The power of patient capital: navigating private credit through market cycles

Stewart (00:02): Welcome to another edition of the InsuranceAUM.com podcast. My name's Stewart Foley, I'll be your host. Welcome back. Thanks for joining us. We've got kind of an interesting take here and we've gotten some comments and people say, "Hey, you've got a lot of podcasts on private credit." And this is another podcast on private credit, but it's not just private credit, it is specifically direct lending and within direct lending, specifically sponsored finance, and within sponsored finance, specifically middle market private equity firms. And we're joined today by Michael King, senior managing director, co-head of senior credit, Manulife Investment Management. Mike, thanks for joining us. Thanks for being on. We're thrilled to have you and can't wait to get a good education in your neck of the woods.

Michael (01:08): Thanks, Stewart. Happy to be here.

Stewart (01:09): So let's start with something fun. So what was your first job? Not the fancy one. We always ask that question. And, a little bit about how you ended up in your current chair today. How did you get there?

Michael (01:24): Well, first job or I would say still is with me today in terms of the lessons learned. My father and mother are Irish immigrants. So my father learned the trade of building homes when he came here. And so at a very young age, I was out on job sites, probably 10, 11 years old and did that through graduating college 10 years later, every summer, winter breaks and so forth. So you don't realize it at the time, of course, and you don't like working as a teenager, but the reality is the lessons learned were pronounced. The common sense that's gained in working construction, you truly learn thinking ahead and anticipating what happens next. So you don't have to do things 2, 3, 4 times over and it's just something ingrained in you and you just build efficient thinking when working on a job site, actually. And a lot of it was carpentry. And so that's where again, the thinking ahead, common sense, what comes next comes into play. And I'd like to think I've employed those skills outside of construction since entering finance.

Your question as to how did I end up here goes back to the early days. I graduated college in '92 and back then, the opportunity to go to graduate school right away was still a reasonable probability. They didn't necessarily have to have work experience post-college. So I did that and I worked in Chicago during the day and went to MBA school at night and by the time a couple of years later, I had made my way around to get introduced to folks at First Chicago. So some of your listeners might recognize First Chicago, it was the largest employer in Chicago at the time. I believe it was over 50,000 employees and it's one of the largest banks in the Midwest at the time. And eventually it was acquired by JP Morgan. So JP Morgan Chase today.

And I got into media lending and that's a form of cashflow lending. And so we were doing deals for TNT, Walt Disney on the larger side all the way down to a small billboard operator in California, you name it. Tremendous learning experience. But that's what got me into cashflow lending. So not ABL lending, not traditional commercial bank lending, this was cashflow. Media specifically was cashflow lending valuations of the underlying companies based on a multiple of cashflow and then of course advancing leverage up to a certain multiple against those valuations. So it was actually something when I was introduced to it, I didn't know much about at all. But the reality is here I am 30 years later still doing cashflow lending, but specifically as it relates to sponsored finance. So providing capital to private equity community.

When I first narrowed my focus in on the private equity community was when I joined Antares Capital back in 1999. And basically from there till now, I've worked at multiple key industry players all in Chicago and have had the fortunate opportunity to sit down with the other co-head of our business, Devin Russell, back in 2016 over lunch. We knew each other generally. We worked at competing firms over the years. He was at Madison Capital, which was owned by New York Life, which is obviously an insurance company. When I was at Antares, it was owned by MassMutual, another insurance company, and we sat down and had lunch over talking about Manulife, yet another insurance company. And we both greatly valued in terms of considering starting this platform, which ended up happening in early 2017. We had great value for the balance sheet backing of an insurance company.

We had learned the value of that. My time at Antares, his time at Madison Capital, now called Apogem. So the two of us had a vision, but to grow this platform in what was a very, very crowded market at the time, the market was very heated, particularly in sponsored finance in 2017. And hence why we found the backing of Manulife to be so important to get off and running. A party that would be patient with us, would consistently provide capital, and had an established presence in private equity and credit for years. For about 20 years at that point, they've been providing mezzanine capital, equity co-investing, and as a limited partner investor with private equity firms; good strong track record there.

