Stewart: Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, and I'll be your host. Welcome, welcome, welcome. And today's topic is direct lending, and we're talking with Trevor Clark, Managing Partner of Twin Brook Capital Partners. Trevor, thanks for being on, man.
Trevor: Thanks, Stewart.
Stewart: I'm looking at your window, and it is a beautiful, sunny day in Chicago, man. We're thrilled to have you on, Trevor, and I was not as familiar with Twin Brook Capital Partners. You came to us, you're part of Angelo Gordon, and we're thrilled to have them on our platform. And I want to learn more about Twin Brook and more about you. But before we get going too far, we want to start this one the way we start them all. What's your hometown, the town you grew up in; your first job of any kind, not the fancy one; and a fun fact?
Trevor: Wow, that's a lot of pressure to start things off, Stewart. So grew up, my father was in the military, so I actually grew up all over the place. Being born in Texas, but lived in seven places between the time I was born and junior high, but then did my junior high, part of high school, and my college years in Iowa, of all places. So definitely Midwest born and bred, but have been in Chicago really since the mid-90s. So I've been a Chicagoan for the majority of my professional career. The very first job, which is very interesting, I worked as a barista in an espresso bar. Definitely didn't portend to becoming a lender later in life, but it did inform me very early on that I did not want to work in retail.
Stewart: And what about a fun fact?
Trevor: Well, I think a fun fact is, my friends and family note that I have a fairly low boredom threshold, so I like to do different things to maintain a certain level of interest. So, in the last ten years alone, I think I've done seven different adventure races, did an Ironman, climbed a couple 14,000-foot peaks. I've definitely had a number of things to kind of entertain me and keep me interested outside of my day job, that takes up a lot of my time as well.
Stewart: Wow, that is a fun fact. So talk a little bit about your background and how Twin Brook Capital Partners fits into Angelo Gordon. How did you get to being managing partner of this firm, and how did you find direct lending as an asset class? I've interviewed a lot of people in this business, and nobody that I know of graduated with the idea of, "Hey, I'm going to go into direct lending," so it's always interesting to see how people end up in their seat today.
Trevor: It's such a great question. You're absolutely right. I did not come out of school and say, "Hey, my dream is to be a direct lender." My path to this really started from coming out of getting my MBA at Indiana University. I graduated in 1994 and got hired on by what was, a name you'd probably be familiar with in the area, Continental Bank, before it became Bank of America. And when you got hired into banks at that period of time, you went into those rotational training programs, and you got placed after three months, and I happened to get placed into what was called middle market lending. Not called direct lending at that date—middle market lending. And I stayed at Bank of America for a couple years, and then my career over those next four years took me from that Continental BofA world, over to GE Capital, and then a short stint at a company called Antares Capital, and it was different forms of the same thing.
This idea of underwriting, getting introduced to these small companies, getting to understand how these different companies kind of created cash flows, understanding how this wild microcosm that I wasn't even aware of existing out there – of all these different small companies across the country – and getting to understand that, "Oh, a company that does the cash flow management for vending machines had a reason to exist, a company that did physical therapy rollups had a reason to exist." So I had this chance to get introduced to this really cool new world out there that I didn't even know existed, kind of scratched the itch of being able to learn about lots of different types of companies. And then for me, it was really taking that experience over that seven-year period of time – at the bank and the non-bank and then with Antares, a company that got backed by a large insurance company, Mass Mutual – that really informed me of saying, "Hey, this is an interesting industry, but, how do I want to basically be able to grow a career within this industry?"
And so ultimately, I decided in the late nineties to write a business plan that, back in the late nineties, in terms of how you formed capital, looks different in the world of direct lending than it is today. And so ultimately, wrote a business plan and presented to a big mutual life insurance company and founded my first direct lending business, which was known as Madison Capital Funding.
Stewart: Oh, wow, I know that name. So, what is the history and current state of the business at Angelo Gordon, and how does Twin Brook Capital Partners come to be, and what's the connection between the two firms?
Trevor: It kind of follows that line that we just had kind of talked through. By the time you got to the 2010 post-GFC era, the ability to form capital more broadly existed. And so for me, I decided to kind of depart, bringing some senior members of my team with me. I looked at Angelo Gordon, a 30+ year asset manager, wonderful culture, and knew that there would be the ability to grow a long-term market leader in the world of direct lending, and so joined Angelo Gordon late in 2014. And when we joined, obviously, we started with zero AUM. And in the eight and a half years since joining Angelo Gordon, we've reestablished ourselves quickly as the leading lower middle market focused performing credit manager in the world of direct lending.
