Episode 271: Direct Lending Decoded: Macquarie's Strategic Approach to Middle Market Investing

 

Stewart Foley: My name's Stewart Foley, I'll be your host. Hey, welcome back. We've got a great podcast for you today, but I want to kick it off with a little bit of background on our events, our event strategy at InsuranceAUM for 2025. We just finished a really successful private credit event in Texas last week. That was toward the end of... just before Thanksgiving in November, and we are planning an ABF event in Philadelphia in May, and of course, along with our annual meeting in July. And we will be having the private credit event again in November of 2025 just in case you're trying to figure out your travel and whatever else. We've added the ABF event for 2025 based on the industry's response to some polling that we did about where our focus should be.

So I appreciate everybody who voted on those polls and thanks so much for everybody who attends our events. We certainly appreciate that and we want to foster an educational environment and foster as much learning as we can. And with that as a backdrop, I want to bring you a terrific podcast on opportunities in direct lending, and we're joined by Brian Van Elslander, Head of MAM Direct Lending Portfolio Management, Americas, and Bill Eckmann, Head of Macquarie Principal Finance, Americas. Gentlemen, welcome. Thanks for taking the time. I'm looking forward to a really good podcast with you both.

Bill Eckmann: Thanks for having us.

Stewart Foley: The way we usually start this off is we want to know a little bit about you, and so can you each tell us a little bit about where you grew up, what was your first job, not the fancy one, and a little bit of an overview about how you focused, how you find yourself focusing in the private credit space right here, right now, today.

Bill Eckmann: Sure. Happy to kick it off. So Bill Eckmann speaking, thanks for hosting. Grew up in Chicago and then went to school in the Midwest, made my way out to New York City after five years of working in Chicago back in 2006. Before I get into how I got into private credit, very first job was being an umpire. I was a ballplayer, and that was my obsession growing up. When that didn't work out, then I pivoted towards finance, but that was my first job.

Stewart Foley: That's super cool. Where in Chicago? I moved to Texas from Chicago, so I know the spot a little bit.

Bill Eckmann: I grew up in a suburb by Northbrook.

Stewart Foley: Oh, sure. My daughter went to high school in Winnetka, and so she went to-

Bill Eckmann: Right next door.

Stewart Foley: Yeah, absolutely.

Bill Eckmann: One of our rivals in all the sports. And I mentioned my first job as an umpire, but I should mention my second job, which was also at Northbrook as a cabana boy at the local park district where I was going around serving food to the mothers during the summer when they were watching their kids. So that's a little about me and then growing up in the North Shore. And then how did I end up getting here? Like I said, when the ball career didn't work out, I then ended up majoring in finance and I really lucked into private credit. I did the standard investment banking, what seems to be standard investment banking for a couple years, then private equity for a couple years. And then I got partnered up. I was working in Chicago and an opportunity came about where Michael Gross and Bruce Bowler were starting up a firm called Solar Capital, and it was a great opportunity, so I joined them as the fourth employee and was one of the founders back in 2006 and spent nearly a decade working with them before joining Macquarie.

Stewart Foley: Wow, that's fantastic. Brian, how about you? That was a great story. Just I can relate to all the spots that Bill's referencing, but what's your story getting to here?

Brian Van Elslander: Well, I have to first disclose, I actually spent a lot of time in Chicago as well, but I actually grew up in Michigan outside of Detroit. I had the classic Midwestern childhood. My family owned a retail business, and my first job was working weekends and after school in the warehouse. It was sort of a rite of passage for my brother, for me, my cousins, and I would say I learned a lot about what it means to work in that job and probably appreciate it a lot more now than then. But as a fun fact, I'm still a proud lifelong Detroit Lions fan. I will say this is our moment and for football fans out there who might be listening, I'll just say that I like to think it's consistent with being a long-term patient investor and that the city waited 70 years for a home playoff victory. So go Lions.

In terms of finding my way to private credit, I spent my entire career in credit. I was an investment banker for a lot of years and have competed in the credit markets and in a number of different ways, in leveraged finance, in sponsors and now in private credit. And moving over from investment banking into private credit, it's an exciting time. There's a lot of runway for this business, and I do think the future of credit still has a long way to play out within private credit.