And we were going to be a product extension. So those track records they already had their commitment to the private equity category and the fact that we had a trillion-dollar enterprise behind us, with Canadian trillion dollars, is what Manulife is, based in Toronto. That gave us great confidence that we would succeed. And so here we are seven plus years later, we've deployed approximately six and a half billion dollars in those seven and a half years. And we've worked with over a hundred unique private equity firms and we've originated roughly 230 unique transactions over that seven and a half years.

Stewart (06:30): That's super helpful. My grandfather was a carpenter as well. I don't think that he and I ever built anything that was square, ever. We built a doghouse that on the way from his house to my house came off the trailer, the roof flipped off of it in the middle of town. I mean, I'm borderline traumatized from my carpenter experience. So it sounds like you had a lot better go of it than I did.

I really appreciate the background and the history of Manulife's direct lending platform. I think you're in a very specific niche. Can you talk a little bit about what the driving philosophy behind what appears to be patient and deliberate growth? Can you talk a little bit about your philosophy there?

Michael (07:16): Sure. And it goes back to having the partner that we have and being in market in good times and bad. So if you think about the period of time since we started, as I mentioned, we had a very heated market, then COVID shows up, something we've never experienced before. We don't have lending data around how portfolios did in a pandemic. So that was unique. Post-COVID, you had inflationary concerns, recessionary concerns. And then of course more recently, spike in interest rates. One could argue if your memory is far enough back, that interest rates are arguably where they have been back in the 1990’s and early 2000’s. So they're not historically high, but certainly significantly higher than they had been since the great financial crisis.

So all that together to have lent money consistently like we have through all those different dynamics over those years is indicative of a strong capital partner. We were back, for instance, in market lending money in May of 2020. We basically took a month and a half to catch our breath, but we were back out there lending money right away. And if you were to look at our progression in terms of deals originated, sponsors worked with, AUM, so forth, it's a very consistent, gradual linear upward to the right curve until actually very recently and in the last couple of years we've gained significant market share.

The other factor now impacting the market in addition to everything I mentioned is that M&A activity basically was drained starting in about 2022 and went through two years, two successive years of double-digit declines. And although 2024 showed great promise in terms of returning, it didn't return to the prior levels prior to 2022 in terms of the level of activity, but it is up, it's better. But when you think through a period like that, and we don't have pronounced M&A activity, we've been growing.

And what I like to say is the other platforms I've worked with and helped grow is at some point you really truly start to gain momentum. You get your footing, you get your name in the market. Our team has years of experience, but private equity firms are still going to want to understand who you are when you're with Manulife, how consistent you're going to be, what your funding sources are. And that proved out over time that we were very stable and consistent and at some point then you start to gain traction and gain market share. And that's what we've experienced over the last couple of years.

Stewart (09:46): Super helpful. So direct lending has been a key focus area for a lot of asset managers. What would be helpful, and I'll be the first to tell you that I don't know all the flavors, but it would be helpful to... I think I'm not alone there. So could you give us a little bit of, with the big crayons, the landscape of the direct lending market and where specifically you're focused and why you think that has good value.

Michael (10:19): For certain the most differentiating factor that I've experienced working here or elsewhere in my 30 years doing the sponsored lending is that sponsor category in particular. And when you go through a pandemic such as COVID or you go through a pronounced economic cycle, great financial crisis or otherwise, the sponsorship is critical. And the reason being is that companies do struggle. And when they go through those difficult times, oftentimes it points to a lack of liquidity and a company's stressed from a liquidity perspective.

