Podcast: Opportunities in direct lending

00:00:00 - 00:00:12

Podcast intro

Welcome to Pathways, a Macquarie Asset Management podcast, where we provide fresh perspectives and insights for institutional investors and consultants about real assets, private markets and macroeconomics.

00:00:13 - 00:01:07

Daniel McCormack

Thank you for tuning in. I'm Daniel McCormack, Head of Research at Macquarie Asset Management. Today we're discussing a sector within private credit that's seeing increased demand, and that is direct lending. Direct lending has established its market presence due to the various benefits it provides to borrowers, including greater deal certainty, faster speed of execution, direct relationships with lenders and more tailored solutions.

In addition, the strategy may generate attractive returns with less downside risk and mark-to-market volatility than more liquid credit strategies like broadly syndicated loans, leading to further interest in the space.

Joining me today are Brian Van Elslander, who's head of MAM Direct Lending Portfolio Management in the Americas, and Bill Eckmann, who's Head of Macquarie Principal Finance in the Americas. Gentlemen, welcome and thanks for taking the time.

00:01:08 - 00:01:09

Brian Van Elslander

Thanks for having us.

00:01:10 - 00:01:22

Daniel McCormack

Before we jump in, can you each tell us a little bit about your background? Perhaps what was your first job, and a little bit of an overview about how you find yourself focusing on the private credit space right here right now today.

00:01:23 - 00:02:27

Bill Eckmann

Sure, happy to kick it off. Bill Eckmann speaking. Thanks for hosting. I 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, my 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. 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 looked into private credit. I did the standard investment banking, what seems to be standard investment banking, for a couple of years, then private equity for a couple of years. And then I got partnered up. I was working in Chicago and an opportunity came about where Michael Gross and Bruce Boer 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.

00:02:28 - 00:02:31

Daniel McCormack

Brian, how about you? What's your story getting to here?

00:02:32 - 00:03:46

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 you know, as a fun fact, I'm still a proud, lifelong Detroit Lions fan. I will say this is our moment and, you know, 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. Moving over from investment banking into private credit, you know, it's an exciting time. There's a lot of runway for this business. I do think the future of credit still has a long way to play out within private credit.

00:03:47 - 00:04:19

Daniel McCormack

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 a very successful balance sheet lending business, you've now opened that strategy up to allow third-party investors to invest alongside it, with really good alignment. Perhaps we can start by you giving us a little background to the lending business. And then we can talk about the market in general and then perhaps dive into some specifics about the market right now.

00:04:20 - 00:06:10

Bill Eckmann

Yeah, happy to. Macquarie has been an established name in the direct lending market now for over 15 years. 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.

We've been sizeable 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.

In 2019, myself and 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.

00:06:11 - 00:06:34

Daniel McCormack

Without a doubt, and it's just one person's opinion but I'm with Brian on the trend here in private capital. There's a long way to go. And the fit between institutions and the tenor of these deals lines up nicely in many different ways.

What was the catalyst to Macquarie opening up our direct lending business to allow third-party investors to come alongside of Macquarie's own balance sheet?

00:06:35 - 00:08:21

Bill Eckmann

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

Second, just from a day-to-day deal perspective, raising third-party capital enhances our already sizeable position in the market, on a per deal basis. Right now, the platform has invested and can invest up to $300 million on a per deal basis, which is very sizeable and relevant in this marketplace.

That being said, our PR private equity sponsors that we work with are desiring even more sizeable hold sizes. So 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 2009 and executed with more than 100 sponsors now in the last five years. We've got a global portfolio today of more than $13 billion and the sizeable 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.

00:08:22 - 00:08:30

Daniel McCormack

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?

00:08:31 - 00:10:29

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, and we’re trusted by insurance companies, of course, but as well as institutions and individuals. We're a global manager, over 2,600 employees, we're 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. And 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, kind of 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. So given that internal partnership, some of the nuances, investors will want to see both strong alignment, as Bill just kind of 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 accomplished that by not only investing in the business but also co-investing in the portfolio companies.

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 the risk framework. Investors need to be reassured with a risk framework to guardrail operations within the firm.

00:10:30 - 00:10:50

Daniel McCormack

It's what we here at Macquarie 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?

00:10:51 - 00:13:11

Bill Eckmann

Happy to. So, you are right that it is becoming an increasingly crowded marketplace, the direct lending landscape. I 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, 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.

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. 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 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 capitalising on their additional touch points and relationships that they have, which just further enhance the quantity and quality of deal flow that we see. So, it's really these – if I had to summarise, it's the global reach, the alignment of the core 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 long-standing reputation and expertise we've had doing this for now 15+ years.

00:13:12 - 00:13:31

Daniel McCormack

From an economic and corporate standpoint, we often hear about higher interest burdens, rising default rates, and the use of pick instruments creeping into the credit markets. How has Macquarie's direct lending portfolio performed, and could you discuss any sector-specific areas where you see opportunity and where you're cautious?