Stewart Foley: Yeah, I'm with you. And I got to say I've never been a Lions fan, but wow, it is really easy to cheer for them. The whole story from the coach, and there's just so much good there, so much to feel good about, right? I just feel like they've picked up a lot of fans that maybe didn't already have a lifelong allegiance, but a lot to like there with the Lions. I mean, for real. That's super cool. But the topic at hand here is direct lending, and one of the things I think that would be helpful to our audience is to understand the evolution of Macquarie's direct lending business, as I believe you guys are doing something a little differentiated in this space, having previously had an extremely successful balance sheet lending business, you have now opened up that strategy to allow third party investors to invest alongside with superior alignment. Can you give us a little background to the lending business and then lets talk a bit more about the market right now and then let's talk a little bit more specifics about that market right now.

Bill Eckmann: Yeah, happy to. Macquarie has been an established name in the direct lending market now for over 15 years. So when we first started doing direct lending in 2009, at the time we didn't call it direct lending, we just called it lending. And direct lending evolved into that nomenclature a number of years later. Since 2009, the Macquarie direct lending business has deployed now $40 billion into corporate credit, financing more than 550 borrowers across a range of industries and transaction types. So we've been sizable and doing this for a long period of time. Now, initially when we started, we were concentrated on buying dislocated syndicated loans. We started around the GFC of 2009, so there was ample opportunity to find great risk return, and that was a great business for us for a number of years. But as the market pivoted, we then pivoted and we started to anchor order into syndicated loans that were being arranged by the banks.

But then very quickly thereafter, we stepped into lead arranger roles and started actively working with private equity firms directly to put together financing packages bilaterally with a club of like-minded investors that we were alongside of. So in 2019, myself, my colleague Patrick Ottersbach took over as head of the businesses here in the US and Europe respectively, and we've leaned more heavily, even further more heavily, into the focus on core and upper middle market sponsor-backed direct lending. And since that time, we've invested more than $22 billion into private credit globally. And today we have a large 50-person dedicated direct lending investment team, which has a global reach, a presence in New York, San Francisco, London, and Paris. And so it's been a long track record of us being in the market.

Stewart Foley: Without a doubt, and at least in my mind just one person's opinion, that the trend in private credit, I'm kind of with Brian on this, I mean, there's a long way to go here. There's a long way to go. And the fit between insurance companies and the tenor of these deals lines up nicely in many different ways. What was the catalyst to Macquarie opening up your direct lending business to allow third party investors to come alongside of Macquarie's own balance sheet?

Bill Eckmann: Yep. Really a couple of factors. The first and foremost was the reverse inquiry we had from investors. So as our business has scaled, Macquarie's a public institution and releases its results publicly, and the direct lending platform has become bigger and a more sizable proportion of the overall results. And as investors have noticed the attractive risk-adjusted returns that we're generating, they've inquired directly about participating alongside us.

Second, just from a day-to-day deal perspective, raising third-party capital enhances our already sizable position in the market. So on a per-deal basis. So right now, the platform can invest up to $300 million on a per-deal basis, which is very sizable and relevant in this marketplace. That being said, our PR private equity sponsors that we work with are desiring even more sizable hold sizes. As a result of that, us even further scaling from the current situation we're in is an enhanced benefit and third-party capital will help get us to that position.

So it's really those two reasons and from a perspective of what we do day to day, we are setting this up such that there's strong alignment and the business remains doing what it always has been doing. So the way we go about doing business won't change. We've been doing this as I mentioned since '09 and executed with more than a hundred, about a hundred sponsors now in the last five years. We've got a global portfolio today of more than $13 billion in the sizable investment team. And so there's going to be strong alignment when we're investing in these middle market borrowers with the balance sheet capital. There will also be now third-party capital invested alongside us.

Stewart Foley: Brian, for you, what are some of the nuances that I need to think about when adding third-party capital alongside a balance sheet business? And most people who know me know that like direct lending is not my jam. So if you can give me the big crayons a little bit and then go into the meat of that answer.