And that private equity sponsorship, we work with firms that we know, we work with firms that we know support their companies in difficult times. And as a partner, a patient partner such as us, we're able to work through difficult times to get to the other side. Our job in terms of when we underwrite a deal on the front end, our work is yes, of course identifying quality sponsors, but secondly is does this company have a reason to exist on the other side of the unexpected or perhaps the expected cycle or whatever it might be.

If we do a good job there, that would typically mean these are companies that have serviced their clients for decades, oftentimes, generate strong margins that have established market share that they can maintain. That means they have a reason to exist on the other side of a cycle or whatever it might be, but they might need liquidity. Remember, we are leveraging these companies on a cash flow basis. We're not lending money near the assets, we're lending a multiple of the annual cash flow. So that's obviously going to create an interest burden that these borrowers probably haven't seen before, particularly if they were previously family-owned. And there's going to be less room for error in terms of having adequate liquidity. So one key factor that I identify as a sponsor, lending drives better recoveries when things go poorly.

So back to more general points of why sponsored finance within private credit is that loans in general don't default at a high rate. These are first lien senior secured loans. The market would point to a 2% to 3% default rate. And if you have a loan that does have a payment default and goes through a process, you can in all likelihood point to an average of about 70 cent recovery, which has got strong recovery on what's a relatively low percentage of the portfolio that ultimately defaults.

Here at Manulife in our seven and a half years here, we've done far better than that. We're about half the industry average. We're under 1% average annual default rate. And to the point earlier about sponsors backing their companies, obviously we went pre-COVID, during COVID, after COVID, and our average annual loss rate is de minimis.

Talking about the category in general though, 60 basis points of losses for the industry data going back a long ways, that's attractive. That's low beta, the sector is low beta and another important factor is it’s floating rate. So it offers a floating rate hedge. Insurance companies are obviously heavily invested in rated fixed rate paper. This is a floating rate hedge, if you will. It offers an alternative in terms of yield. The yields over a long period of time are very consistent and strong. We call it an 8% to 9% category over a very long period of time. At the moment we're living in our heyday, I can't recall a period of time where for an extended stretch we were able to generate yields of 11% to 12%.

That's obviously correcting towards the historical norms as we speak. So the Fed is lowering rates and projecting to do so again apparently, and spread compression is taking place real time in our market. All of that was expected. So we're coming down from an all-time highs and yields back towards a more normalized level that you would expect if you looked at historical data over a very long period of time. Regardless, it's consistent and when you're taking a loss profile that our sector offers in terms of ultimate losses, it just results in a very stable quality return, risk reward, over a long period of time.

Stewart (14:46): Mike, that's very interesting. Can you talk a little bit about the duration of the assets that you're talking about?

Michael (14:52): Insurance companies normally investing in bonds, rated bonds, obviously a fixed rate for X period of time, and with our product it's a three-year average life. Now that's not what the maturity is. Our maturities range from five to seven years in terms of contractual maturity for a given loan. However, private equity firms realize on companies in a shorter window than that. Or they refinance companies, capitalize them, whatever it might be. So that drives about a three-year average life for loans.

Loans, there are prepayment penalties at times, but realistically they're often soft call and so forth to where the company can prepay a loan without penalties just about at any time. And so when you're an insurance company looking at liabilities that are extended, depends what type of insurance company you are, but say a life insurance company is looking at extended liabilities, how do you deal with the short duration asset or why does it make sense?

So the way to answer that is, well, one, you need to be investing with a firm that has pronounced market access, which we've proven over time. I mentioned we've worked with over a hundred different private equity firms, but we've also grown our book every year. So when you have 20% to 30% of your portfolio coming back to your year because you have a three-year average life, it's coming back your way. You need to either reinvest in the resulting deal, which you may or may not have the opportunity to do when that deal pays off or you need to grow and bring in new deal flow and have net growth when all is said and done. So you need to catch the 20% to 30% you're getting back and then you need to grow on top of that.