00:13:32 - 00:15:24

Bill Eckmann

Since 2009, the Macquarie Private Credit platform has had, across those 550 deals and $40 billion+ invested, has had a historical loss rate of approximately 1 basis point 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 our team – we have a dedicated workout team to help us in troubled situations. But like I said, we've had those have been few, 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 invest in, be it software, insurance services, education – businesses that have a profile where the service or product being offered with high likelihood is 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 followed to help offset those inflationary pressures, which really helped insulate our portfolio from a downturn.

So, by prioritising these mission-critical, recession-resistant businesses, we're building a diversified robust portfolio we believe that can weather 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.

00:15:25 - 00:15:51

Daniel McCormack

Yes, it's interesting. Given the current dynamics and uncertainties in the credit markets, what perspective should investors adopt when they're evaluating the opportunity set that's available right now? There are a lot of institutional investors who are already active in this space, but there’s still a significant number that aren't or would like to be but don't know how.

What should a CIO or a private credit market investment professional be thinking about as they look at these markets?

00:15:52 - 00:18:22

Brian Van Elslander

We have these conversations regularly with our clients. We manage about $240 billion in credit on behalf of our 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, and asking how to really think about this asset class. I'll start by saying direct lending is a large and now permanent asset class and has 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, a very safe defensive credit strategy, but also one that offers historically attractive return profiles in current income as well.

It's an asset class that's – direct lending, I should say, is an asset class – that's averaged near 10% returns over the last 20 years. That’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 uninvestable, 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 kind of the same 5,000 to 6,000 public companies and these portfolios all end up kind of 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.

00:18:23 - 00:18:42

Daniel McCormack

That's a really interesting comparison that they would be the fourth-largest economy in the world. That certainly helps me put it in a different frame. Really interesting stat.

But when you think about issues that investors need to keep in mind when they're thinking about direct lending strategies, what are some of the best practices for investors to keep in mind?

00:18:43 - 00:20:55  

Brian Van Elslander

OK, so we're speaking here to experienced listeners. I think many of the benefits of investing in direct lending are pretty well known: 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, is diversification and portfolio construction. I think as Bill touched on, broad investment selection is critical. It's very hard to replicate an origination team of an established firm. Our investment team, established 15 years ago, over 100 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 labour 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, is maintaining a very strong focus on quality and due diligence. Partner with experienced lenders like us. We have a very detailed investment process performing kind of private equity-style primary diligence and importantly demonstrating some patience and selectivity even in frothy, maybe even especially in frothy, markets. And 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 investors 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. I know investors are already giving this a lot of thoughtful consideration. We appreciate the opportunity to weigh in here.

00:20:55 - 00:21:10

Daniel McCormack

As a final question, I'd be curious as to your outlook for direct lending. Having evolved significantly over the past decade, if you had to predict one major shift in direct lending over the next five years, what would it be, and how do you see it shaping the future of private credit?

00:21:12 - 00:22:50

Brian Van Elslander

Over the next five years, we think the biggest shift in direct lending will be its continued institutionalisation, securitisation, and increasing accessibility to retail investors. This will be driven by insurance companies, pension funds and likely some public market integration. Historically, direct lending has been a niche strategy, really dominated by private funds and alternative asset managers. Direct lending is now attracting institutional capital at unprecedented scale, with insurers and pensions seeking long duration, high yielding private credit as a fixed income alternative. This has also accelerated the adoption of rated note feeder structures, allowing insurers to participate in direct lending, while also optimising the regulatory capital treatment.

At the same time, the market is becoming more liquid and tradable, with an increasing number of securitised loan vehicles, ETFs, hybrid structures that blend private loans with structured credit elements, and retail investors are also gaining more access. BDCs are expanding and diversifying, publicly traded credit vehicles are growing in popularity, and fintech platforms are also trying to push direct lending towards a more democratised investment model. Ultimately, direct lending will likely transition from a niche alternative asset class into more of a mainstream credit solution characterised by broader institutional and retail adoption, enhanced liquidity, and a renewed focus around credit discipline, and all of this solidifies direct lending's role as a permanent pillar of global credit markets.

00:22:51 - 00:23:17

Daniel McCormack

Thanks, Brian. And I think we've got a great education today on direct lending and best practices, and I certainly appreciated you and Bill being on.

To our audience, you can listen to additional insights from our Pathways podcast series at macquarie.com/mam. That's macquarie.com/mam. You can also find more information in the episode show notes, and until next time.

00:23:16 - 00:23:41

Podcast outro

Thank you for listening. For show notes and more information on topics from this episode, please visit the Insights section on macquarie.com and be sure to subscribe to Pathways wherever you get your podcasts. This recording is intended for financial professionals and institutional investors only. This is not intended for use with the general public. The views expressed in this podcast represent those of the speaker and are subject to change.