HomeMy WebLinkAboutReports - 2020.10.02 - 33708Direct Lending – Senior ReviewOctober 2, 2020Oakland County ERSDefined Benefit Plan
1IMPORTANT DISCLOSURE INFORMATIONThis material is confidential and not intended for distribution to the public. AndCo Consulting (“AndCo”) compiled this report for the sole use of theclient for which it was prepared. AndCo uses the material contained in this evaluation to make observations and recommendations to the client,however the strategies listed may not be suitable for all investors and there is no guarantee that the strategies listed will be successful. Anyinformation contained in this report is for informational purposes only and should not be construed to be an offer to buy or sell any securities,investment consulting, or investment management services. Additionally, the analysis provided, while generally comprehensive, is not intended toprovide complete information on each of the management organizations ortheir underlying strategies. Please refer to their respective Form ADVs,pitch books, and/or offering documents for complete terms, including risks and expenses.Information is based on sources and data believed to be reliable, but AndCo cannot guarantee the accuracy, adequacy or completeness. Theinformation provided is valid as of the date of distribution or the as-of date indicated and not as of any future date, and will not be updated orotherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after such date.The source of data and figures provided is generally the respective managers, including their Form ADVs, pitchbooks, offering documents and othersimilar documentation. Additional information included in this document may contain data provided by 3rdparty subscriptions, index databases orpublic economic sources.Return data presented in the “Track Records” is provided for historical and informational purposes only. The results shown represent pastperformance and do not represent expected future performance or experience. Past performance does not guarantee future results. Returns statedare net of fees, which may include: investment advisory fees, taxes and other expenses. When client-specific performance is shown, AndCo usestime-weighted calculations, which are founded on standards recommended by the CFA Institute. In these cases, the performance-related data shownare based on information that is received from custodians. As a result, this provides AndCo with a reasonable basis that the investment informationpresented is free from material misstatement.RISK FACTORSAs presented in this report, although investing in private debt funds can be beneficial, it is also important to consider the associated risks. Investing inprivate debt funds is higher risk, may involve speculation, and is not suitable for all investors. Prospective investors should be aware of the long-termnature of an investment in private debt funds. Investments (direct or indirect) in private debt are typically illiquid. Other general risks and importantconsiderations associated with private debt funds include, but are not limited to: volatilities in political, market and economic conditions; extensiveand frequently changing regulation; downturns in demand; changes to private debt values and taxes; valuation and appraisal methodologies; interestrates; and environmental issues. The risks outlined herein do not purport to cover all risks or underlying factors associated with investing in privatedebt funds. Please refer to the respective offering documents for complete information.
2Private Debt Overview
3Benefits of Direct Lending – SeniorCategory Expected Return1,2Expected Volatility1,2Return/Risk Ratio4U.S. Large Cap Equity7.2%14.3% 0.5U.S. Small Cap Equity7.2%19.0% 0.4International Equity59.5% 17.3% 0.6U.S. Core Fixed Income2.8%3.4% 0.8U.S. Bank Loans65.3%7.6% 0.7U.S. High Yield Bonds6.9%8.2% 0.8Private Equity 9.8% 20.2%0.5U.S. Core Real Estate6.6%11.1% 0.6U.S. Value-Added Real Estate 8.7% 17.2%0.5Direct Lending – Senior68.5%13.9% 0.6Senior direct lending strategies originate corporate loans. The debt is normally floating-rate and secured by first- or second-lien claims on corporate assets. The category isexpected to outperform U.S. equity, core real estate and fixed income over the next 10-15years, with a higher return per unit of risk than private equity or value-added real estate.1PublicPrivate1 Expected returns and volatility are from the “2020 JPMorgan Long-Term Capital Market Assumptions” (LTCMAs) as updated March 31, 2020 and rounded to the nearest 0.1%.2Expected return is shown on a compound, annualized basis.3Volatility is defined as annualized standard deviation of total return.4Return/risk ratio was calculated by AndCo Consulting and is defined as expected return divided by expected volatility.5AndCo blended JPMorgan’s developed- and emerging-market equity assumptions using the categories’ approximate weightings in the MSCI All Country World ex-U.S. Index.6In JPMorgan’s LTCMAs, bank loans are called “Leveraged Loans” and Direct Lending – Senior is “Senior Direct Lending.”
