Following on the heels of a record year of capital raising, debt financing provider Churchill Asset Management recently closed a $300 million collateralized loan obligation fund, Churchill Middle Market CLO IV. Churchill is part of Nuveen, the asset management division of TIAA. Overall, Churchill manages more than $4.4 billion in committed capital. We asked CEO Ken Kencel about his firm’s investment approach and thoughts on middle-market lending.
Describe Churchill’s investment strategy.
Churchill is a leading provider of senior and unitranche debt financing to middle-market companies, primarily those backed by leading private equity firms. As a majority-owned affiliate of Nuveen, the asset manager of TIAA, we invest materially alongside our third-party investors in every transaction we do. This alignment is a key distinguishing characteristic of our firm. In addition, we enjoy long-standing and very strong relationships with our private equity sponsors that go back, in many cases, over a decade. TIAA is also a large investor in many of these firms, which gives us a significant advantage in sourcing higher quality opportunities from these firms. Finally, in the current competitive financing environment, our ability to be both highly responsive and to invest with significant scale further distinguishes us from our competitors. Private equity sponsors increasingly are focusing on a small core group of relationship lenders that they trust and can rely on. These key relationship lenders must be able to underwrite and invest a material amount in a given transaction, typically at least $100 million. We deliver on both counts.
What’s new in middle-market lending?
The biggest change we’ve seen is the shift from banks to non-bank lenders. Suppliers of private credit, in turn, are enhancing their ability to compete with investment banks to lead deals. They accomplish this by being able to hold larger commitments and syndicate transactions that banks don’t want to hold. The other major change we’ve seen is a loosening of loan terms in the middle market. With more capital coming online, terms are becoming increasingly issuer-friendly and the lines between financing options are blurring. Covenant-lite loans are coming down market, as are looser debt baskets and wider cushions. Finally, relationships increasingly matter. Sponsors are limiting their financing partners to trusted lenders and limited partners. This has led to a concentration of the middle market into fewer platforms that can underwrite bigger tickets. The ability to aggregate investor demand for loans from a wide range of capital sources has made the largest platforms even more relevant to private equity sponsors.
Why do investors like CLOs?
First and foremost, collateralized loan obligations across the capital structure offer attractive risk-return profiles compared to other forms of corporate debt. The competitive yields offered by CLOs are a huge draw for income-hungry investors, especially in a rising rate environment. The CLO market has also proved to be resilient over time. During the credit crisis and throughout this current cycle, middle market loans have performed better than many other loans, which in turn has expanded the potential universe of investors willing to invest in them. Lastly, we think greater transparency has played a role in rising investor interest. In the case of middle-market loans, the information flow on loan performance, mark-to-market values, etc. has improved considerably over time. Managers such as Churchill have worked hard to provide detailed information on each loan to investors so they have the ability to track progress beyond the data produced for monthly trustee reports.
What is your outlook for M&A?
We think M&A in the middle market will continue to be robust in 2018. The Gross Domestic Product is expected to track at or above 2 percent for the next several years, buoyed by corporate tax cuts. Dry powder for both private equity and private credit has also been accumulated in significant amounts over the past several years. That capital needs to be deployed, so investors are feeling a sense of urgency to participate in auctions. In addition, corporations have a record amount of cash on their balance sheets – more than $2 trillion at last count. Middle-market companies are attractive targets for corporations that are looking to make strategic acquisitions. This is especially true for target companies that provide a technology edge or a discrete opportunity to grow revenues and margins, as is often the case for middle market companies. This has contributed to purchase price multiples for middle market sponsored transactions also being at record levels.