And how do you do that? And that is very broad funnel wide market access, and then from that very broad funnel, having the disciplined approach to where you can deploy in the manner you see fit to drive, for instance, the default recovery rates that our portfolio has. So longer term then for the insurance company perspective. All right, so is it three years or is it actually so long as you grow? It's more just a perpetual book of loans that generate a floating rate yield over a long period of time.

Yeah, of course the duration is what it is, but if you maintain or grow a diversified book of loans, then that's really all it is. It doesn't matter that it's three years. If the appetite is there for the insurance company investor and you can stay at or above that invested appetite through market access, then the duration arguably is moot.

Stewart (17:24): And they can swap it anyway, can't they, Mike? I mean, can't they swap floating and fixed if they want to?

Michael (17:30): Yeah, they can reallocate. Oh yeah, of course they can.

Stewart (17:32): Yeah.

Michael (17:33): But it's something in particular. So for Manulife, stepping into the senior loan product category back in 2017, it was unlike anything they have done in the past. If you think about the other products I mentioned that they've been investing with for 15 to 20 years, mezzanine debt, long-dated paper, equity co-investing, LP investing with private equity firms, that's all long-dated duration and we brought something new to the table, but now if an insurance company is investing in a certain way for a long period of time, they're going to identify that duration right away. You're going to say, first reaction might be, I don't get that. How does that work in our complexion? So that's what we got them comfortable with conceptually.

Now over time they've seen it. They've seen that the allocation to the category has actually grown and they very much like it. They're seeing the risk reward benefit, nice yields, very low defaults, very, very low losses. And that so long as you can replenish really the three-year duration kind of takes care of itself because you have an allocation to that category and you just end up on an extended duration through reinvesting over a longer period of time.

Stewart (18:49): So Manulife Investment Management, you refer to it as PE&C, which stands for Private Equity and Credit Division is positioned as a full capital solutions provider. Can you first tell us what that means and how does that differentiate you or what advantages does it bring to your clients to be positioned in that way?

Michael (19:20): It's certainly a differentiating factor. So the different product groups I've mentioned multiple times already that have been around for 20 plus years now that we operate as one group. So the senior loan group, I co-head with Devin, we specifically all of our team members focus on senior loans. Each of those other product groups also has their own dedicated personnel to those product groups. But we all report up into one larger group called Private Equity and Credit. It's a $25 billion plus when you aggregate it all together.

And the power in particular that comes to light is you have the individual products, but then we have the fact that we're a limited partner investor with private equity firms, and that's with over a hundred unique private equity firms that we are a limited partner investor. And then multiples of that in terms of the number of funds we invest in, because we've invested multiple times with the same private equity firm, that's a great calling card. Obviously if we're an investor with that private equity firm and we're seeking to deploy our other products and the companies that they own, then obviously we're very well positioned to participate in those deals.

So the power of the platform is basically we can bring to a particular private equity firm when you sit down with them and you introduce the private equity and credit platform, and we might specifically be there to talk about senior loans, but if they're looking for LP investors, we can invest as an LP. If they're looking for equity co-investors in the companies they own, we can provide equity co-invest. If they're looking for mezzanine financing, we can provide mezzanine financing.

So pretty much anything a private equity firm would be looking for, Manulife can provide. Now are there some conflict issues in terms of us providing more than one product? Of course there is. To a given company within a sponsor's portfolio? Yes, we worked through those. But suffice it to say, at the end of the day, having the full product suite is what the private equity firm benefits from, access to the full product suite.

Stewart (21:18): Thanks, that's helpful. So given your background, you mentioned 30 years experience in the credit management arena. What do you think the key traits or strategies are that have been instrumental in Manulife's success in private credit up until now?

Michael (21:38): Certainly patience. The patience to, regardless of the environment, invest in a manner, a prudent manner consistently. To take your eye off the ball for whatever reasons ultimately will likely move you away from the performance you're seeking. So again, it's prudent credit acumen exercised consistently, and I can say firsthand, myself and my colleagues have never felt pressure to deploy, if you will. Deploy in a manner that makes sense and do deals that make sense relative to your credit acumen.