Brian Van Elslander: First, to your point, Macquarie Asset Management is already a large asset manager in the markets. We manage over $600 billion in assets across a range of capabilities. We're trusted by insurance companies, of course, but as well institutions and individuals. We're a global manager of over 2,600 employees who are operating in more than 30 countries around the world, so we already have a substantial third-party investment strategies business. We manage a little over $200 billion in credit, of which about $40 billion is in private credit. So direct lending is a natural asset class for us within asset management.

The key point here, as Bill said, direct lending is not new to Macquarie. We're an established name. It's a very important and strategic business for us. So back to your question, the nuance here is that the strategic partnership is inside the firm. We've seen many firms have partnered with external managers, particularly some of the large banks over the last couple of years, and we're building this together internally.

Given that internal partnership, some of the nuances, investors will want to see both strong alignment, as Bill just mentioned, but also robust governance inside the firm. And with alignment, really where the firm and investors have a shared outcome. The offering has to demonstrate that we are aligned in our financial goals. And thus, what Bill mentioned, that we accomplish that by not only investing in the business but also co-investing in the portfolio companies.

And then with respect to governance, I think there's really three features. One being that both the investment team and the portfolio managers are represented on the investment committee and have independence. So the portfolio management team and the investment committee as a whole has independence in making any final investment decisions. And then of course, a risk framework. Investors need to be reassured with a risk framework to guard rail operations within the firm.

Stewart Foley: It's what people around me refer to as skin in the game, and it matters at the end of the day when you're making those investment decisions. One of the things I think that is hard to ignore is that the direct lending space is becoming increasingly crowded with new market entrants. Can you talk a little bit about what sets Macquarie's proposition apart?

Bill Eckmann: Yeah, happy to. So you are right that it is becoming an increasingly crowded marketplace, the direct lending landscape. Strongly believe Macquarie distinguishes itself with a holistic approach that sets the proposition that we offer apart. I mentioned our 50-person investment team. Our direct relationships with the borrowers and sponsors and advisors is really pivotal to differentiating ourselves because that's really the underlying foundation to us getting high quality deal flow from private equity firms where we do repeat business.

But I think there's a few factors to point to, specifically. One standout feature is Macquarie's approach to alignment, which both Brian and I have just mentioned. It's marked by significant capital investments of Macquarie's balance sheet alongside third party capital in every transaction in addition to a substantial GP commitment. So this model reflects really a very strong belief in the commitment to shared success with our investors. Because of this alignment, the Macquarie balance sheet will suffer with a mistake alongside any investor.

Our origination capabilities are really enhanced by Macquarie's very vast global network and diversified financial services portfolio. The Macquarie network helps provide, in addition to differentiated origination, it provides unique insights and access. And so this, call it comprehensive partnership approach, there's other divisions within Macquarie, whether that's funding groups, the FX hedging group, the industry investment banking industry advisory group. We can leverage all these different individuals outside of our team to help provide sector-specific expertise as well as capitalizing on their additional touch points and relationships that have, which just further enhance the quantity and quality of deal flow that we see.

So it's really these, if I had to summarize, it's the global reach, the alignment of Macquarie balance sheet alongside the third-party capital, it's the different pockets of Macquarie that help both indirectly or directly to drive both origination and insights. And it all comes down to the longstanding reputation and expertise we've had doing this for now 15 plus years.

Stewart Foley: And as you know, I mean, we do a fair amount of podcasts here and we hear about higher interest burdens, rising default rates and the use of PIK instruments creeping into the credit markets. How has Macquarie's direct lending portfolio performed, and could you discuss any sector specific areas that you see opportunity and where you are cautious?

Bill Eckmann: Since 2009, the Macquarie private credit platform has had across those 550 deals and $40 billion plus invested has had a historical loss rate of approximately one basis points per annum. So, it's been a strong track record, and I'll get to why. We do have a dedicated, across the Macquarie platform, both within asset management and in our team, we have a dedicated workout team to help us in troubled situations. But like I said, we've had, those have been fortunately to date, those have been few and far between.

In a market like this and really in every market, but in particular in a market like today, sector and asset selection are paramount. We focus on defensive sectors with resilient cash flows, revenues that are very recurring. And we saw this during Covid where some of the sectors we inv est in, be it software, insurance services, education, businesses that have a profile where the service or product being offered with high likelihood going to renew the next year. And that gives these businesses pricing power. And we saw this during Covid when cost inflation was rampant across each and every business, but in the majority of the businesses we had invested in, pricing increases also follow to help offset those inflationary pressures, which really helped insulate our portfolio from a downturn.