4Direct Lending – Senior Category’s Risk and ReturnSenior Loan4.0x EBITDA$200.0M Loan ($50.0M x 4)5-Year Stated TermOften Repaid After ~3 YearsMezzanine Loan1.0x EBITDA$50.0M Loan ($50.0M x 1)5.0-7.0 Year TermEquityEnterprise Value of CompanyMinus More Senior ObligationsRemainder is 4.0x EBITDA ($200.0M)LIBOR + 6.0-8.0%+ 1.0-2.5% One-Time Fees111.0-14.0% Fixed Rate2+ 1.0-2.5% One-Time Fees1+ Equity participation>25.0% Target IRRCredit LossesCapital Structure YieldRisk of corporate investments is affected by borrower risk and seniority. Investments inthe senior part of the capital structure have lower expected returns and risk.Higher-Risk and Expected Return- LowerAssumptionsCompany with $50.0M EBITDATrades at 9.0x EBITDAEnterprise Value = $50.0M * 9.0EBITDA is a measure of cash flow equal to a corporate borrower’s annual Earnings Before Interest, Taxes, Depreciation and Amortization.Enterprise ValueIllustrative Liabilities + Equity=1One-time fees include items like origination fees and original issue discounts. Borrowers may also pay other types of fees for items like early repayment and loan amendments.2 Mezzanine coupons often comprise cash and payment-in-kind (PIK) interest. PIK represents increases in the principal balance owed. Receiving PIK in lieu of cash increases the investor’s risk but may also increase return multiples due to compounding.The above represents a hypothetical scenario and is intended for illustrative purposes only, reflective of a sample capital structure for a mid-sized company. Hypothetical yields and target IRRs shown are intended to be long-term in nature, and do not reflect current market conditions.
5Implementation Considerations – Illiquid Limited PartnershipsAsset managers cannot readily buy or sell illiquid assets to invest contributions or payredemptions, so investors primarily invest in private debt through closed-end limitedpartnerships.Limited partnerships are generally not registered with the SEC.Partnerships are managed by “General Partners (GPs).” Investors are “Limited Partners (LPs).”Limited partnerships are offered using a private placement memorandum (PPM) and governed bya limited partnership agreement (LPA).Fees are usually assessed on the portfolio’s fair value, including any assets purchased usingleverage. Some funds charge management fees on committed capital, but this is no longercommon.Unaudited March, June and September financial statements are typically available 45 days afterquarter-end. Audited financial statements are typically available 90 days after year-end.Closed-end limited partnerships have limited terms, often 8.0-10.0 years plus extensions.Investors join by submitting subscription agreements (SAs) at closings held during the fundraisingperiod, which is often 12-24 months.Each LP commits to invest up to a maximum amount. When the money is needed, the GP sendscapital calls to LPs requesting contributions to pay for investments and expenses, up to theirmaximum commitments. LPs who do not contribute capital on time are in default at high cost.The GP makes investments during the investmentperiod, which is usually 3.0 years. While mostpartnerships reinvest cash flow during the investment period, many directlending partnershipsdistribute borrowers’ interest payments.When reinvestment ends, the partnership enters the harvest period and distributions accelerate.While many strategies sell their holdings in the harvest period, most direct lending strategies exittheir investments through maturity.
6Implementation Considerations – Fund-Level LeverageThe above is considered representative based on AndCo Consulting’s research. The cost and availability of leverage may differ for specific strategies.Many senior direct lending funds use leverage to enhance returns. These funds may bestandalone offerings or marketed alongside an unlevered fund in the same strategy.When a partnership uses leverage, we typically see managers target leverage of 1.0-2.5x thepartnership’s equity. We generally expect each 1.0x of fund-level leverage to increase netexpected return by 2-3% for a representative strategy that we would consider well-managed.Expected return does not rise one-to-one with fund-level leverage due to the cost of financing,which we expect to be 2-3% over LIBOR at current interest rates. We also tend to see higherincentive fees for levered funds than unlevered funds.The availability of leverage is affected by the portfolio’s quality and diversification. In contrast tosenior direct lending funds, distressed debt and mezzanine funds are normally unlevered due tothe higher credit risk of those strategies.AndCo expects more-levered funds to have lowerreturns per unit of risk than less-levered funds,all else held equal. We expect investors to be fully exposed to the risks of assets purchased withleverage, but for returns on these assets to be reduced by financing costs.However, levered options can be a better fit for investors with higher return objectives or thosewho prefer to make smaller commitments in order to have more total portfolio liquidity.
