Stewart: As we all know, insurance companies are fighting for yield and investment income every day. As yields stay low, how to find it, good value, good risk return profile, tough to find, investment grade private credit is certainly an asset class that deserves consideration. And we are very fortunate to be joined by Chris Gudmastad, the head of Private Credit at Securian Asset Management. Welcome, Chris.
Chris: Thank you, Stewart. Happy to be here today.
Stewart: So, a lot of us know Minnesota Life, which is now Securian Financial. Securian Asset Management is part of that group. Can you tell us a little bit about the firm and the investment grade private credit team?
Chris: Absolutely. Thanks, Stewart. Appreciate the opportunity and the chance to get in front of a great audience. Securian Financial is based in St. Paul, Minnesota, and we've been around for over 140 years. And we're a Fortune 500 company and the eighth largest US life insurance company. We're a member held model structured as a mutual holding company. Securian Asset Management manages money on behalf of both our parent and external clients, and we manage over 50 billion of AUM. And that's managed across both public and private markets.
Chris: The private market strategies comprise just over a quarter of our AUM, and they include an investment grade private credit, also known as private placements, commercial mortgage loans, and alternatives. We manage money on behalf of a wide range of insurance companies, life, P&C and health, as well as the broader retail and institutional marketplace. When you look at investment grade private credit at Securian, we've been managing money for over 40 years in the space. In fact, rumor has it that we had a private placement team before we had a public bond team here. And we currently manage $6 billion in investment grade private credit on behalf of both our parent and third parties.
Stewart: So, private credit has become a bigger and bigger part of insurance company portfolios as rates have fallen over a long period of time, right? So, I think it's never a bad idea to get an educational base around the asset class at a 50,000 foot level. So can you tell us a little bit about the space and where you think it fits into an insurance portfolio?
Chris: Absolutely. Now starting first with the market, the investment grade private credit market has steadily grown from roughly $20 billion in 2000 to over a hundred billion dollars today. And to bride a little perspective, there was 1.8 trillion in investment grade public issuance in 2020. So it's a small fraction of the public investment grade market. What we find is the typical insurance company will compliment their public portfolio, setting aside a little bit of liquidity for some of the benefits of the asset class. The main benefit of the asset class is, it offers higher yield through the cycle versus similarly rated public bonds with the added benefit of downside protection and diversification benefits. Now we believe that these outweigh the illiquidity of the asset class. So, starting with the illiquidity premium or spread advantage over public bonds, that's the most observable portion of the value proposition, and that upfront yield. Unlike public bonds, we also have the benefit of strong covenants, or covenant packages which provide that downside protection, and early seat at the table, which result in lower credit losses versus public bonds and additional fees.
Stewart: When you go in, people talk about covenants, right? Is that negotiated deal by deal? Because obviously in the public bond market it's take it or leave it as is, right? But privates are different. So can you talk just a little bit more about the covenant component?
Chris: When you hear of covenants and covenants in private credit, often you hear covenant-lite transactions. That is not a case of investment grade private credit. We're buy and hold investors, and covenants are essential to hold the securities through maturity. When you look at the typical covenants we have, they limit the amount of leverage that the company can take from their balance sheet, debt to EBITDA, or interest coverage. And these are negotiable in all our transactions. So when we're looking at a transaction and underwriting a transaction, our private credit analyst and legal team will structure a covenant package that's appropriate for that borrower, and unique to that borrower.
Stewart: Thanks, that helps me.
Stewart: I'm the one who learns the most on these things, Chris.
Stewart: Everything I don't understand you can expect a question. Sorry, go ahead. I'm sorry.
Chris: No, no. And In addition, the goal is for it to trip. You can get the early seat at the table. Typically it trips at let's say a double B level or a single B level.
Stewart: Good, that helps.
Stewart: So, how big is the IG private credit market? I know it's growing, and we've talked a little bit on other podcasts private versus public market, the future of those two markets. Can you give me a little bit of background about the growth both historically and where we're headed?
Chris: Absolutely. The market in 2000 was around $20 billion in issuance. And we've seen that steadily grow to over a hundred billion dollars today. And to provide perspective, there was 1.8 trillion in investment grade public issuance in 2020. That steady growth over time is due to a number of factors. First, back in 2008 to 2010, insurance companies had very good performance through the GFC within their private placement portfolios. So you saw increased allocations on the back of that. Second, investors with the current low interest rate environment are searching for additional yield. So we've seen insurance companies take on more illiquidity for the additional yield of the asset class and that downside protection. And then finally, there's been increased sophistication of investors over time. We've seen issuance in the project finance, private ABS sector that wasn't around 10 years ago, which has supported the growth of the asset class.