So, by prioritizing these mission-critical, recession-resistant businesses, we're building a diversified robust portfolio we believe that can weath er these economic uncertainties. And we tend to avoid the sectors that have the non-recurring revenue or products that are at risk of being disrupted by changing market dynamics or heavy tech risk. We're looking for businesses that are, I'd say simple to understand, that have been around a while, and that exhibit that recurring type revenue characteristic.

Stewart Foley: Yeah, it's interesting. I mean, given the current dynamics and uncertainties in the credit markets, what perspective should insurers adopt when they're evaluating the opportunity set available right now? I think that a lot of insurance companies, I mean, many of them are actively in this space, but there are still a significant number that aren't or would like to be but don't know how. Or what should an insurance CIO or someone who's in charge of private assets at an insurance company be thinking about as they look at these markets?

Brian Van Elslander: So, we have these conversations regularly with our insurance clients. I should mention we're a top-ten insurance asset manager. We manage about $130 billion on behalf of our insurance clients globally. Obviously, credit has been a very exciting sector over the last few years. I think there's a new chapter emerging here, one with declining rates, but maybe still some economic and market uncertainty. That being said, I think your listeners are asking, rightly, why direct lending? And why now? How to really think about that asset class. So, I'll start by saying direct lending is a large and now permanent asset class, and it's provided opportunity to not only diversify, but enhance portfolios for all types of investors. It's one that's focused on capital preservation. It's at the top of the capital stack, so a very safe, defensive credit strategy, but also one that offers historically attractive return profiles, and current income as well.

Direct lending, I should say, is an asset class that's averaged near 10% returns over the last 20 years.  It's why it’s sometimes referred to as the all-weather strategy, because of the resilience against market volatility and economic volatility. And also, generally low correlation to public markets. But another reason, really, on diversification, and I think this is an important point but not often made, is that the middle market exposure in and of itself also offers diversification. So direct lending is generally a middle market lending product, but until recently, investors have been unable to invest directly into the middle market in any way. There are no public equities or really, public debt. So now the middle market is open to many types of investors, which was before otherwise un-investable unless you were a bank or invested in middle market private equity or maybe a high-yield mutual fund.

Meanwhile, investors in public securities are all investing in the same five to 6,000 public companies. And these portfolios all end up somewhat correlated with each other. At the same time, the middle market is a third of the US economy. There's over 200,000 middle market companies in the US. If the US middle market was a country, it would be the fourth largest economy in the world so that's a huge opportunity. And middle market direct lending, in turn, offers a huge opportunity for investors, really to diversify into new names and new categories. And they've been rewarded now historically for doing that, for having senior debt exposure with these types of return characteristics.

Stewart Foley: It's a really interesting comparison that they would be the fourth largest economy in the world. That helps me put it in a different frame. That's a really interesting stat. But when you think about issues that insurance investors need to keep in mind when they're thinking about direct lending strategies, what are some best practices for insurance investor to keep in mind?

Brian Van Elslander: Okay, so we're speaking here to experienced listeners. I think the top three allocators to private credit are all insurers. I think as are the top seven out of 10. And the benefits of investing in direct lending are pretty well known to them, diversification, high returns, current income and stability. So, investors really need to have a strategic mindset around the risk return metrics. So first I would say diversification and portfolio construction, I think as Bill touched on. Broad investment selection is critical and it's very hard to replicate an origination team of an established firm. Our investment team, established 15 years ago, over a hundred borrower relationships, it's very hard to build your own portfolio in this market. The large established teams with relationships and experience, they have the advantage.

Macquarie has that advantage, but also keep in mind it's time intensive. The origination is not like choosing securities - 60 to 90 days or longer to make an investment. We look at a thousand deals. We do a very small percentage of them, so it's incredibly labor intensive as well. And people who do this all the time are specialists. We know the market, we know the documents.

Second, I would say maintaining a very strong focus on quality and due diligence. Partner with experienced lenders like us. We have a very detailed investment process performing private equity style, primary diligence, and importantly demonstrating some patience and selectivity even in frothy, maybe even especially, in frothy markets. Documentation is extremely important. I mean, some have thought maybe this is a lost art. We don't think so. It's incredibly important to have the right package as a lender. There's tremendous value in the terms and conditions of lender protections.