7Current Market Environment
80102030405060700204060801001202001200220032004200520062007200820092010201120122013201420152016201720182019YTDCapital Raised ($ Billions)Number of FundsFundraisingDirect Lending FundsNumber of FundsCapital Raised$0.0$100.0$200.0$300.0$400.0$500.0$600.0$700.0$800.0$900.020002001200220032004200520062007200820092010201120122013201420152016201720182019Dry Powder ($ Billions)Dry PowderBuyout and Direct Lending FundsDirect Lending - SeniorMezzanineDirect Lending - OtherBuyout$845.6$170.0Fundraising and Dry PowderSource: Preqin. Accessed September 9, 2020. The charts include the most recent data in the Preqin database on the access date. The numbers to the right of the chart on the right are 1) the total dry powder of buyout funds and 2) the sum of the dry powder of the three types of private debt funds shown (Direct Lending – Senior, Mezzanine and Direct Lending – Other).Direct lending fundraising accelerated after the Global Financial Crisis. The pace year-to-date has been slightly slower than in 2017-2019. Dry powder remains much lower than the private equity buyout funds that direct lending funds complement.
9Market EnvironmentPrivate-market data is reported with a longer lag than public-market data. Privatecorporate valuations rose from 2015 through 2019 and declined slightly in the first quarterof 2020. The trend toward larger equity contributions continued.Source: PitchBook Data. Q1 2020 US PE Middle Market Report. Retrieved from https://pitchbook.com/news/reports/q1-2020-us-pe-middle-market-report. The report was published June 17, 2020.6.1x5.6x6.9x3.2x4.6x4.5x4.5x6.0x7.1x5.5x5.2x6.3x5.8x5.9x4.0x3.9x4.6x5.2x4.8x3.6x4.5x3.9x4.0x5.8x4.4x5.3x5.9x5.8x6.8x8.2x9.9x10.2x12.1x8.0x8.2x9.1x8.4x10.0x12.8x10.0x10.5x12.2x11.5x12.7x12.2x0.0x2.0x4.0x6.0x8.0x10.0x12.0x14.0x200620072008200920102011201220132014201520162017201820191Q 2020Median Multiple of EBITDAPrivate Equity Buyout MultiplesDebt/EBITDAEquity/EBITDAEV/EBITDA
10Private Debt Market ConditionsCOVID-19’s Impact on Private CompaniesIn addition to its humanitarian toll, the pandemic has negatively impacted portfolio company cashflow due primarily to the decline in economic activity, which contributed to wider credit spreads.Among portfolio companies, providers of in-person services such as groups of gyms, dental orphysicians’ offices, and day-care centers tend to be more adversely affected. This has eased assome areas have re-opened. Sometechnology and business services companies haveexperienced increases in cash flow due to demand for remote solutions.When the situation requires, most senior lenders have required thatinvestors with lower priorityclaims, such as private equity (PE) sponsors, reduce risk by adding equity capital before they willconsider granting loan amendments or covenantwaivers. In exchange for this relief fromcommitments the borrower made in loan covenants, some lenders assess fees and increase loanspreads. These fees and increased coupons are expected to pass through to their funds.Slower DeploymentA decline in mergers & acquisitions (M&A) caused most direct lending strategies to invest moreslowly in spring and summer 2020.Direct lenders tell us that M&A activity has accelerated since then, but that volume remains belowpre-COVID-19 levels.Higher YieldsMarket conditions have recentlyshifted in lenders’ favor. Depending on the strategy, senior lendersgenerally cite 1-3% wider credit spreads, lowerloan balances, and more conservative loancovenants on new originations than had prevailed prior to the pandemic’s arrival in the U.S.The update on this page is based on AndCo’s conversations with certain direct lending, distressed debt and private equity managers. These statements are therefore not intended to be exhaustive and are largely anecdotal. While we believe their perspectives are representative and have found them to be in consensus with one another, these expectations cannot be guaranteed and may ultimately not come to pass. Information provided is valid only as of the date of distribution.