And that has us right around $17 billion of AUM, 236-odd individual borrowers, and relationships with, well today, we've closed transactions in the last 5 years with over 100 unique private equity groups.
Stewart: Wow, congratulations. Good for you. That's amazing success. Can you talk a little bit about Twin Brook's specific strategies and your focus on lower middle markets? How does that focus help you? I heard the term ‘performing’ sneak in there a little bit. That's a very important term to our audience. And can you talk just on that specific niche, tell me how you got there and just walk me through that strategy?
Trevor: Okay, so let's start with this. The business plan I wrote had a very specific goal, and that is, while focused on direct lending, what I had found earlier in my career was, there are lots of different ways to approach this asset class, and not everyone had the same level of reliability. My focus in this business plan was: Produce the most attractive, reliable return available. I wasn't targeting just the highest return today, because as you and I know, if you went back five years, you'd sit back and say, "Oh, do a super highly levered tech-focused fund that did enterprise value lending, that's a great return." And then you fast-forward three years, and all of a sudden that looks super volatile and less attractive. So for me, it informed not only target market, as you highlight, lower middle market, but also the different pieces of the role we play, the industries we target, the leverage profile of our borrowers. All of those things were also critically important to producing that stability.
To your first question, in terms of target market, you did hear me say correctly, lower middle market-focused of performing companies. For us, lower middle market is defined as companies with cash flow, and cash flow in this case is defined by EBITDA of $25 million or below. Our reason for targeting the lower middle market versus upper middle market, and I get asked this question a lot: Why? If you're stability focused, why wouldn't you target large companies? And the simple reason there is, I learned very early in my career, the relationship between a borrower and a lender had a direct correlation towards more transactional when you moved up in size of borrower. Meaning, you really got asked, "How much debt are you giving me? And what's its cost?"
When you moved down in size a borrower, all of a sudden my reliability, my experience, my consistency, much more important. So for us, to be treated much less like a commodity, we knew the lower middle market was the part of the marketplace we wanted to target. And to be really clear, when you think about this, it's also important: Consistency. You hear the term ‘style drift’ thrown out a lot. For us, we have been a consistent participant in the lower middle market.
Stewart: It's a great point. And I mean, we're a small business, and I live it every day, right. The ability to get financing is a challenge. I mean, we put this thing together on our own, through any means of financing that we could find, and the lender matters. I mean, the banks are not... they're not lending the way that they used to, and in my mind, maybe the way that they should be. I mean, my experience is that it's like, "Here's our spreadsheet, enter your numbers, and the ratio in cell G2 didn't pass our tests, so you're out." There's no really like, "Hey, let me get to know your business." I've had a couple of business lenders, in my experience, that want to understand my business and understand what we’re up to, but for the most part, it's very cut and dry.
Let me back up just a second. Private credit has been a very hot asset class for insurance companies for quite some time. Nothing new. There's a lot of private credit shops, lenders who are finding their way into this space. Frankly, it's been a tailwind for us, right, because of our narrow focus on the insurance asset management audience. But whenever I'm interviewing an expert in this space like you, I've got my surrogate CIO hat on. I mean, my CIO buddies, they let me kind of play CIO on TV. They're just like, "Just don't touch any of the buttons or anything, but you can go ahead and ask the questions." So, you know when I look at Twin Brook as a CIO trying to make an allocation, help me understand what differentiates you and how I should be thinking about you when I'm looking at deploying my resources into the private credit space.
Trevor: Yeah, that's a great question, Stewart. And it's funny you say that because I feel like I get asked that same question a lot. And what I try to do as much as possible, having done this for so long, is I try to take opinion out, and I try to use facts and math. Because, if you went out to the population of direct lenders... And globally, I don't know if you've heard this, but some of the statistics I've seen is there's over 2,200 direct lenders globally. That's a huge number that your average CIO friend and insurance company has to sift through, and it's candidly too big of a number. They're going to have to get forced to windle that down to a more rational number of groups. So what I try to start with is, let's just do this simple large-level sifting.
