Is a "zombie apocalypse" really on the horizon?
And how investors can use private markets to profit without the volatility of public markets.
There have been a number of headline grabbers of late stoking fear in investors about a corporate zombie apocalypse on the horizon - it's emotive wording that packs a punch. But is there any substance to these claims?
"Zombie firms" were made famous in Japan during the "Lost Decade" of the 1990s, when lenders continuously rolled over maturing debt to help unprofitable companies avoid bankruptcy - although the practice of saving "zombie firms" is thought to go far further back than that.
According to Kelli Marti, Senior Managing Director, Portfolio Investment Strategist, Churchill Asset Management, by Nuveen, there is no evidence of a zombie outbreak - at least in the US.
"I think a big driver of that fear is the fact that there's this perception that there's been a flood of new entrants into the private credit market, and is that creating too much demand on these assets... And I have to say that from our perspective to be a new entrant in the private credit space would be a very difficult position to be in," she says.
"We're not seeing systematic cracks in our portfolio. If anything, we're seeing very strong performance in our underlying borrowers."
In this episode of The Pitch, Marti outlines why these headlines may be misplaced, the impact of interest rate cuts on private market investments, as well as the opportunity she is seeing in middle-market companies today.
Note: This episode of The Pitch was recorded on Thursday 15 August 2024. You can watch the video or read a transcript below.
Edited Transcript
Ally Selby: Hello and welcome to The Pitch, brought to you by Livewire Markets. I'm Ally Selby, and today we're joined by Kelli Marti from Churchill to learn why she believes investors can profit from private market investments as public market volatility soars. Thanks so much for joining us today, Kelli.
Kelli Marti: It really hasn't, and there's a distinct difference between valuations that are ascribed in the private markets versus those in the public markets. In the public markets, you see a lot of supply-demand imbalance, and that can cause volatility in the underlying prices of the loans, despite the creditworthiness of the underlying borrower. That volatility, that supply-demand imbalance, is eliminated in the private markets. So the valuations ascribed to the loans that we're underwriting are really a true reflection of the underlying credit performance of the borrower. So, much less volatility.
As I mentioned in the intro, we have seen a lot of volatility in public markets recently. Has that bled through into private markets?
Volatility in public markets versus private markets
Ally Selby: Let's go back to basics. You invest in middle-market companies. What are those?
The opportunity in middle-market companies in the US
Kelli Marti: In the US, we often interchange the words private credit with middle market. And the middle market is a very wide range. It really encompasses three distinct segments. We have the lower middle market, and we would define that broadly as companies generating below US$20 million of EBITDA. The traditional or core middle market, where we at Churchill invest, would be defined as companies generating broadly between US$20-$80 million of EBITDA in the US. And then the upper middle market would be defined as companies generating above US$80 million of EBITDA. And the underlying company and credit characteristics of those three segments can differ.Ally Selby: It sounds a lot bigger than what we would have here in Australia. What is the risk-return profile of those companies?
Kelli Marti: So right now we're investing in the senior secured top of the capital structure. These are floating rate instruments, they're based on SOFR as the base rate, and we're earning between 10.5% and 11% for these assets. So, a really nice risk-return profile for investing at the top of the capital structure, the most secured debt in the structure. That's about a 200 basis point premium over what you would earn in investing in the public debt markets. So from a risk perspective, these companies are smaller, but that does not equate to a higher risk. It's all about choosing the right investments, picking the right borrowers, and more importantly, structuring the transactions appropriately with low leverage and a significant sponsor contribution to the capital structure.The impact of interest rate cuts on private market investments
Ally Selby: Many market commentators are predicting that we'll see quite a few interest rate cuts over the next 12 months. How does that play into returns?
Kelli Marti: It will certainly reduce returns a bit, but on the flip side, it's easier for borrowers. So this high interest rate environment has been nice from a yield-generating perspective, but it is creating a more expensive debt profile for our borrowers. We've certainly structured our businesses to withstand the debt burden that we've put on them, but a lower interest rate environment would be welcome from an interest coverage and fixed charge coverage perspective.Ally Selby: Last question for today. We've had quite a few famous market commentators in Australia talk about this oncoming zombie apocalypse in private credit and debt. Are you seeing that play out in middle-market companies?
Is a zombie apocalypse on the horizon?
Kelli Marti: It is a great question and there's certainly been some headline grabbers out there with a fear tactic being employed in the papers and the press. And in the US, we're really not seeing evidence of that. I think a big driver of that fear is the fact that there's this perception that there's been a flood of new entrants into the private credit market, and is that creating too much demand on these assets and are we doing things that are unnatural to our business? And I have to say that from our perspective to be a new entrant in the private credit space would be a very difficult position to be in. You have to be an established manager to really get the transaction opportunities. We've been doing it in the market for 18 years. We have a consistent deal flow, so we don't have to stretch to unnatural levels to find the assets that we want to invest in.Again, the headlines I think are misplaced. If we look at our portfolio specifically, we have 300 US middle-market borrowers that are in our portfolio, with very tight management of that portfolio. We're not seeing systematic cracks in our portfolio. If anything, we're seeing very strong performance in our underlying borrowers and it's really a testament to the way we approach these transactions, our conservative nature, and our very high selectivity for transactions. So no, I think a zombie apocalypse is definitely not on the horizon.
Learn more about the Nuveen Churchill Private Credit Income Fund here.
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian Group, Your Money, Sky Business and Sky News.
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This information has been prepared for use only by wholesale clients (as defined under the Corporations Act 2001 (Cth)) by Nuveen Australia Limited (ABN 981.686.90444) (AFSL 460770). The statements contained herein represent the views and opinions of Nuveen as of the August 15, 2024 and may change without notice at any time based on market and/or other conditions and may not come to pass.
All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Past performance does not guarantee future results. Investments in middle market loans are subject to certain risks such as: credit, limited liquidity, interest rate, currency, prepayment and extension, inflation, and risk of capital loss.
Private equity and private debt investments, like alternative investments are not suitable for all investors given they are speculative, subject to substantial risks including the risks associated with limited liquidity, the potential use of leverage, potential short sales, concentrated investments and may involve complex tax structures and investment strategies.
Video was filmed on August 15, 2024
Featured Speaker: Kelli Marti, Senior Managing Director and Portfolio Investment Strategist at Churchill Asset Management.
Churchill Asset Management is a registered investment adviser and affiliate of Nuveen, LLC Notice 9:49
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
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Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...
Expertise
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