11Candidate Overview
12Candidate Selection CriteriaQualities to consider and evaluate when reviewing Private Debt managers:ExperienceA long history as a reliable partner helps to drive deal flow by increasing the manager’s reputation withprospective borrowers and intermediaries, allowing for greater selectivity.Track RecordPast success relative to strategies taking similar risks, including in adverse environments, increasesconfidence that the strategy will be successful in the future.Institutional Investment ProcessTeams with established investment processes that do notoverly rely on any individual, in order to increaseconfidence that past success may be repeatable.Differentiated SourcingDifferentiated approaches to originating deal flow mayallow the manager to find opportunities that are lesscompetitively priced.Strong Underwriting (forDirect Lending strategies)The ability to protect investor capital, as reflected in low historical annualized credit loss rates.Credit Workout CapabilitiesResources and experience working through troubled loans and restructurings.Relative ValueCompetitive net expected returns in the context of the risks being taken.Illiquidity PremiumA well-grounded rationale for the strategy to outperform public investments of similar risk in the future.
13Candidates1Based on our research process, we present the following candidates:Firm FundBlackRock, Inc. (BlackRock) BlackRock Direct Lending Feeder IX-LChurchill Asset Management Churchill Middle Market Senior Loan Fund IIIDeerpath Capital Management (Deerpath)Deerpath Capital Advantage V (US)GC Advisors LLC (Golub) Golub Capital Partners 121Unless noted otherwise, all data is as of the date each fund was added as an approved strategy with AndCo.
14Firm OverviewFirm Direct Lending StrategyInceptionOwnershipFirm / Direct Lending AUMDirect Lending Team Primary LocationsDirect Lending ProfessionalsBlackRock200078% the public (NYSE: BLK) or employees. 22% PNC Financial Services Group.$6.5 trillion /$9.7 billionSanta Monica, CA; New York, NY45Churchill2015(2006 predecessor firm)75% owned by Nuveen, LLC, a division of Teachers Insurance and Annuity Association of America (TIAA), a not-for-profit stock life insurance company. 25% owned by Churchill senior management.$22.1 billion / $7.6 billionNew York, NY; Chicago, IL; Charlotte, NC63 in senior lending. 82 including junior lending and private equity.Deerpath2009100% employee-owned by presidentJames Kirby (40%), principal John Fitzgibbons (30%), chairman Gary Wendt (20%) and partner Tas Hasan (10%).$1.3 billion / $1.3 billion (sole strategy)New York, NY; Chicago, IL; Boston, MA; Los Angeles, CA; Fort Lauderdale, FL40Golub199480% owned by Lawrence Golub, David Golub and Golub family-related trusts. 20% owned by DyalCapital, an affiliate of Neuberger Berman that makes passive investments in alternative managers.Over $30 billion / Over $25 billionNew York, NY; Chicago, ILOver 100
15Strategy FocusFirm Fund Offering Strategy FocusBlackRockBlackRock Direct Lending Feeder IX-LFirst-lien, second-lien and unitranche loans to complex or overlooked U.S. companies in the core middle-market with $15-85 million in EBITDA. Historically, about half of the loans made were to companies owned by private equity (PE) firms or funds.ChurchillChurchill Middle Market Senior Loan Fund IIISenior loans to PE-owned U.S. companies in the core middle market with $10-100 million in EBITDA.DeerpathDeerpath Capital Advantage V (US)First-lien (lower leverage) loans to PE-owned U.S. companies in the lower middle-market with $5-15 million in EBITDA.GolubGolub Capital Partners 12Unitranche (higher leverage) loans to PE-owned U.S. companies in the core middle-market with $10-100 million in EBITDA.
