IG Private Credit: Managing through Change

Everybody knows that there’s a big flow of funds to private assets. Eight months ago, everybody was talking about maximizing yield and eight months later, everybody’s talking about risk management. So today we have a very good podcast for you on investment-grade private credit, and we’re joined by Sara McCrady and Michael Kelleher from Securian Asset Management. Welcome.

Michael: Thank you, sir.

Sara: Thank you.

Stewart: It’s great to have you both on. And it’s going to be a good conversation. But we’ll start this one like we start them all. Hometown, first job of any kind, fun fact. Sara, go first. I know you better than Michael.

Sara: All right. My hometown is Northfield, Minnesota.

Stewart: Nice.

Sara: A very nice little town to grow up in. And my first job was at the grocery store in town. Loved it. It was fantastic. And then a fun fact, I have met George Clooney and given him a kiss on the cheek.

Stewart: Holy smokes! This is a G-rated show, Sara. Come on. All right, Michael, how about you?

Michael: So I’m from Bloomington, Minnesota originally. My first job was as a caddy at Interlocken. My second job was as a bag boy at a grocery store. And I’d say a fun fact is I’m still in Coast Guard Reserve. Been there for 14 years. And Securian’s very much in support of that.

Stewart: Wow, that’s great. Thank you for your service. Okay, private credit. Securian’s been at this a while. You’ve been managing money for the mothership for quite a while. And then Securian Asset Management does it on a third-party basis. Can you tell me, at a high level, what’s Securian’s background in private credit and investment-grade private credit, in particular?

Michael: Yeah. So I believe we’ve been investing in the asset class for over 50 years here. It’s definitely been one of the staples of our strategy. Typically, an insurance company is going to have about 12% to 17% of the overall portfolio in the asset class of the private sphere. Some of the main reasons they’re looking for that diversification is you pick up a liquidity premium on issuance. Also, you have covenants. And then you do have a diversification factor. Seen a lot of different issuers in our market that you’ll only see in the public market as well.

Stewart: Yeah. And it’s interesting. I mean, there’s a lot of vol, year to date, a bunch of vol. Private assets have typically been less volatile. Have you seen that in the portfolios you’re managing there?

Michael: Yeah, I’d say that’s the case here as well. Definitely, we’re having different pricing. We use VBAL, as Sara can probably speak to. But overall, volatility as far as expected losses, very low. I don’t think our portfolio has really changed as far as quality. And again, we do also have that downside protection when we talk about covenants. It factors in a lot when we go through these periods of volatility here.

Stewart: There’s concerns of the economy that weren’t there several months ago, a year ago. We’ve got high inflation. I saw this morning, people are talking about canceling closings on homes that they’ve purchased and been like, “Uh-oh, this doesn’t look good.” And when you look at that, everybody kind of says, “Wow, what’s my downside risk here?” So, can you talk a little bit about drawdown protection and the value of the covenants that you mentioned just a minute ago?

Michael: Yeah, absolutely. And I think that comes down first, to our underwriting. When we’re initially doing a new transaction, we go through about a two- to three-week what we call marketing period. So the deal will launch from an issuer via a broker. And then we usually have a management call or meeting followed by, like I said, a couple weeks of due diligence, where we really have a back and forth conversation with the management team, answering questions, really figuring out what their plan is, how they envision moving forward here.

Stewart: This is just for clarification, and I’ve never been through this process. You’re talking about the management team of the issuing entity, right?

Michael: Correct.

Stewart: You’re talking directly to the folks, to the borrower.

Michael: Yep. So there’s usually an initial call or meeting with the management team. Oftentimes the CFO. If it’s a little smaller, maybe the CEO, various other people who would make sense to be on that call. Then with that back and forth, we’re usually going in between with a broker. So there’d be Bank of America, JP Morgan, you name it. And also during that time, we’re really looking at the business itself. And then we’re also forming that covenant package. So they usually come to us during a new issue and say, “Hey, here’s our deal. Here’s our terms, and here’s the legal side, and here’s the covenant package.” And this is kind of our opportunity to go back and forth and figure out what we do need in that covenant package to make this deal investible.

For instance, if it’s a smaller, more volatile company, do we need additional balance sheet covenants? Do we need income statement covenants? Any sort of sale of assets. That’s the time where we can really tailor-make a covenant package, so when we get to these kinds of situations, we can be comfortable that there’s that downside protection.

Stewart: How often are you the lead on the deal?

Michael: I’d say we’re pretty in the middle in terms of the market. But definitely, a few times a year we will be lead. And that just does come with additional filing (with the NAIC).