If you went across that population of 2,200+ groups and said, "I'm just going to do a high-level simple screen before really digging in on the most relevant groups," and I used this, and said, "I only want to talk to groups where the team has been together for at least 10 years. Out of that, I want a group that has deployed at least a billion dollars annually for the last five years, because that's telling you how relevant they are in the overall market scheme, versus a group that just comes and goes. I want a group that has not had style drift, meaning I didn't start in the lower and move to upper middle market. I didn't do non-sponsored and move to sponsor. I didn't do industry-specific and then move to generalist, which would speak to how reliable my performance is." If you just took those three high-level screens, out of that 2,200, you might have 20 groups that would survive those things.
It just goes to show you, the vast majority of those 2,200 groups are new since coming out of the GFC, so they haven't been cycle tested; have had huge turnover of their teams; or, if you can check those two boxes, you most likely raised more and more capital and moved up market. From our perspective, what we love about our strategy is, we check all of those boxes. Because of our focus on sustainable, durable returns – because we focused on the culture and the creation of something that has some durability – we feel very good about not only our history of delivering this, but the stability of our team and our maniacal focus on this lower middle market, that has the ability to produce an output on return perspective. That's very different than when you move up to that more commoditized upper middle market.
Stewart: Thank you, and that's really helpful. And so, I think it's important for us to timestamp today's podcast because we are recording on the 27th of March. And as quickly as things are moving, I think it's important for folks to know when we were speaking. So as we approach the end of the first quarter here, I wonder if you would give us your view on your market in particular and then perhaps crank your lens out a little bit and look at the private credit market a little bit more generally.
Trevor: Well, you hit a couple of key points, which is, private credit / direct lending as an asset class has become wildly popular, and that really started coming out of the GFC. When the broader investor base saw how these assets performed during a period of severe economic disruption, and more importantly, the relative return. Historically, people looked at broadly syndicated loans, corporate investment grade bonds, and thought those were the bastions of safety and stability. And so when they saw direct lending, private credit performing better than those other asset classes on a risk-adjusted basis, all of a sudden people sat back and said, "There's a great trade-off for liquidity, a greater return with better downside protection, we're going there." So that brought people to the asset class. To your point, what maybe got lost in that move towards the asset class, was really manager differentiation. Not every manager was bringing the same access, experience, oversight.
And so, you really have seen over the last three to four years, a greater focus on, "Yes, I need exposure into direct lending." More importantly, "I need to find the right manager to give me the right kind of exposure into direct lending." So when I take a step back and say, "What's been playing out over these last three years?" and we can drill in more to the last six months as well, but obviously the introduction of the pandemic started to create that understanding that manager selection, manager experience, reliability did matter. That was step function one. Step function two was, how did that start to manifest? You didn't see as much return compression as you would've expected because, obviously, the government's response to the pandemic lessened the individual portfolio impacts.
What you've seen over the last two years is something quite different; the effects of inflation, interest rate changes, supply chain, impacts of being able to access human capital. All of those things have started to create greater dispersion amongst different managers by strategy and experience. And now what you're seeing is, in the world of who can access the very best high-quality borrowers and who can access the most reliable scaled investors, has really started to shift out, such that you are seeing a major difference between the winners and losers in the world of direct lending.
Stewart: Okay. So, this is going to be me practicing without a license, so prepare yourself.
Trevor: I'm ready.
Stewart: So, let's talk a little bit about sponsored versus non-sponsored. So, my understanding, and I'm, again, practicing without a license here, sponsored means that there's a private equity firm involved, and that's the space that you play in, and it's advantageous from a lender's perspective because the PE firm can add capital if the company shows signs of distress. As opposed to what would be called a non-sponsored, where you'd be investing in a business such as mine where there's not a PE backstop; it would just be the merits or the economic engine of the business itself. Have I got that about right?
Trevor: Sure. Well, you did an excellent job of laying the groundwork there, so I think you've earned your stripes of being able to play a professional in regards to what CIOs are and are not looking at, because you're absolutely right. The basics of the sponsor versus non-sponsored are exactly that. Do you have a private equity group, a group that forms capital to go out and buy and manage and grow companies? For us, remember this is going to keep going back to this recurring theme, producing the most reliably consistent and attractive return available in the asset class. Because we saw that lower middle market as the one where the ability to be decommoditized – experience, relevance, reliability did matter more than cost and amount of debt – well, we had to do two things because of that. The average small company doesn't have the same consistency, reliability, diversity as the average large company.