16Key DifferentiatorsFirm Key Strengths Points to ConsiderBlackRockBlackRock’s low annualized credit-loss rate of less than 0.1%may indicate strong underwriting. This is particularly strong for atrack record including the Global Financial Crisis (GFC).The fund may earn higher yields than other core middle-marketoptions because it can invest in non-PE-sponsored companiesand focuses on more complex or less understood transactions.The team’s experience navigating over 100 restructurings orbankruptcies, which are part of the special-situations PEstrategy they have managed since 1996, may help themmanage credit workouts.Deep industry experience may help with underwriting and creditworkouts. The team includes 19 overlapping industry-specialistverticals, each led by an “industry captain” with at least 10 yearsof experience in the subject industry.Most of the team is from Tennenbaum Capital Partners(TCP), which BlackRock acquired in 2018. The team wascombined with BlackRock’s smaller direct lending team. WhileTCP already had a New York office, it is less centralized inSanta Monica than it had been due to the combination. Thesechanges could affect how well the team works together.TCP’s deployment pace has accelerated. From 2013-2016,the firm generally invested less than $1.75 billion in directloans annually. The firm deployed over $2.0 billion in 2017and $2.5 billion in 2018.Prior to 2012, TCP’s direct lending transactions were part ofits blended special-situations-and-direct-lending products.Investor preferences caused the strategies to stop beingcombined that year.ChurchillThe fund’s 0.5% management and 10% incentive fees are eachlower than most direct lending funds we see.Focusing on stable companies in non-cyclical industries that areowned by leading PE sponsors may reduce risk. Further, fromJune 2015 through March 2020, the strategy historically lent4.3x borrower EBITDA on average. This is on the conservativeend of the 4.0-5.0x range we consider typical.Relationships with PE sponsors from Churchill and TIAA’s PE-fund investments may contribute to the fund’s deal flow.Churchill closed on about 6% of 700 opportunities seen in the12 months ended June 30, 2020.The loans in which the fund will invest tend to have 2-10 co-lenders. This “club loan” structure may allow for more holdingswith less capital, increasing diversification.PE-sponsored, core middle-market loans may be moreefficiently priced than loans to non-sponsored and/or smallercompanies. Leading PE sponsors tend to have capitalmarkets specialists whose role is to manage competitiveborrowing processes. This could reduce the illiquiditypremium and limit the opportunity for manager alpha.Focusing on “club” loans with 2-10 co-lenders may limit thefund’s ability to earn fees by serving as a loan agent. It couldalso dilute the team’s influence in restructurings.Returns have been lower than those of the other candidates.Gross unlevered IRRs were 5-7% in each of the four vintageyears since Churchill’s formation within Nuveen in 2015, fromthe deals’ inceptions through June 30, 2020.Increasing AUM may cause the team to be less selective.Churchill originates more than $3 billion annually, which ismore than double its pace when the prior fund was raised.The fund may use up to 2.0x debt/equity leverage, which is onthe high end of the 0.0-2.5x range we see in the category.
17Key DifferentiatorsFirm Key Strengths Points to ConsiderDeerpathRegional offices allow the team to be more selective by drivingbroad deal flow of >1,500 opportunities annually. This allows fora low closing rate of about 2%.Consistently strong performance. As of June 30, 2020, thesince-inception unlevered gross IRR of investments made inevery vintage year from the strategy’s 2009 inception through2017 were 8% or more. Since senior loans tend to beoutstanding for two to four years, more recent vintages may besubject to more volatility in since-inception gross IRRs, basedon marks to market for unrealized positions.Conservative credit underwriting, including a focus on lowleverage multiples and loan-to-value ratios. The typical borrowerhas 15 years of operating history.Deerpath was founded in 2007 but made its first loan in 2009,so its track record does not include the GFC.Lower middle-market companies are expected to havegreater business risk than larger companies, all else heldequal, because they may have fewer business lines and morecustomer concentration.Deerpath charges administrative fees on top of themanagement fee. We consider the fund’s fees lower thanusual for its style, even after accounting for this factor.GolubGCP 12 invests in a large, evergreen portfolio that comprised$11.8 billion in fair value across over 450 borrowers as ofDecember 31, 2018, providing broad diversification.Deep resources. Golub has more than 200 back-office staff, inaddition to more than 100 investment professionals.A strong reputation among PE firms contributes to deal flow andrepeat business. About half of new loan commitments from2013-2018 were to repeat borrowers.Golub’s substantial assets under management may limit itsability to pursue smaller transactions.GCP 12 uses more fund-level leverage (2.0-2.5x investorequity) than the other candidates.Golub has the highest management and incentive fees amongthe candidates. Golub also charges administrative fees on topof the management fee.