Stewart: Yeah. And I mean, at the end of the day, though, whether you’re lead or not, you’re in the covenant discussion and that’s part of the structure of the deal. I mean, you’re structuring the deal as it’s coming in the door.

Michael: Correct. Yep.

Stewart: Yeah. So, I mean, I’ve got a host of opinions. One of them is that I think insurance companies sometimes overstate their liquidity needs, because there’s FHLB memberships, and there’s lines of credit. There’s other ways to manage liquidity other than selling the portfolio, which is why I think that private assets have had a big run for a long time and will probably continue to have. But if I do have liquidity needs, what are my considerations in IG private credit? And is there a way to put in a complementary allocation there?

Michael: Yeah, private debt is definitely less liquid than public debt. However, there is a secondary market out there. There are a few main traders that do provide liquidity for the market. Granted it’s going to be different on a security-by-security basis. Also, if there’s more opaque security, they’re also actively pricing a lot of these securities as well. So we can get a better sense of what quarter-end pricing might look like based on kind of a few data points out there.

Stewart: Sara, I want to get you in here. We’ve been talking to Michael. But Securian has a team approach to dealing with clients because you’ve got to consider, each insurance companies are like snowflakes. From far away, all look the same. But up close, all different. Can you talk a little bit about your role at Securian Asset Management and kind of how you play into the IG private credit story?

Sara: Absolutely. So I started in the industry in 1998. But since 2007, I’ve been working exclusively with our third-party clients, most of whom are insurance companies. And we build a portfolio for each client based on their investment policy. So we work with them to customize duration needs, credit needs, and really build around what each of the clients needs individually.

Stewart: And when you see, and Michael maybe, when you see deal flow, and as a substantial player, and I think that’s an important point. To get deal flow in investment-grade private credit, you have to be a player in the space. And that requires a certain amount of AUM for anybody to pick up the phone and call you. How do you fit the client guidelines? I’m sure every transaction you see doesn’t fit everybody. That is a tailored, bespoke approach, right, Sara? This bond fits in this portfolio. This bond does not fit in this portfolio. That’s an oversimplification, but is that your process?

Sara: You’re right on, Stewart. We bid for each portfolio based on their needs, and then we’ll aggregate those bids. We have a process in place. We’ve had the same process in place for many years. It’s documented and it works well so that we can build these out for each client.

Stewart: And I think it’s an important point because there are asset management firms that are standalone, and then there are asset management firms that are part of an insurance company, like yours is. And I think sometimes the perception is that your clients are getting the castoffs from what the mothership doesn’t want. I think that some of the documentation processes that you’re talking about ensure that that’s not the case. Is that a fair assessment? Because I think that’s a concern that people have when they’re looking at selecting asset management firms.

Sara: Sure, sure. Yeah, our parent company is in every one of our deals. And that just makes sure that we have skin in the game as a firm, alongside of our clients. If we wouldn’t recommend a deal for our parent, we wouldn’t recommend a deal for the client. That being said, our bid process takes all of those bids, aggregates them. And the parent is not receiving more or less. They’re receiving a pro-rata share based on the bid.

Stewart: But from a third-party client perspective, I am benefiting from the size of the parent. I’m basically getting better pricing than I would on my own. I guess that’s where I’m headed.

Sara: Sure. Getting better allocation, for sure, that we’re able to go in for a more sizable bid. We’re nimble enough that we can adjust as necessary. But we are big enough that we are getting the attention of brokers and the proper attention of each of the deals.

Stewart: Yeah. And I mean, you bring up a good point. So I think sometimes in asset management we talk about ‘more is better’. But there are opportunities in… I mean, I worked for smaller asset management firms. And we found value in smaller deals that some larger managers simply couldn’t play in, because there just wasn’t enough of the deal to go around. Do you find, and I don’t know if this is Sara or Michael, do you find that there’s value in deals that are a little bit smaller in size, that your size helps you add value to a client portfolio?

Michael: Yeah, I think that’s spot on in a few different ways as well. Like you said, there might be that overlook from some of the top three or four firms that they just don’t want to spend the time on a smaller deal, where it might be a name that we know, And we’re definitely able to turn that around pretty quickly. Also, we might have more specialty in a different area than a lot of the market. For instance, our firm has a pretty heavy weight towards real estate. So we might be able to lean on some of our CML or other aspects of real estate to become the team here and to really underwrite that deal properly. Or also, some of the more esoteric names. We’ve seen a lot of, especially finance BDCs issuing in our market.

We’ve been doing those for quite a while. So we know kind of what we’re looking for. And we’re able to, like I said, make those appropriate covenant packages to make those work for us. Also, we’ve been participating in club deals as well. So more direct lending deals, they kind of-

Stewart: Okay, so hang on a minute. This is where the dumb guy in the podcast starts asking the simple questions. Okay, so talk to me about, what’s a club deal?

