INVESTMENT INSIGHTS

The four mythsof private credit

APRIL 2022

New York Life
Investments
Our multi-boutique business model isbuilt on the foundation of a long andstable history, which gives our clients
proven performance managing risk
through multiple economic cycles.
With capabilities across virtually
all asset classes, market segments,
and geographies, our family of
specialized, independent boutiques
and investment teams allows us
to deliver customized strategies
and integrated solutions for every
client need.
Our investment managers offer deep
domain expertise and diversity ofthought, generating deeper insights
alongside a strong conviction todeliver better outcomes.
This piece explores private credit
investing with investors at Apogem
Capital, Kartesia, and our MultiAsset Solutions team.

In the wake of an unprecedented economic cycle, we have noticed
an uptick in investor questions regarding direct loans. Supply chain
imbalances, higher raw material costs, rising interest rates, labor
shortages, and geopolitical risks each contribute to business risk —and therefore to credit risk. Investors are prudent to consider how
these risks will play out in their portfolios.
In our conversations with investors, we have identified fourcommon concerns — our “four myths of private credit”—that
we believe need not influence investors’ allocation to theasset class. On the contrary, oft-cited objections can be a sourceof investment strength with the right partners. This piece explores
those objections with subject matter expertise from private credit
investors Apogem Capital and Kartesia.

The four myths of private credit
Myth 1:
Rising interest rates are a threat to the asset classMyth 2:
Slowing economic growth will lead to higher defaults
Myth 3:The middle market is riskier
Myth 4:
Sponsor-less deals are riskier

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May Lose Value

The four myths of private credit

Myth 1:

Rising interest rates are a threat to the asset class
The COVID-19 pandemic disrupted supply and raised demand for raw materials, goods, and labor. The
resulting higher inflation is putting pressure on central banks to raise interest rates globally. As interest
rates rise, investors may see a valuation re-rating across asset classes, impacting asset allocation. Higher
rates may also increase portfolio companies’ capital costs, influencing security selection.
That said, we are not concerned about rising interest rates in the context of a direct lending portfolio forseveral reasons:
The asset class is floating rate. Private credit is a floating-rate asset class, meaning the loan’s coupon
rate resets or “floats” with the current level of interest. As a result, the asset class has virtually no duration
risk making it well suited for a rising rate environment. In addition, our managers’ loan portfolios use seniorsecured loans, which have the first position in the capital stack, leaving them strategically well-positioned
to recover collateral should risks arise.
Higher inflation rates do not mean high-interest rates. Even as expectations for interest rates haverisen, we expect interest rates are likely to remain low by historical standards. In the U.S., where inflationarypressures are most pronounced, estimates for the 10-year Treasury yield at the end of 2023 are between
2% and 3%. In Europe, where policy rates are still negative, the figure is between 0% and 1%.

Investor yields have been declining for decades.

12.4%
10.3%

7.3%

7.7% 7.9%
6.4%

6.3% 6.4%
5.4%
4.0%

4.1%

3.8% 3.8%

2.0%
1.0%
0.1%

1980s
U.S. Bonds

1990s
U.S. Treasury 10-year yield

2000s

2010s

German Bund 10-year yield-0.4%-0.1%

2020s
European Bonds

Sources: New York Life Investments Multi-Asset Solutions team, Bloomberg Finance LP, as of 3/15/22. U.S. bonds are represented by the Bloomberg U.S. Aggregate
Bond Index and European bonds are represented by the Bloomberg Euro Aggregate Bond Index. Results for the Euro Aggregate Bond Index were not available before
1998, and therefore are not included until the 2000s. Index definitions can be found at the end of this piece. Past performance is not indicative of future results.
An investment cannot be made directly in an index.

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The four myths of private credit

Portfolios are built for rate resiliency. Most borrowers have a LIBOR, SOFR, or EURIBOR floor in theirborrowing costs. This means that rising policy rates will generally not have an impact on borrowers’ costof capital until interest rates rise above the relevant level. In the U.S., a LIBOR or SOFR floor of 1.0% iscommon. Once interest rates exceed that level, careful credit analysis tests for cash flow to cover higher
interest costs. European borrowers have experienced a similar dynamic. With 3-month EURIBOR in strongly
negative territory and interest rate floors at 0.0%, the planned small increases in policy rates are unlikely
to impact borrowers.
In addition, the structure of direct loans allows for more flexibility through shifts in a company’s operating
environment. For example, in a broadly syndicated loan, it can be challenging to convince all lenders to agree
to changes in terms. Direct lenders can be agile in supporting their borrowers, with the goal of building
stronger and more resilient companies for the long term.

