How to spot the difference between the good, bad and ugly of private markets

Another thing that differentiates us is our sourcing strategy. As we're sourcing transaction opportunities from private equity sponsors, we have consistency of deal flow, seeing transactions from private equity sponsors because we're investing in over 300 private equity funds. That's a distinct competitive advantage for us.

The other thing would be our scale. Churchill has now amassed US$50 billion of committed capital. As we're approaching these deal opportunities in the market, we have the dry powder and the ability to speak for the entire transaction, be that US$300-$400 million transactions and sponsors like to see that scale in an asset manager that they choose to align with. They want to see scale at the onset as well as dry powder to support the businesses going forward. And we can certainly show them that.

What used to happen was that a lender would be awarded the lead title in a transaction and then they would sell parts of that loan to other participants in the market. That doesn't exist anymore. The sponsor is dictating who is shown the transaction and who has allocated the deal. So again, it's that very relationship-driven process with the private equity sponsors that's going to ensure your success.

And the third component is the structure of the transaction. I mean, you can have a great business and you can have a great sponsor, but you can structure that transaction too aggressively and that's going to lead to trouble. So what you want to do is make sure you're structuring that transaction with a conservative lens and importantly aligning the lender and the sponsor.

Typically, what we want to see is the sponsor investing more capital in the transaction than the lender - because the alignment of interest is going to make sure that the interests are where you want to see them down the road if you're starting to address amendments or something down the road from a financial performance perspective.

So when we see those types of attributes, we tend to get excited about the transaction and want to dive deeper into our full due diligence process. That can take several weeks. I mean, as we're assessing these businesses, we're spending three, four, or five weeks analysing the business, meeting with the management team, talking to the private equity sponsor, buying the business, really understanding their investment thesis. So again, it's a very deep dive into these investment decisions.

Things that we don't like to see in a borrower, the red flags, if you will, cyclical trends. So if you're looking at a borrower opportunity that is highly cyclical, that's going to be very difficult to underwrite and hard to cash flow model that transaction. Another red flag that we would see that would turn us off with the transaction is customer concentration. So again, if you're looking at a borrower and they have one customer that they're selling to that's 25% of their revenue, for example, you run the risk of them losing that customer and having a massive impact on that business. So that's definitely a red flag for us.

I would say a third red flag we look for is regulatory risk. If you're underwriting a business that in the status quo environment is fine from a regulatory perspective, there's no impact, but you have a line of sight into knowing that there's some regulation coming in the foreseeable future that will impact that business, that's a massive red flag. So again, there are very specific credit attributes that we look for and also specific red flags that'll turn us away.

The good, the bad, and the ugly of private managers  

Another thing I would look at is track record. So for example, I mentioned Churchill. We've been investing in the US middle market for over 18 years. We have a very strong and defensible track record that our investors are able to see. If you're aligning with an asset manager who's new to this space and can't demonstrate that strong track record, that would definitely be a red flag, in my opinion.

And one additional thing I would say is scale. When you're looking at an asset manager, it's important to know that that asset manager has significant scale because again, the more capital they have to deploy, the more investment opportunities they're going to see and the more likely they're going to be leading those transactions, which is just great position to be in as an asset manager.

Learn more about the Nuveen Churchill Private Credit Income Fund here.