Michael: So a club deal is going to be originated by a larger lender and then going out to a small group to form maybe a 150, 200 maybe, million dollar deal. So instead of going to the widely-syndicated market, where you might have 20, 25, 30 investors looking at a deal, this is going to be more of a direct to a club. So maybe 4 or 5 investors. The advantage of this is going in, you’re pretty much going to know what your allocation is instead of going to the food fights at the end of one of these larger-syndicated deals. Also, you’re going to save a lot of time on these, more direct access to management and those Q&A, go through it pretty quickly. And once you participate in some of these club deals, they’re more likely to return again to the same club.

Stewart: And that’s where I was headed. Like all clubs, your conduct while you’re in the club, determines whether you’re going to stay in the club. And so the fact that you are a consistent player or a consistent investor, and that this is in your wheelhouse, allows you to stay in clubs. And there’s value in that, right?
Michael: Absolutely. Absolutely. Again, you’re going to see some other deals that might not be out to the broad market. And you’re going to see a lot more of those as well, kind of add-ons or new deals from the same kind of club.

Stewart: So you mentioned at the top of the show that Securian has been doing investment-grade private credit for something over 50 years. Sara said, “I’ve been at this since 1997.” And I’m like, “You’re trying to make me feel bad.” I mean, when somebody says 50 years, I feel like that sounds like a lot shorter time than it used to, let’s put it that way. But when you look at this market over time, and particularly in the last couple of years, what changes, if any, have you seen in the deals that you’re being shown?

Michael: Stewart, a couple of things on that note. First of all, there is a cyclicality to the business here. You’re going to see that mostly with that acquisition spread that we mentioned earlier. On a normal year, you might see 40 to 50 basis points of relative value versus publics. However, when you do see market disruption, lastly, we saw in COVID, you’re going to see that really widen out. And you’re going to see that as the issues in our market might be smaller and they might need to offer more spread to be able to access the market, especially on a refi deal versus an opportunistic, where they can hold off for a while.

Stewart: So you’ve seen its cyclicality. You’ve seen tighter spreads. You saw a bit of widening during COVID. A little bit more spread compression now. But we’re faced with a significant increase in interest rates. What have you seen as a result of this most recent rise?

Michael: Yeah. So there’s a couple things that we are noticing here. First of all, we’ve seen a kind of slowdown in new issuance in the market as a whole. I think, especially when we first saw the rates rising in the second quarter, there was kind of a pause of issuers saying, “Is this going to be long term? Is this going to be a quick up and down? Where’s inflation going?” But now, we’re seeing those go up and up. We’ve seen the Feds say, “We’re probably going to have 75 bids at the end of the month, maybe 50 in September.” So it’s still going up. So I think it’s a matter of, do we have to refi debt now? Or, if it’s, like I said, opportunistic, we can just hold off.

I think during the initial rise in rates, it was more of a, “Let’s hold off for a bit, see if we’re going to get lower rates in the future.” But now, it seems like, “All right, even though we’ve got a hike, this might be the lowest that we’ll see in some time.”

Stewart: I’m an insurance CIO and I don’t know a lot about this market, and Sara mentioned duration and we’ve talked a little bit about covenants and so forth. Are most of the coupons fixed or floating? So start there. And what are the typical maturities that you’re seeing as far as what kinds of durations can I expect to see from this asset class?

Michael: So as far as fixed and floating, definitely a majority is going to be fixed. There’ll be some deals where it’s majority floating. Some deals might have a tranche floating. But I’d say the majority are just fixed. I would say just as an estimate, probably 80%, 85% fixed. But there’s also a cross-currency in there as well. About a third of the market is cross-currency. So I think those are some of the different factors there in our market.

Stewart: So explain that one to me. Can you unpack what that means when you say cross-currency?

Michael: Sure. So we could have a European issuer that wants to issue Euro-denominated debt. And we have a lot of Australian issuers doing sometimes Aussie dollars. It’s mostly up to them if they want to issue in dollars and swap back themselves, or if they just want to issue their foreign currency to the issuers and have them swap back.

Stewart: Yeah. From your perspective, and I saw a headline this morning that the Euro and the dollar achieved parity for the first time in 20 years. You want to go diving off into that quagmire? What do you see there? Did that surprise you?

Michael: I think it is very surprising. However, we do not do foreign currency right now, so that’s not something I paid attention to too closely as far as the investment side.

Stewart: Yeah. And it’s funny you say that, because when I was managing money, it’s the same deal. Your insurance clients, their claims are denominated in dollars and that, it makes all the sense. I mean, if they want to take currency exposure, that’s up to them. But it’s kind of like we’re adding an element there that we might not need to, at least that was our approach.