18Investment TeamFirm Key Decision-Makers Team StabilityBlackRockDecisions are made by seven voting members of theinvestment committee. Five voting members are permanentand two rotate.Managing directors (MDs) Rajneesh Vig, Philip Tseng,Howard Levkowitz, Michael Leitner and Jason Mehring are thepermanent members. They each joined BlackRock or TCP in2006 or earlier and have more than 20 years of experience.The two rotating seats are held by two of five otherMDs. The other MDs are Rob DiPaolo, Christian Donohue,Brad Pritchard, Nik Singhal and Dan Worrell. They each havemore than 15 years of experience. Alex Dashiell was an MD atthe time the product was approved by AndCo. He left the firmin 2020 and was from the legacy BlackRock side. We do notconsider his departure material.BlackRock acquired TCP in August 2018. Most members ofthe team are from the legacy TCP side. We consider thecombined team’s turnover normal: low for TCP and high forBlackRock’s legacy team.The TCP team had 30-35 professionals and 2-4 annualdepartures over the last five years, which was about 10%average turnover. We consider this low. None of thedeparted team members had voting rights.The legacy BlackRock team had about three departuresannually over the last five years and included 12 membersat the time of the merger, for a rate of about 25%. Otherthan Alex Dashiell in 2020 (mentioned at left), thesedepartures were more junior, including a few contract hires.We are comfortable with them.ChurchillDecisions are made by a five-member investment committeecomprising Ken Kencel, CEO; Randy Schwimmer, Head ofOrigination; Christopher Cox, Chief Risk Officer; MathewLinett, Head of Underwriting and Portfolio Management; andShai Vichness, CFO.Ken Kencel is the firm’s CEO and is involved in all aspects ofits operations. The other members of the investmentcommittee head functional areas within its investmentprocess.Churchill was formed within Nuveen in 2015, but three offive investment committee members have worked togethersince 2006. Messrs. Kencel, Schwimmer and Cox co-founded predecessor firm Churchill Financial in 2006. Mr.Linett joined Churchill at its 2015 inception and has morethan 25 years of experience. Mr. Vichness joined Nuveen in2005 and Churchill in 2018.Churchill has had three departures in the last five years,which we consider low for a team of this size. Among themwas Head of Underwriting and Portfolio ManagementGeorge Kurteson, who retired on March 31, 2020. He wassucceeded by Mr. Linett, who worked closely with him forabout five years.
19Investment TeamFirm Key Decision-Makers Team StabilityDeerpathDecisions are made by a five-member investment committee.Four members are permanent and one rotates.The permanent members are principals James Kirby, GaryWendt and John Fitzgibbons, and partner/investment teamhead Tasabbur (Tas) Hasan. They each have more than 15years of investment experience.The rotating seat is held by one of six managing directors onthe investment team. The managing directors are MauricioReyes, Reed Van Gorden, Natalie Garcia, Marcus Badger,Allen Ameri and Orin Port. They each have more than 10years of investment experience.The three principals co-founded Deerpath in 2007 and hiredMr. Hasan that year.We consider Deerpath’s turnover low. There have beenabout 10 senior departures from the firm since its inception.About half of them were in business development. Only oneof the departed senior investment professionals had beenwith the firm for more than five years.GolubThe direct lending strategy, including GCP 12, is led by a four-member investment committee comprising Lawrence Golub,David Golub, Andrew Steuerman and Gregory Cashman.Lawrence Golub is the firm’s CEO and David Golub is itspresident. Messrs. Steuerman and Cashman are seniormembers of the middle-market lending team.Investment opportunities are sourced across the firm, but alarge group of 11 originators leads that effort.Due diligence on identified investment opportunities isconducted by an exceptionally large team of more than 60underwriters.Lawrence Golub founded the firm in 1994. David Golub,Andrew Steuerman, and Gregory Cashman have each beenwith the firm for at least 15 years.The middle-market lending team experienced about 10departures at the vice president or level or above over thelast five years, which we consider normal for a large team.