So for us, if we're trying to produce a reliable return, we had to cast a really wide net to make sure we saw the largest number of companies within the lower middle market. We then did a tremendous amount of due diligence to find the very best small companies, that had the cash flow stability as the very best big company, but under better terms and lender protections. That's the basis for the stability. We also said, ownership mattered. To your exact point, in the upper middle market, people say to us, "Well, hold on a second. Yes, private equity groups are important, but they still look at us and say, 'Cost of debt, amount of debt is going to drive the decision.'"
Our view in the lower middle market is different. The lower middle market-focused private equity groups do exactly what you said. They bring that capital support, but more than that, they bring operational oversight, they bring expertise in terms of how to execute a growth strategy, and their value proposition is very much focused on a lender who they can partner with to transform and grow these small companies. So I'm not saying a non-sponsored relationship with the borrower is bad, I'm just saying, when you add stress to those portfolios of non-sponsored borrowers, you're introducing more return volatility because you don't have the oversight and the capital support that you find in the world of private equity-backed transactions.
Stewart: So just talk a little bit about industry concentration. I know some PE firms have a particular focus in industries. You have a lot of relationships across a lot of PE firms. You see a lot of deal flow. Can you talk a little bit about how you think about industry diversification as you're building a portfolio there at Twin Brook?
Trevor: For sure. So, let's unpack that in a couple different ways. First, because of this focus on attractive, reliable return. Because, as I mentioned to you before, our selection – looking at 1,500 companies every year down selecting to the top 3% – everything's based on the cash flow stability of these companies. That clearly moves itself into, what are the industries we're targeting? For us, what we have found over the 20+ years we've been doing this: There are certain industries that just have more inherent stability than others. It's not hard to discern that something that's based on retail is going to have more volatility. Something that's commodity-based, something that's based on energy – if you are based on a commodity price input swing, you're not going to have the same stability as something that's a standard, mainline manufacturer, distribution, business services company. We also lend in healthcare.
So if you look at our industry exposures, yes, to your initial point, diversification matters, both at the individual borrower position size – which we target about 0.5% to 1%, so very granular at the individual borrower level – then at the industry level. We really are looking at our industries, and I think if you look across all the SIC codes, we have about 50 different industries that we've lent into. Healthcare, as a segment, is our largest individual grouping, and that has around 30% of our overall portfolio would have some healthcare exposure. I will tell you, we have 19 sub-segments even within healthcare, but every one of those industries has a similar theme; GDP growers and shrinkers – so you don't have wild volatility – and strong cash flow stability and predictability that defines your industry.
Stewart: And that stability of revenue is so critical to lending because you've got essentially a fixed set of payments, right, and it's the stability of that revenue stream that's so important. Have I got that right? So when I think about Twin Brook being the largest lender in a lower middle market space at $17 billion of AUM, it gets me to wondering about capacity constraints in this asset class. So, what should I be thinking about if I want to deploy capital in this asset class? Do I need to be worried about capacity constraints? And if so, how would they impact me, and what should I be doing?
Trevor: So, when I think about the capacity limitations, is there an upper bound of how much you can do in the lower middle market? And the answer is, there will be. I think we are a classic example of being a market leader, what do our numbers look like in terms of our origination – and we have a direct origination funnel. You should be also focused when you're asking that question on, how do you source? Meaning, do you directly originate? Are you the ones calling on the creators of the assets? Are you directly underwriting? Are you calling other financial institutions to source for you? Not that that model is wrong. We directly originate, we want to control the raw material we're seeing. We want to do the direct origination ourself. We believe that, again, that provides more stability. When you have indirect origination – call in other financial institutions – remember, you are only seeing what they want to sell.
And as the world of asset managers that are direct lenders has continued to evolve, the very largest groups have created more capital for themselves, so they sell off less. So it's an interesting nuance that creates more inherent instability for those indirect originators. Piece number one. Piece number two for us. When I think about how we've built this platform, with that individual hold size I mentioned to you before: Important because, the last two years alone, we had gross originations of $9 billion. Because of the amount of capital we've formed and the individual hold size, we wanted to have net originations of around $6 billion. So the last two years alone, we’ve sold off, on average, $3 billion per year. So, when you ask me about capacity, we have the ability to grow and form more capital and still have a reasonable hold size and not have to sell that off to other institutions. So I do think we have runway to continue to have someone look at us and say, "Oh, you had the ability to take on more capital."