Finally, I would just say insurers need to think about the long-term strategic fit of direct lending within their overall strategy. So one, obviously considering the liability profiles and capital requirements, but asking what role can direct lending fill that's missing in their portfolios today, whether that's diversification or current income or preservation of capital. Direct lending really should be a part of a diversified portfolio. So, I know your clients are already giving this a lot of thoughtful consideration. We appreciate opportunity to weigh in here.

Stewart Foley: Thanks, Brian. And I think we've got a great education today on direct lending and best practices and certainly appreciate you and Bill being on. I've got a couple of fun ones for you on the way out the door, if you will. I always have people who are earlier in their career. A question for both of you. You both have senior leadership positions in a major financial services firm that's doing really interesting stuff. And if someone were coming out of college or fairly recently out of college, what advice would you give those folks who could be potentially sitting in your chair someday?

Bill Eckmann: Yeah, certainly. I'd probably answer it with a generic answer, but I think the basics go a long way, which is in order to succeed in most any business, you need to put your, especially coming out at a young age in your early twenties, my advice would be put your head down, work hard, listen, do more listening than talking and absorb learnings from those around you. I think at least what I feel like I've done in my career is there's been a lot of leaders around me and no one's perfect, including myself. So what I try to do is as I spend a lot of time with people, develop a perception of things that I can take with me and things that I can improve upon and then continually learn from there in order to develop leadership capabilities.

To me, it's really, especially at that young age, really the basics. Put your head down, work really hard, absorb, listen, and learn from others around you and embrace mentorship because success is partially driven by those things I mentioned, but also by luck and also by having people around you that support you on the way up. And so developing those relationships is critical for long-term success.

Stewart Foley: That's fantastic. Thank you. And my last fun one is, and this is kind of interesting, whenever we have two guests, each person gets to have one and then you got to agree on one. So this is the question around who would you most like to have lunch or dinner with? You can have the two of you and you both get to pick one more and then you got to agree on one. So a total of five, alive or dead, that's the scope. So who would it be? I'll start with you, Brian. Who would you most like to have lunch with, alive or dead?

Brian Van Elslander: Well, I'm sort of drawn to presidential history, so I'd have to narrow that down a little bit. We're going to go back in time on this one though. But I think presidents and having read so many biographies sometimes find their way to that office in a very circuitous way, and they have great backstories. And whether it's a World War II president, during the reconstruction period or in the earliest days, I think there's so many great candidates who may be popular or may not be popular, but really interesting backstories and would love to hear more about the kind of challenges they confronted at that time. 
Stewart Foley: That's super cool. That's an interesting thing to know. That's cool. So how about you, Bill? Who's your guest?

Bill Eckmann: I swear Brian and I did not coordinate at all on this answer, but I'm also a history buff. I majored in political science. I guess my answer would've been George Washington and really any of the founding fathers would've been my choice. And just especially with what's going on in the political landscape of the last 10 to 20 years to see our system of government work the way it does, I just find it astounding and it's so impressive how the founding fathers set up the government the way they did with checks and balances and sort of in a way anticipated some of the dynamics that we're seeing. And so to have that live perspective would certainly be what I would love to sort of understand over a lunch or dinner.

Stewart Foley: That's super cool. That would be an amazing lunch. George Washington, a founding father, and someone who is president during one of the key times of our country's history. So well done. Thank you both for being on. I really appreciate it. We've gotten a great education today and it's been great to get to know you both.

Bill Eckmann: Likewise, thank you.

Brian Van Elslander: Thank you very much.

Stewart Foley: We've been joined today by Bill Eckmann, Head of Macquarie Principal Finance, Americas, and Brian Van Elslander, Head of MAM Direct Lending Portfolio Management. Thanks for being on and thanks for listening. If you have ideas for podcast, please shoot me a note at Stewart@insuranceAUM.com. Please rate us, like us, and review us on Apple Podcasts, Spotify, or wherever you listen to your favorite shows. We'll see you again next time on the next edition of the InsuranceAUM.com Podcast.

 

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