20Key TermsFirmTarget SizeMinimum CommitmentBorrower ProfileFund-Level LeverageFirst CloseFinal Close1Target Net IRRFund LifecycleBlackRock$4.0 billionNegotiable2Core mid-market companies with $15-85M EBITDA1.0x debt/equity312/18/19TBD. Dec 2020 -March 20219-11%Six years from the final closing, plus up to three one-year extensionsChurchill$500 million$5 millionCore mid-market PE-owned companies with $10-100M EBITDA2.0x debt/equity3/31/20 3/31/2149-10%Six years from the final closing plus up to two one-year extensionsDeerpath$1.0 billionNegotiable5Lower mid-market PE-owned companies with $5-15M EBITDA2.0x debt/equity6August 20192/6/21710-15%Eight years from the final closing plus up to two one-year extensionsGolub$3.0 billion8$1 millionCore mid-market PE-owned companies with $10-100M EBITDA2.0-2.5x debt/equity7/1/18 1/1/21 10-13%10 years from the first closing plus up to two one-year extensions1 Anticipated final closing dates are as of the time this report was prepared. They may have changed since the respective product was approved at AndCo.2The fund’s stated minimum is $10.0 million. The minimum for AndCo clients is generally $1.0 million. BlackRock may accept smaller commitments on a case-by-case basis.3The BlackRock strategy is also available in an unlevered vehicle, BlackRock Direct Lending Feeder IX-U, LP, which targets a 6-8% net IRR and is also approved at AndCo. Its terms differ from those of the BlackRock Direct Lending Feeder IX-L, the levered option that is shown in this report.4Churchill may extend the final closing date by up to six months by giving written notice to the fund’s limited partners.5The fund’s stated minimum is $5.0 million. Deerpath may accept smaller commitments on a case-by-case basis. The minimum is generally waived for AndCo clients.6The Deerpath strategy is also available in an unlevered, evergreen vehicle, Deerpath Capital V, LP, which targets a 6-9% net IRR and is also approved at AndCo. Its terms differ from those of Deerpath Capital Advantage V (US), LP, the option that is shown as representative in this report. A third partnership, Deerpath Capital Advantage V (Cayman), LP, is also approved at AndCo. Its terms are similar to Advantage V (US), but we expect it to earn a slightly lower return within the cited range due to actions we expect it to take in order to limit the chance of incurring unrelated business taxable income (UBTI) or effectively connected income (ECI). There is no assurance that the Cayman feeder will not incur UBTI or ECI. 7This date refers to Deerpath Capital Advantage V (US), LP. Deerpath Capital Advantage V (Cayman), LP is expected to hold a final closing by January 23, 2021. Deerpath Capital V, LP is expected to hold a final closing by May 1, 2021.8Golub does not specify fundraising targets. This is an estimate of its possible size. Through its quarterly closing on July 1, 2020, the fund has raised $2.8 billion.
21Key TermsFirmInvestment PeriodInvestment Management and Admin Fees1Preferred Return Carried InterestBlackRockThree years fromthe final closing,plus one one-yearextensionManagement Fee: 1.15% annually on invested capital.2Invested capital includes drawn equity and subscription lineborrowing during the investment period. After the investmentperiod, invested capital is the fair value of portfolio assets,including assets bought using leverage.Administrative Fees: Does not charge administrative fees.7% 15%ChurchillThree years fromthe final closing.Management Fee: The greater of 1) 0.50% of the aggregateoutstanding principal loans owned and the cost of equitysecurities held by the fund, including assets purchased usingleverage, reduced by any net write-downs and write-offs thatare considered permanent impairments; and 2) $150,000annually, assessed at the level of the partnership (i.e. noteach limited partner).Administrative Fees: Does not charge administrative fees.7% 10%DeerpathThree years fromthe final closing.Capital may stillbe reinvested fortwo years afterthat.Management Fee: 1.00% annually on the fair value of thefund’s investments, including assets purchased usingleverage but excluding cash and cash equivalents.Administrative Fees: Estimated at 0.3-0.4% of gross assetsannually.8% 15%GolubFive years fromthe final closing.Capital may stillbe reinvested forsixmonthsafterthat.Management Fee: Estimated at 1.00% on gross assets. Therate is 1.25% on middle-market loans and 0.50% on broadlysyndicated loans that the fund is also expected to hold.Administrative Fees: Estimated at 0.10-0.20% of grossassets annually.8% 20%1Each candidate is expected to use fund-level leverage. Consistent with prevailing direct lending industry practice, fees for each option are assessed on gross assets, including assets purchased using debt as well as equity. Management and administrative fees would be much higher, approximately the rates shown multiplied by the expression (1 + the amount of fund-level leverage), if expressed as a percentage of investor equity.2BlackRock offers discounted fees for large commitments and has agreed to aggregate AndCo client commitments for these discounts. If AndCo clients’ commitments are at least $100 million in aggregate, a discount of 0.10% from the management fee may be applied, which would result in a rate of 1.05%. There can be no assurance that any discount will be available.