Stewart (22:19): Well, it's interesting because it leads me to my next question, which is private credit appears to be a big part of Manulife's investment management growth plans. Can you talk a little bit about the ambition to grow your AUM and are you confident that you can find deals that will meet your criteria and allow you to grow and reach your AUM objectives?

Michael (22:44): Yes and yes. So this year alone, we've closed four new third-party mandates and we have grown AUM well north of 20% plus, since the end of the year till recently. So we couldn't do that unless we were either doing one or two things or both. And that is originating a significant number of new deals, which we have in 2024. But also, our AUM is increasing because we're grabbing white space. And by that I mean that we're taking our new clients and we're investing them in the same deals we would otherwise be doing, whether we were just our insurance company account or otherwise. And we're upsizing our hold level. So said another way prior to increasing our hold level, which we doubled it this year, we were arguably leaving money on the table.

Stewart (23:33): Can you just define what ‘hold level’ means? I'm not familiar with the term.

Michael (23:39): Right. The amount of exposure you would take to one given issuer.

Stewart (23:42): Oh, okay, good deal. So your percentage share of a given deal?

Michael (23:48): Yeah, the percentage share or it's usually expressed in a dollar amount, meaning the most we can take is X. And when you bring on new clients. So for instance, our insurance company is technically a client of ours and we invest on their behalf and they have appetite of X. And then we also have, you mentioned earlier, the Asian insurance company affiliates.

And as you establish those and grow those, your hold size, you have more mouths to feed and your hold size expands. And so given we started with a very strong team with good sponsor relationships and so forth, that in time, as I mentioned, we hit our stride as a platform where we're demonstrating plenty of market access, but we could only take so much for the miles we have to see. So we're still at a very nice growth trajectory, an attractive place in terms of potential additional third party clients wanting to invest with us because we're demonstrating that we're grabbing the white space we were leaving on the table before.

Stewart (25:23): So in closing, when you look ahead and I think the criticism of private credit is that it's grown so quickly, I think that creates some concern. And I don't know that there's anything other than much driving it other than, "Gee, it's grown a lot." So when you look out at private credit markets in 2025, particularly in light of the current economic environment, we just had an election, pretty resounding result. Are there some specific areas that you're keeping an eye on, both from an opportunistic perspective and also I always like to ask, "What are you cautious on?"

Michael (26:07): Arguably the market was heading in a pretty good direction already. 2024 is not going to be as much as a bounce back as everybody hoped for, but it sure seems 2025 should be pleasant in terms of, I think everyone is now gauging their expectations because it's taking so long for me to come back, so that's why I use the word ‘should be’ a good year in 2025. You would think the new president's policies will in all likelihood drive economic growth, TBD ultimately, but that would seem to be indicative given its policies. So we feel positive.

Your initial question, I believe centered around just the formation of private credit and how much it's growing and so forth. And we do hear that a lot. The reality is private credit captures a lot of categories outside of sponsored. There's non-sponsored lending and so forth. So really it's knowing who you're investing with and what they do specifically. And I think that's important and what the differentiating factors are between the different types of private credit.

I mentioned earlier why I value sponsored finance angle because of the sponsorship that allows you to, in most instances, gain some liquidity on behalf of the issuer in tough times and come out the other side with a good outcome. And then as it relates to the amount of capital in the space, the reality is the amount of private equity out there that's waiting to be deployed is dramatic. It's substantial. So specifically to our space, we feel good that that capital will in time be deployed. We know for a fact, including many of our portfolio companies that sponsors have been holding companies for a relatively long period of time, they will bring those companies to market to realize returns obviously.