Most of our borrowers in the U.S. and Europe have LIBOR, SOFR, or EURIBOR floors
in their borrowing costs. This means that rising policy rates will generally not have an
impact on borrowers’ cost of capital until interest rates rise above the relevant level.
Modest interest rate increases can help reduce cost pressures elsewhere. Central banks are likely
considering interest rate increases to help tame imbalances between supply and demand. Those same
imbalances have historically impacted borrowers through higher labor costs and increased raw material
prices. While rising interest rates will likely impact demand, reduced cost pressures and more predictablebusiness conditions may potentially offset some of that impact.

3

The four myths of private credit

Myth 2:

Slowing economic growth will lead to higher defaults
If rising interest rates are manageable, investors may still wonder if slowing revenue growth would be.
Certainly, slowing economic growth and softening demand can weaken borrowers’ ability to manage risingcosts. In our view, navigating the ebb and flow of macroeconomic cycles comes down to credit selection,
portfolio construction, and manager value-add.
Credit selection. Direct lending is a long-term investment, with funds often targeting 5, 7, or even 12 years
of invested capital. Changes in the macroeconomic environment, and the arrival of unexpected risk, are likely
to occur in those time frames. As a result, underwriters work to understand a borrower’s demand drivers, cost
structure, and sensitivity to impacts to those drivers. This deep understanding of a borrower’s creditworthinesshelps not only in making the proper security selection and investment structure, but also in the ability to takea proactive stance in supporting borrowers when risks arise. The capital structure, collateral, and covenants
that our investors require create room for the risks that arise.

Historically, middle-market default rates have been lower and recovery rates havebeen higher when compared to similar asset classes.

Default rates 1995-2019

Recovery rates 1995-2019

4.0%

90%

3.5%

80%

3.0%
2.5%

Middle market
had fewer
defaults

Middle market
had a higher
rate of recovery

70%
60%
50%

2.0%
40%
1.5%

30%

1.0%

20%

0.5%

10%

0.0%

0%

Middle market loans

Broadly syndicated loans

High-yield bonds

Sources: Mercer, S&P Credit Pro, 2021. The “middle market” and “broadly syndicated” market default and recovery rates are calculated by S&P Global Market Intelligence
research. High-yield bonds are defined by the S&P U.S. High Yield Corporate Bond Index. Index definitions can be found at the end of this piece. Past performance is notindicative of future results. An investment cannot be made directly in an index.

4

The four myths of private credit

Portfolio construction and diversification. The middle market provides a large universe of businesses
with funding needs, allowing our managers to be selective in whom they include in a portfolio. Our portfolios
have been particularly resilient to changes in the macroeconomic cycle due to overall portfolio diversification
and avoiding highly cyclical or trend-based sectors. Apogem Capital, for example, has historically avoided
sectors such as oil and gas, hospitality, and retail within its private credit portfolios, while prioritizing specialty
silos such as insurance and financial services, healthcare, and software and technology, based on revenue
reliability and earnings quality. Similarly, when constructing a portfolio, the Kartesia team focuses intensively
on diversifying across industry and geographies, assessing borrower liquidity and transparency, and avoiding
credits with highly binary outcomes (i.e., those likely to perform very well or very poorly).

In the event of a more significant economic slowdown, our managers have the provenability to proactively identify and support borrowers through any issues that arise.
Manager value-add. In the event of a more significant economic slowdown, our managers have the provenability to proactively identify and support borrowers through any issues that arise. This demonstrated flexibility
and support can sustain enterprise value where public investment vehicles cannot. In addition to making theasset class more attractive in our view, this value-creation approach can help minimize the risk of default andmaximize recovery values.
In addition, data suggest that public markets are more susceptible to volatility. While their liquidity allows
investors the flexibility of entry and exit, it can magnify risks. Active portfolio monitoring and management1
allows our investment teams to provide borrowers with flexibility when they are struggling.
Finally, while periods of reduced economic activity can mute transaction volume, managers can also provide
the opportunity to negotiate for improved credit terms or generate amendment-related fees. Lower transaction
volumes can also reduce portfolio run-off and create opportunities for portfolio accounts to make add-on
acquisitions at more attractive valuations.