The last piece I think you'll find equally interesting, in the world of direct lending and specifically lower middle market direct lending, the average life of our loans is three-and-a-half to four years, so you always have a turnover of capital as well. Today's transaction, you lend money to it, it grows over a period of time, and then you get repaid. So we also have the ability to continue to kind of reinvest our capital over time as well, which creates new opportunities to lend money again.
Stewart: I think that's what my insurance colleagues would refer to as adverse selection. When you're buying only what others don't want to retain, it kind of makes you scratch your head. Before we go today, I want to make sure that we touch on an important topic because I think CIOs take comfort in knowing that a manager is working with other insurance companies and that they're familiar with the nuances and all of the idiosyncratic issues related to managing insurance money. So, can you talk a little bit about your experience working with insurers and just give us a little bit of a rundown there?
Trevor: It's such a great question, Stewart, because it's been interesting. As the world of investors have come to the direct lending landscape, a number of them who were really focused on highest absolute return at this period of time have gotten burned because they went with groups that had, unknowingly, more inherent volatility. The world of insurance investors, much more focused on longevity, reliability. I think the other thing that the insurance community has really been focused on is how you produce that return. Is it repeatable?
Again, I will highlight for you, whether it's our hold sizes, whether it's the stable industries, our leadership position, first dollar in the capital structure – all of those things have continued to resonate with that investor community. And more recently, the fact that we don't do covenant light structures, the fact that we don't have highly adjusted cash flows, as we mentioned before, the fact that we don't rely on other institutions to source for us or underwrite for us, all of those things have become even more important as you've added economic stress onto this whole population of companies in the United States.
Stewart: And sort of along the same lines. In the private debt space, Trevor, what factors do you think will drive manager differentiation going forward?
Trevor: There's probably three primary areas that the investor community specifically is going to focus on. Experience is the most obvious one. You are not going to choose a manager who has not been a lender through a cycle. There are so many choices to avoid that, why would you go that direction? That would be number one.
Number two, and we've touched on this topic before, the idea of your experiences' relevance. And what I mean by that is, what style drift have you as a group had? Were you lending to highly performing companies at the top of the capital structure with lightly adjusted cash flows ten years ago, and today, you're at the bottom of the cap stack in wildly cyclical companies that don't have reliable cash flows? That is a different type of lending. Your track record means something much different if that's the case.
And then finally, scale. Scale matters. Have you been managing a very small amount of money historically, all of a sudden you raise 3 times, 10 times, 30 times the amount of money, your selection criteria looks different. All of a sudden you do half the due diligence on twice the number of companies – leads to a different type of outcome. That seems to be where we're feeling the focal points being, in terms of manager differentiation, to be the primary areas of focus.
Stewart: Thank you. I really appreciate it. I’ve learned a lot today, and I really appreciate that. I’ve got one question. It’s a new one for 2023. It’s a fun one. So here we go. So, who would you most like to have lunch with alive or dead?
Trevor: Wow, alive or dead? That's going to take it to a whole ‘nother level. What I'm going to tell you, and it's going to be timely right now because I'm thinking about what's kind of playing out in real time. And as you point out, we're March 27th time stamping this, I would look at the NCAA tournament right now, and seeing some of what took place in terms of some of the coaches and some of the outputs of this. And I look at teams like Florida Atlantic and others getting into this NCAA Final Four at a level you haven't seen. It's maybe not as interesting as me saying some very famous historical figure, but talking to some of the coaches and seeing their ability to be able to take these teams from real obscurity – in the world of these super teams that have been created – and seeing what made them successful. Because I'm always fascinated, when I think about my job, of taking this large team in a very shifting world, and trying to find out what's making other leaders successful despite the fact that today's landscape looks much different than the past. That's probably the answer I'd give you today.
Stewart: Wow. That's a great answer. Yeah. So listen, Trevor, thank you so much for being on. I've learned a lot today. I really appreciate you being on and really just for taking the time. Thanks so much.
Trevor: Appreciate it, Stewart.
Stewart: Thanks for listening. We've been joined by Trevor Clark, Managing Partner at Twin Brook Capital Partners. If you liked this, please rate us, review us on Apple Podcast. We certainly appreciate it. If you have ideas for podcasts, please email me at podcast@InsuranceAUM.com. My name's Stewart Foley, and this is the InsuranceAUM.com Podcast.
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