All right, Sara, back to you. Client case studies, without naming any names, can you give me an example, I know it’s mixed, between life and P&C, but can you give me a P&C example of how a client’s using investment-grade private credit and then a life example?

Sara: Sure, absolutely. So P&C, just based on their liabilities, are going to need shorter duration. And we can achieve that a couple of different ways. A lot of times issuers are going to be coming to market with several maturities. And we can bid specific for our P&C clients to target those shorter durations, whether it be 5-year, 7-year. And then we try to tailor make the portfolio specific to the client’s needs. Whereas life insurance companies, generally, their liabilities are going to be longer. And we’ll tailor our bids for them to the longer side of the curve. So looking for 10, 12, 15. There’s 30-year that come to market occasionally or longer. So we’re able to really pick and choose for each client’s needs.

Stewart: All right, so let’s go back to portfolio construction for a minute. And Michael, you mentioned that you were seeing some deals coming out of finance companies. If I show up at your doorstep and I want to make an investment-grade private credit allocation, how do I build a diversified portfolio? What are some of the key requirements?

Michael: Yeah, so I think first of all you have to have a solid network throughout the community. Good relationships with all the brokers will help you see more deals and allow you to kind of funnel those in, to get the right ones for your portfolio. Next, whether we’re working with ML, our parent company, or if we’re working with the third-party companies as well, just following that IPS and figuring out what is the right mix for each person’s portfolio. Some people might be more apt to have a larger REITs exposure. Some might be more apt to have a higher financial exposure. Really based on what their risk-return profile is. And if they’re looking for higher excess spread, if they’re looking for different duration, those are going to be tailor-made to each one of those portfolios.

Next, our analyst team, we’re going to be funneling through those 200, 250 deals we see a year. And then we have a hit rate of about 20%, 25% or so, the deals we actually invest in. So once we do make a recommendation from the analyst side, we’ll go to the portfolio managers and let them decide, where does this fit in each person’s portfolio? And Sara mentioned earlier she’s going to look through all 25 or so IPSs. We’re going to talk individually with our head PM and let them decide what’s the best for the portfolio and make sure we have a real diversified offering. So they do have those opportunities to pick the right securities.

Stewart: And just to be clearer, when you use the term IPS, that stands for ‘investment policy statement’, right?

Michael: Correct.

Stewart: So you’re going in and looking at… I mean, I’ve always used it like a silkscreen on a T-shirt. It’s like you have bonds, but you have to look at each portfolio and say, “Okay, this works for here. This works for there.” But you can’t just allocate across accounts pro-rata. I realize it’s a by-hand kind of process.
Okay, so to wrap it up, Sara, I’m coming to you. The flow of funds to private assets has been increasing. It is large. And by all indications that it’s not going to slow down. In fact, I’ve had major CIOs tell me that they thought that the private market may be larger than the public market, at some point. With regard to the allocation to the third-party asset managers, how are you seeing the growth in your business in this asset class?

Sara: IG private credit has been an area of focus for our parent company, and it’ll be a continued area for growth going forward. An important part of that growth is our third-party business and continuing to bring more assets to the market, because really, it is driven by supply, the supply of the new deals, the new issuers. And our continued demand is going to be driven by the appeal of the market. And it really does offer very nice relative value compared to publics and some of those downside protections. The covenants are very important. And our process is very important. It’s been time-tested and has not changed. We feel that this is one of the areas that we want to continue to grow over time.

Stewart: And as they say in the investment business, you eat your own cooking. You’re on every deal. The parent company’s on every deal. And that’s got to make you feel good about your process. Sara McCrady, Director, Client Portfolio Manager, and Michael Kelleher, Private Credit Analyst at Securian Asset Management, thanks for being on.

Sara: Thanks, Stewart.

Michael: Thank you very much. It’s been a pleasure.

Stewart: My pleasure as well. Thanks for listening. If you have ideas for a podcast, please email me, Stewart@insuranceaum.com. My name’s Stewart Foley, and this is the InsuranceAUM.com Podcast.

Securian Asset Management
Securian Asset Management

Our asset management business has been built with a risk and liability management focus, coming from our history investing for the General Account of our parent, Securian Financial Group. Since 1880 we’ve been committed to providing investment solutions enabling our clients to achieve their goals with confidence.
We are staying true to our purpose, and our values, while being innovative and nimble to prepare our clients to meet their future from a position of strength. As a financially stable, non-public company we focus on the long-term and execute consistently for our clients.

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Vice President, Institutional Solutions
(651) 665-5097

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