So we think there's a good amount of latent demand that's going to drive significant deal flow and will absorb a good amount of the private credit capacity out there in the market. So the capacity is huge. So I don't see it surpassing it necessarily, but that goes back to the point as private credit gets more crowded and other categories do kind of move their way in there and become available to institutional investors, it goes back to my point of you really need to diligence specifically what sector that manager operates in and why the results are at the level that they point to, and that you're obviously comparing it to truly relevant comparables in terms of performance by category.

Stewart (28:39): Great advice. I want to give a shout-out to your undergraduate university Marquette and your MBA at DePaul University. And I want to kind of get you back. I, too worked when I got my MBA, I was a little later on down the road than you were. What advice would you give somebody who was coming out of Marquette in May of 2025 and looking to get into this business? What advice would you give them?

Michael (29:08): First off, I would let them know that in all likelihood, they don't know what they want to do. When you're 22 years old and you really have to go experience something, perhaps a job or two, perhaps jobs that are very different to really figure out what it is you can see yourself doing. And I would also caution them, you may love your job down the road, but really thing you need to focus on is something you can be successful at. That's really the most important thing is you need to get into a specific space, figure it out. Maybe it's not for you, maybe you won't be terribly successful at it and you'll make a move, whatever it might be. But certainly don't put all your eggs in one basket on that first job and that that's going to be the job for you. It's very hard to do at age 22.

That said, if you choose private credit and you're fortunate enough to get a job in the sector, it's a tremendous learning experience. So to dovetail with my earlier unsolicited advice I'd provide, it's that you won't be any worse off for the experience because, particularly for some of the junior levels within private credit, you're learning the basics of just about everything. It's finance, it's accounting, multiple different industries. You're looking at in all likelihood that private credit shop is going to be generalists looking at all kinds of industries. And you get a look into the world of private equity and LBOs and how all that operates. Ultimately three plus years, someone might decide, "Hey, it's not for me. I want to do something else." But the experience is widely applicable, widely applicable in all kinds of different walks of life. And you should be able to leverage that experience regardless of what you decide to do longer term into your next move, the one that you find right for you longer term.

Stewart (30:55): Very cool. Very good advice. So last one, a fun one. So you can have lunch or dinner with up to three guests, including yourself. Who would you most like to have lunch with? Alive or dead?

Michael (31:10): Thomas Jefferson.

Stewart (31:11): There you go. Any reason why or is just somebody that you've always wanted to?

Michael (31:15): A bit of a history buff, but also I find the vision our founding fathers had has proven to be just extraordinary.

Stewart (31:24): Yeah, I agree.

Michael (31:26): And it's just you'd want to get behind that and be like, "What were all your lessons learned up to that point in time that you and the founding fathers had so much vision?" You almost knew what was going to happen to certain degrees and what you were trying to avoid realistically. But I think that'd be a fascinating conversation. But also if he's at lunch, I guess he's back from the dead or whatever.

Stewart (31:49): Yeah, alive or dead, you can have anybody you want.

Michael (31:51): Right? It would be interesting for him to comment on how much has changed in the last 200 plus years, which the degree of change has been dramatic, and would he ever have envisioned that particularly technological change and so forth.

Stewart (32:08): So you got Thomas Jefferson, yourself, anybody else?

Michael (32:12): Muhammad Ali.

Stewart (32:14): There you go. So you, Thomas Jefferson, and Muhammad Ali. That's a great lunch or dinner. I've learned a bunch today. Mike, thanks so much for taking the time. We've certainly enjoyed having you on. You're welcome back anytime. So thanks so much.

Michael (32:28): Thanks, Stewart. Appreciate it.

Stewart (32:29): Our pleasure. We've been joined today by Michael King, who's the senior managing director, co-head of senior credit, Manulife Investment Management. If you like what we're doing, please rate us like and review us on Apple Podcasts, Spotify, Amazon, or wherever you listen to your favorite shows. If you have ideas for podcasts, please shoot me a note at Stewart@InsuranceAUM.com. My name is Stewart Foley. We'll see you next time on the InsuranceAUM.com Podcast.

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