Alternative Credit: Let the Circle Be Unbroken

Although middle market direct lending volumes have firmed relative to a moribund 2022–23, easier financial conditions have yet to unleash the massive wave of mergers and acquisitions (M&A) activity needed to truly open the floodgates.

 

Key Takeaways

• Though the volume of large M&A transactions has remained muted, lower middle market companies—particularly those businesses with private equity sponsors—may represent a sweet spot for nonbank lenders.
• ABL facilities have long served as an all-weather financing option for asset-rich but cash-constrained companies whose access to traditional capital market channels is often limited.
• Given the low correlation between direct lending and ABL returns, lenders with the experience and flexibility to opportunistically toggle between the two may be positioned to potentially provide investors with complementary sources of return across credit cycles.
• The ability to provide borrowers with flexible lending solutions while maintaining disciplined underwriting standards underpins consistent access to deal flow and may help drive attractive risk-adjusted returns for investors.

The opinions expressed are not necessarily those of the firm. These materials are provided for informational purposes only. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Any statistics contained herein have been obtained from sources believed to be reliable, but the accuracy of this information cannot be guaranteed. The views expressed herein may change at any time subsequent to the date of issue hereof. The information provided is not to be construed as a recommendation to buy, hold or sell or the solicitation or an offer to buy or sell any fund or security.

Past performance is not indicative of future results.

Risk Disclosures

All investments involve the risk of loss of principal.

Alternative investments can be speculative and are not suitable for all investors. Investing in alternative investments is only intended for experienced and sophisticated investors who are willing and able to bear the high economic risks associated with such an investment. Investors should carefully review and consider potential risks before investing. Certain of these risks include:

• Loss of all or a substantial portion of the investment;
• Lack of liquidity in that there may be no secondary market or interest in the strategy and none is expected to develop;
• Volatility of returns;
• Interest rate risk;
• Restrictions on transferring interests in a private investment strategy;
• Potential lack of diversification and resulting higher risk due to concentration within one of more sectors, industries, countries or regions;
• Absence of information regarding valuations and pricing;
• Complex tax structures and delays in tax reporting;
• Less regulation and higher fees than mutual funds;
• Use of leverage, which magnifies the potential for gain or loss on amounts invested and is generally considered a speculative investment technique and increases the risks associated with investing in the strategy;
• Carried interest, which may cause the strategy to make more speculative, higher risk investments than would be the case in absence of such arrangements; and
• Below-investment-grade loans, which may default and adversely affect returns

Definitions

Asset-based lending (ABL) is corporate borrowing supported by specific assets of the borrower rather than its cash flows.

Direct lending refers to a loan agreement between a borrower and single lender or small group of lenders. Direct lending can also be referred to as “private credit” or “private lending.”

Dry powder is the amount of committed but unallocated capital a private equity fund has available to invest.

Loan-to-value ratio (LTV) compares a loan amount to the estimated value of the asset being financed.

Senior secured loans are commercial loans that have the highest priority claim on a borrower’s assets in the event of a default.

Standard deviation is a statistical measure of volatility that captures the degree to which an investment’s price has deviated from its average over time.

Indexes are unmanaged and one cannot invest directly in an index.

Bloomberg US Aggregate Bond Index (Gross/Total) measures the performance of the investment grade, US dollar-denominated, fixed-rate taxable bond market in the US, including Treasuries, government-related and corporate securities, fixed-rate agency MBS (agency fixed-rate and hybrid ARM passthroughs), ABS and CMBS. A total-return index tracks price changes and reinvestment of distribution income.

Bloomberg US Corporate High Yield Bond Index (Gross/Total) measures the US dollar-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. A total-return index tracks price changes and reinvestment of distribution income.

Bloomberg US Municipal Bond Index (Gross/Total) measures the performance of the US municipal tax-exempt investment grade bond market. A total-return index tracks price changes and reinvestment of distribution income.

Cliffwater Direct Lending Index (Gross/Total) is an asset-weighted index of US middle market direct loans. A total-return index tracks price changes and reinvestment of distribution income.

ICE BofA Current 10-Year US Treasury Index (Gross/Total) measures the performance of US Treasury securities with a remaining maturity exceeding seven years and less than or equal to 10 years. A total-return index tracks price changes and reinvestment of distribution income.

Morningstar LSTA US Leveraged Loan Index (Gross/Total) is a market value-weighted index that measures the performance of the US leveraged loan market. A total-return index tracks price changes and reinvestment of distribution income.

S&P 500 Index (Gross/Total) measures the performance of 500 of the top companies in the leading industries of the US economy and is widely recognized as a proxy for the US market as a whole. A total-return index tracks price changes and reinvestment of distribution income.

FEF Distributors, LLC (“FEFD”) (SIPC), a limited purpose broker-dealer, distributes certain First Eagle products. FEFD does not provide services to any investor, but rather provides services to its First Eagle affiliates. As such, when FEFD presents a fund, strategy or other product to a prospective investor, FEFD and its representatives do not determine whether an investment in the fund, strategy or other product is in the best interests of, or is otherwise beneficial or suitable for, the investor. No statement by FEFD should be construed as a recommendation. Investors should exercise their own judgment and/or consult with a financial professional to determine whether it is advisable for the investor to invest in any First Eagle fund, strategy or product.

First Eagle Investments is the brand name for First Eagle Investment Management, LLC and its subsidiary investment advisers. First Eagle Alternative Credit and Napier Park are brand names for the two subsidiary investment advisers engaged in the alternative credit business.

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