Stewart: So, Securian Asset Management's approach to investing in this market, right? Can you talk about building portfolios for clients? One of those clients is your parent, so I'm thinking that you're coming at the world as an asset owner as opposed to simply an asset manager. Am I close?
Chris: Absolutely. We invest in every transaction that we invest in. We're investing on behalf of both our parent and our third-party clients. So we have skin in the game and interests are aligned. I mentioned earlier that we've been investing in this asset class for over 40 years. So we have a strong experience underwriting through a variety of economic cycles. We've also been offering this asset class to third parties for over 30 years. So over this time, over that 30 years, we've continuously offered investment grade private credit to third-party accounts, and have allowed our clients and our parent to grow alongside one another. When we manage money for third parties, we offer customized solutions based on asset quality, asset type and duration preferences.
Stewart: So, the private credit market is dependent upon deal flow, right? You can't just show up one day and be in this market. The fact that you've been here for 40 years gets you into deal flow, but can you get more specific about that? I mean, what's your sourcing process?
Chris: We focus on developing long-term relationships with peers and sell-side investment banks. And those relationships are not only at the firm level, but the analyst level. I think what's important to know is Securian doesn't employ a production mindset, we're highly selective in our approach. We invest in less than one in every five transactions that come across an analyst desk. Our focus is on sourcing strong, unique deal flow, focusing on transactions that offer the strongest risk reward. We don't have volume metric goals internally.
Stewart: So, you mentioned peers in the space, there's been a lot of growth here, there's money flowing into the IG private credit market, but my understanding of your firm is that you don't invest across the board, and that you've liked particular segments better than others, or some better than others. Can you give me some details and examples, what you like, what you don't?
Chris: Absolutely. That's a great question and there's several differentiating factors, so let's unpack that. First, Securian, we feel, has an investment size, forty to one hundred million dollars, that fills a sweet spot. We believe this range allows us to be meaningful in the larger transactions, seeing all those transactions from the investment banks, but also participate in the smaller transactions that maybe fall under the radar on some of the larger peers, but still provide strong risk reward and are meaningful for our clients. Sectors that we have an internal expertise and where we see strong opportunities include project finance infrastructure. We happen to have a former project finance banker on the team. Specialty finance, where we leverage our alts team, and my background, as well as real estate, both across REITs and credit tenant leases where we're leveraging our equity REIT team and commercial mortgage loan team.
Chris: We also feel that Securian Asset Management size offers a clear benefit to our clients. We're large enough where we can employ a dedicated private placement team, yet small enough, where we actually work across investment teams. Just outside my office sits the public team where we leverage them on getting their sector views, views on an individual credit and relative value assessments. I spoke earlier about us leveraging the real estate team and equity REIT team on our real estate transactions. And I would just note this collaboration across investment teams occurs not only at the analyst level, but at the approval level. We have a cross collaborative credit committee as well.
Stewart: So one of the things that would really help me I think would be to get a few examples of some recent deals you've done, so maybe our audience can get a feel for the process in action.
Chris: Would love to and agree;relatable examples really bring the process of value proposition to life. And I'll start out with a good example of receiving a structuring premium, or additional spread on top of the typical illiquidity premium we receive for legal complexity. Late last year, a leading publicly traded North American beverage company was looking to reacquire some distribution rights. And this is a name we really liked on our public team, but had an undersized position just given low yields. And given the complexity of this transaction, along with the duration, the public and bank markets were not options for the company.
Chris: The no holders spent weeks negotiating a complex leverage license across the companies with the issuers at various operating entities. And relative to the public bonds, which are unsecured, we received a parent guarantee. So we were pari passu with the public debt. But in addition, we received additional collateral security of those distribution rights, which we had valued by a third-party firm. We also received additional credit enhancement, a springing letter of credit, in the case the company is downgraded below investment grade. The structural complexity provided the no holder with additional hundred basis points of yield relative to the company's public bonds. And finally, we have a security here that I would rather own, versus the public bonds, given the downside protection and security benefits.
Stewart: So, I know that our audience is a bunch of grizzled veterans like myself, but just on the odd chance that someone doesn't know the meaning, what's pari passu?
Chris: Pari passu means we're equal in rights with a bankruptcy. We're alongside one another.
Stewart: Great. That's exactly what I thought. I was hoping you were going to say that. So, you mentioned a minute ago that right outside your office sits the public credit team, right? So, I'm assuming that you're able to bridge across teams when needed. Can you give us a live fire exercise of how that might work?
