRRs.

In the fall, we hosted a series of dinners across the US with institutional private credit investors. Our LP Dinner Takeaways report outlined how LPs are increasing allocation to private credit as a result of it serving different, sometimes multiple roles in their portfolios. In addition to diversification, private credit allows some investors to rotate their credit hedge allocation for return enhancements. So, yes, investor appetite is changing in that more and more institutions are seeking greater allocations to the class.

3. Higher Rates. It’s likely we’ll be in a rising rate environment for a while. A 3% Fed funds rate doesn’t seem outlandish, particularly with the Fed’s recent 75 bp hike. How will this impact private credit?

Investors should expect US interest rates to continue rising likely into 2023 and potentially beyond, but private credit remains attractive to investors because it offers strong, uncorrelated returns. While the floating rate nature of most private credit strategies creates increased margins to lenders in a rising rate environment, it also increases interest expense for borrowers, which can stress balance sheets and create opportunities for distressed and special situations investors.

Today, there is an enormous pool of corporate debt exceeding $1.3 trillion which represents a 127% increase from pre-crisis high. But, corporate earnings are not keeping pace. The confluence of high debt, higher leverage, and rising interest rates creates a compelling backdrop for special situations and distressed managers. These strategies can invest opportunistically when traditional credit sources are unavailable to stressed companies and perform well by identifying durable businesses with quality assets and dependable cash flows.

Interest rate increases are here for the foreseeable future, and we are confident the strategies we represent are well positioned to perform despite of them.

4. Recession Scenario. The current volatility in publicly traded securities is being driven by concerns that the inflation / interest rate situation will send us into a downturn. What’s your prediction, and how does that fit into your outlook for private credit?

Equity repricing and market volatility drives interest in private credit. In addition, deal flows are slowing. For example, we’ve seen US and European IPO levels fall drastically this year, declining nearly 90%. Early-stage company credit strategies can benefit from these conditions as the pipeline for venture and growth deals transitions from equity to debt. During periods of multiples compression, companies face a predicament of a down-round to raise capital as their runway diminishes. In this scenario, growth debt offers an alternative, non-dilutive capital solution that can be utilized to avoid the potential down-round. Companies with proven market traction, especially in technology and healthcare, can use structured credit to provide liquidity when equity capital markets are unfavorable. During these times, lenders have negotiating power over terms and pricing, and can structure loans to provide optimum income and downside protection.

Growth debt is likely to garner more attention from investors as their need for downside protection increases with the shift in market dynamics.

5. Private Credit: Crowded? Jess, you often highlight projections that private credit will be almost a $3 trillion asset class in the next several years. That’s double where high yield bonds and leveraged loans are today. Should investors worry that private credit is becoming too crowded?

Absolutely not! There’s plenty of room for private credit allocation. Beyond the trend of institutional investors moving more capital into private credit, these current macroeconomic conditions are attracting even greater interest as LPs seek strategies uncorrelated to equity markets. Large pensions and institutional investors have internal performance hurdles of 7% or 8% which other assets simply aren’t providing on a consistent basis. In terms of sourcing, most of our economy consists of privately owned companies, so there is no shortage of borrowers, particularly as long as the large banks don’t provide lending. That access is critical for these types of companies, which provides incredible opportunities for sophisticated, esoteric private credit strategies, like those we represent at Briarcliffe Credit Partners.

Churchill Asset Management
375 Park Avenue, 9th Floor
New York, NY 10152
(212) 478-9200

Subscribe to our premier middle market newsletter: Subscribe

Copyright © 2024 Churchill Asset Management LLC. All Rights Reserved. | Privacy Notices

The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Past performance does not guarantee future results. Please note investments in middle market loans are subject to various risk factors, including credit risk, liquidity risk and interest rate risk. Churchill Asset Management LLC is a majority-owned subsidiary and member of the TIAA group of companies.