5

The four myths of private credit

Myth 3:The middle market is riskier
Investors, particularly those outside the U.S. and Europe, have sometimes expressed concern that the
middle- and lower-middle market segments of private credit are riskier than other segments. For experienced
investors, this simply need not be the case. A few key characteristics of the middle market leave us confident
in the opportunity there:
Investor positioning. Our managers are senior secured lenders, taking the first position in the capital stackand, thereby, increasing the odds and amount of recovery in the event of a default.
Large universe of quality companies. The middle market includes a large universe of diversified
companies, allowing our investors to select a priority subset of names that can potentially outperformthe segment’s average risk and return.
Relationship-driven market. The middle market, and particularly the lower-middle market, is strongly
relationship-focused. Our managers have a long track record in middle market private credit, giving us
an incumbency advantage in originating and securing the most attractive deals. Our teams have establisheddeep connections in the marketplace with sponsor and owner-managers. Through these ongoing relationships
we have developed a reputation for being capable of coping with deal complexities. In many cases, this has
allowed our investment teams to become the counterparty of choice.
In turn, this market positioning provides our investment teams with more access to diligence, information,and direct communication with company management and sponsors than that afforded by the larger market.
It also allows our investment teams to support operational and business development as companies growand navigate economic cycles.
Attractive yield. In exchange for the due diligence, legal know-how, and expertise that management teams
must bring to the middle market segment, investors may be correspondingly rewarded. Over the last 15
years, middle market loans have outpaced large corporate loans by a spread of 77 basis points.2 These
market-level figures may understate the opportunity provided by managers with a long track record of
middle- or lower-middle market lending.

The middle market for private credit is strongly relationship-focused. Deep connections
and a long track record may allow managers to access more information, navigate
operational complexity, and originate more attractive deals.

6

The four myths of private credit

Myth 4:

Sponsor-less deals are riskier
Both sponsor-driven and sponsor-less deals have benefits to investor portfolios. While the approaches differ,
one need not necessarily be riskier than the other. Instead, investors must assess which approach is best
suited for the geography and segment they are considering for their portfolio.
In Europe, for example, sponsor-less deals make up the large majority —nearly 90% —of the universe oflending opportunities available. In other words, by focusing on the sponsor-less market, investors expand theirinvestment universe by nine times. In our view, this allows our investment teams to avoid compromising on
quality of management teams, information provided, collateral secured, and other essential investment items.
In the U.S., on the other hand, a more mature and highly competitive market means that sponsor partnerships
can offer distinct competitive advantages under the right circumstances, particularly when leveraged over along investment track record and with strong investor relationships.
In both cases, choosing the right opportunity for the market, and the right partners for that opportunity cancontribute positively to investor results.

Potential positives of sponsor-driven and sponsor-less deals, assuming experienced
partner selected:
Sponsor-driven

Sponsor-less

Discipline

Sponsors care about theirreputation with preferredlenders, encouraging morediscipline in the sourcing anddue-diligence process.

Sponsor-less deals often require
heavier financial covenants and more
attention to collateral, including cash
flow and hard assets on hand.

Riskmanagement

Sponsor partners often provide
third-party due diligence.

Leverage levels are often lower.

RecoveryPatient, committed capital gives
private equity sponsors theability to assist businesses
through incremental capital
investments to support growth
or in times of distress.

Sponsor-less transactions often havean extra layer of interest alignment, assponsor-less companies’ management
often take further steps to preserve
their credibility and/or family history.
For them, the deal is about more thanthe loan.

Transparency

Sponsors have their own lens into
the breadth and depth of portfolio
companies and can be called
upon for insights and deal flow.

Negotiating with sponsor-lesscompanies provides a structuraladvantage, potentially allowing for
better terms or bespoke opportunities.

7

CIO perspective			
Jae Yoon			
Chief Investment Officer			

New York Life Investments

In our view, private credit provides one of the most attractive ways for investors to harvest yield.
Many countries are experiencing negative real yields on government debt, and even as interest rates rise,
the absolute level of government bond yields is likely to remain anemic. Private credit provides investors
with the opportunity for higher risk-adjusted return potential and a diversification of credit exposure.
In addition, we believe that including both U.S. and European private credit exposure in a global
portfolio may allow investors to leverage the regions differing historical backdrops and funding environments.
The U.S. is a large, mature, and fairly homogeneous structure, while the European market is more fragmented,
with documentation, origination strategy, and banking structure varying by country. Together, these markets
may offer opportunities for private credit partners who can navigate the respective challenges and opportunitiesof their regions.