Chris: Absolutely. A good demonstration of collaboration across teams is the example of a large globally traded defense company that issued on our market last year. The company was looking to finance their regional headquarters, and it was structured as a credit tenant lease or CTL. And what ended up happening here, and what was unique about this transaction is we were actually taking construction risks, something our firm had not taken before. So what ended up happening here is the private analyst collaborated with the public analyst to cover the credit. The private analyst also worked with the commercial mortgage loan team analyst to value the property. We conducted a go-dark analysis, and also looked to better understand that local market.
Chris: And then, with regard to that construction risk we were talking about, the commercial mortgage loan analyst, legal counsel, our in-house counsel, and the private placement analyst collaborated to ensure the proper structural items were in place to mitigate that construction risk. The outcome here was we obtained exposure to a credit that our public analyst liked, entrenched market position, and very strong investment grade credit profile. We had a structure in place to mitigate the primary risk of the deal, construction. We also had security in the real estate, which our CM, commercial mortgage loan team, viewed as an attractive location, providing that downside protection in the case that something unexpected happened. And finally pricing was attractive with us receiving an above market premium over public bonds more than compensating us for the illiquidity and construction risk.
Stewart: Good stuff. So let's wrap up the formal because this is the part that you don't know that's coming. The formal part of the presentation is to me the most important, which is, what do you think the market looks like over the last year or so? And bust out that crystal ball and tell me where we're going.
Chris: The past year was a great example of the full cycle value proposition of the asset class. Now in 2020, the credit markets, both public and private, held up quite well, given the strong fiscal and monetary government support. We saw covenant amendment activity increase as general business activities were wildly impacted by shutdowns at the beginning of the pandemic. Now to us, that means that our underwriting standards were strong. At the point of the cut the stance was to get involved early and really understand what's going on in the company, get that early sit at the table, and hopefully get compensation, and we did see that last year. The investment grade private credit transaction volume rebounded strongly in June last year towards the second half of the year with overall volume exceeding 2019 record volume. And I think we finished the year at around $108 billion, that really speaks to the durability and attraction to the asset class.
Chris: In addition, given the disruption in debt capital markets, last year was a very strong year in terms of the illiquidity premium. We saw an illiquidity premium for the transactions that we underwrote at just under a hundred basis points. Looking at 2021, we had a very strong pipeline heading into year end, which resulted in a really strong January and February, particularly within the specialty finance sector. Since then, we've become more selective in March and April as illiquidity premium has come in. As we look forward, we're encouraged by the marketplace, robust issuance, investor interest in performance in both the depth and continued strength of the IG private credit market will continue. Now, I don't think the illiquidity premium will approach last year's at a hundred basis points, but certainly we'll be above, let's say the 20 or 30 basis points of a couple of years ago.
Stewart: Yeah, It's a great asset class when done right. And you guys obviously are our veterans in the space, and I appreciate the comments about your market. Now this is the portion, the "ask me anything" portion, Chris.
Stewart: So I want to pose this question to you. It's a question I always close with. So roll your memory back to graduation day of your undergraduate institution. Now regardless of the festivities the evening before, I'm quite sure that you were bright-eyed and bushy-tailed on this momentous occasion, and you stand there waiting patiently for them to call your name, up the stairs you go, across, get your diploma, quick photo op, back down the stairs. And at the bottom of the stairs, you run into yourself today. What do you tell your 21 year old self?
Chris: The first thing I would tell myself is, "If you work hard, do what you say you're going to do, answer all emails, answer all phone calls, you're ahead of 95% of everyone else." So that's the first thing. The second thing is, find a job that challenges you and forces you or gives you something new every day, right? That works for me. What I love about private placements and private credit is seeing new industries, a new structure, and also mentoring the younger analysts and helping them develop their own views, and soliciting different sets of opinions.
Stewart: And in this business you become a news junkie by default, right? You don't have any choice. You're staring at new screens and developments every minute of the day. So it is different every day.
Chris: Absolutely. Absolutely. If you love reading macro and micro, this is a perfect industry for you.
Stewart: Yeah, it's good. And now, we're on a podcast, they can't see you, but I can. And as I look over your shoulder, I see a CFA certificate. Would you characterize Securian Asset Management as the CFA shop?
Chris: Absolutely. Absolutely. For some of the younger analysts looking to pursue a CFA or MBA, I can't recommend the CFA enough. And I think it shows discipline and also gives you the knowledge to be successful in investments.
Stewart: Yeah, the body of knowledge. I mean, we work closely with the CFA societies, and are really fortunate to do so. And I think it's such an important thing for young professionals to know that just because you got your degree doesn't mean the education process is over. There's plenty more to learn and it happens every day. Chris, thanks for being on.
Chris: No, thank you so much, Stewart. Had a great time today. Much appreciated.
Stewart: Chris Gudmastad, head of Private Credit at Securian Asset Management. My name is Stewart Foley. I've been your host, and this is the insurance AUM journal podcast.