North American and European private credit comprise the majority of capital raised
Private debt capital raised by region
100%

80%

64.6%
North American shareof private credit market

60%

40%

32.5%

20%

European share ofprivate credit market

0%

2006

2007

2008

North America

2009

2010

Europe

2011

2012

Asia

2013

2014

Oceania

2015

2016

Middle East

2017

2018

2019

Africa2020

2021

Rest of world

Source: PitchBook, 12/31/21.

However, as the themes of this paper outline, there is no risk-free investment. Allocators concerned aboutmacro risks should consider the following factors when choosing an investment partner:n Exceptional credit evaluation is key in accessing the best companies and limiting risks.
n Diversification of borrowers across industries helps build portfolio resiliency.
n Strong partnerships, backed by a long track record in the market, provide access to the best deals

and transparency into borrowers’ business operations. In our view, transparency provides meaningfulvalue in managing risk.
n Patient capital and a long investment time horizon permit investors to turn down unattractive deals,

maintain a strong pipeline, and build enterprise value over economic cycles.
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The four myths of private credit

DEFINITIONS
The 10-year Treasury note is a debt obligation issued by the United States
government with a maturity of 10 years upon initial issuance. A 10-year Treasury
note pays interest at a fixed rate once every six months and pays the face value
to the holder at maturity.

1. Active management typically involves higher fees than passive management.
2. Source: S&P Global Market Intelligence, as of 12/31/21.

The 10-year Bund is a debt obligation issued by the German government witha maturity of 10 years upon initial issuance.
The Bloomberg Euro Aggregate Bond Index includes fixed-rate, investmentgrade Euro-denominated bonds. Investors frequently use the index as a stand-in
for measuring the performance of the European bond market.
The Bloomberg U.S. Aggregate Bond Index is a broad-based, market
capitalization-weighted bond market index representing intermediate-term
investment grade bonds traded in the United States. Investors frequently use
the index as a stand-in for measuring the performance of the U.S. bond market.
Broadly syndicated loans are floating rate loans made to corporate borrowersthat generally have greater than $50 million in EBITDA (in most cases, at least$100 million). They are senior in the capital structure and have a first claim on
the assets of the borrower.
The Euro Interbank Offered Rate (Euribor) is based on the interest rates
at which a panel of European banks borrows funds from one another.
The federal funds rate is an interest rate at which depository institutions
trade federal funds (balances held at Federal Reserve Banks) with each otherovernight. It is the U.S. Federal Reserve’s primary policy interest rate.
The London Inter-Bank Offered Rate (LIBOR) is a benchmark interest rate
at which major global banks lend to one another. The Secured Overnight
Financing Rate (SOFR) is a broad measure of the cost of borrowing cash
overnight collateralized by Treasury securities. A LIBOR or SOFR floor is aprovision in a loan agreement that establishes a minimum base floating rate
to be paid by the borrower before the fixed spread.
A “middle market” loan is a loan made to an issuer of a certain size inthe leveraged loan market. There are many definitions of this size, but in the
research references, Standard & Poor’s uses a $50 million threshold, meaningloans made to issuers with no more than $50 million of earnings before interest,
tax, depreciation, and amortization (EBITDA), in its reports and statistics.
S&P Global LCD Quarterly Average All-in Spread of B+/B Institutional
Loans is a benchmark metric for the return performance of institutional loans
rated B/B+ including all fees, interest, and charges from the transaction.
The S&P U.S. High Yield Corporate Bond Index is designed to track the
performance of U.S. dollar-denominated, high-yield corporate bonds issued bycompanies whose country of risk uses official G-10 currencies, excluding thosecountries that are members of the United Nations Eastern European Group(EEG). Qualifying securities must have a below-investment-grade rating (basedon the lowest of S&P Global Ratings, Moody’s, and Fitch) and maturities of one
or more months.
Spread per unit of leverage (SPL) is defined as the ratio of potential return(spread) that an investor might receive per unit of risk (leverage). The higher
the SPL, the better the compensation for the investor, holding risk constant.
A “U.S. Single-B Corporate Debt Index” is meant to designate a benchmark
for corporate bonds rated B1/B+, one of several non-investment gradecredit ratings that may be assigned to a company, fixed-income security, or
floating-rate loan. This rating signifies that the issuer is relatively risky, witha higher than average chance of default.

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