22Performance and Fee Comparison
23Vintage-Year PerformanceDiverse vehicle structuresand amounts of fund-level leveragecan make direct lending trackrecords difficult to compare. Reviewing gross unlevered IRRs by vintage year can reduce thedistortions of timing and leverage.The table below includes each manager’s investments that we consider similar to those of thecandidate funds, regardless of the product that held them. The returns shown do not reflect anyspecific product and were not realized by any client.Vintage Year1BlackRock Churchill Deerpath Golub2005 and Prior 17.2% N/A N/A N/A2006 10.6% N/A N/A 8.2%2007 5.8% N/A N/A 6.2%2008 20.5% N/A N/A 10.7%2009 20.3% N/A 19.8% 11.6%2010 19.2% N/A 14.1% 9.5%2011 6.7% N/A 14.3% 9.3%2012 12.0% N/A 11.9% 9.1%2013 7.6% N/A 9.6% 7.8%2014 10.7% N/A 10.3% 7.3%2015 12.1% 6.1% 10.2% 7.8%2016 11.9% 6.3% 10.5% 7.5%2017 7.6% 5.2% 8.2% 7.3%2018 8.6% 4.9% 7.2% 6.3%2019 7.2% N/M26.0% 5.4%2020 17.9% N/M20.5% N/M2Aggregate IRR 11.4% 5.1%310.6% 8.1%4As-of Date 6/30/2020 6/30/2020 6/30/2020 6/30/20201Vintage year refers to the year that the manager made an investment in a portfolio company. Performance is shown since inception, from the date the investments were made through the as-of date. For example, the performance of an investment made in 2009 is not only the performance of that investment during 2009, but from the date the investment was made through the earlier of when it was fully realized and the as-of date.2Churchill and Golub did not report performance for the most recently incepted investments. Due to the youth of these positions,their returns are not yet considered meaningful.3Churchill’s gross unlevered IRR was calculated by AndCo using quarterly portfolio company-level cash flows and June 30, 2020 valuations that Churchill provided.4An aggregate IRR using pooled cash flows is not available. The IRR shown in the "Aggregate IRR" row for Golub is an equal-weighted average of the vintage-year returns shown as calculated by AndCo.
24BlackRock, 0.1%, 11.4%, 740Churchill, 0.2%, 5.1%, 228Deerpath, 0.3%, 10.6%, 188Golub, 0.5%, 8.1%, 7950.0%5.0%10.0%15.0%20.0%0.0% 0.5% 1.0%Gross Unlevered IRRAnnualized Loss RateDirect Lending Track RecordsSince Inception7Track Record Robustness and Credit-Loss RatesRobust track records give us confidence that past results arose from skill rather than luck.We associate low annualized credit loss rates with strong underwritingand/or credit workoutcapabilities, which may help managers to provide downside protection. We consider loss rates of0.5-0.8% typical for a senior direct lending strategy across a full market cycle.Since-Inception Statistic BlackRock Churchill Deerpath GolubTrack Record Inception 2000 2015 2009 2006Portfolio Companies 740 228 188 795Total Cost ($M) $21,316.3 $9,333.9 $3,020.7 $77,729.2Gross Unlevered IRR 11.4% 5.1%110.6% 8.1%2Annualized Loss Rate30.1%40.2%40.3%50.5%6As of Date 6/30/2020 6/30/2020 6/30/2020 Various61 Churchill’s gross unlevered IRR was calculated by AndCo using quarterly portfolio company-level cash flows and June 30, 2020 valuations that Churchill provided.2 The return shown in the “Gross Unlevered IRR" row for Golub is an equal-weighted average of the vintage-year returns shown on the prior slide, as calculated by AndCo.3Each candidate’s loss rate includes realized losses and mark-downs on unrealized positions. Private debt is marked to market based on public credit spreads as well as borrowers’ fundamental performance. Heightened volatility in public credit spreads in 2020 has contributed to volatility in unrealized values, which can cause loss rates calculated from time series to be elevated.4Loss rates for BlackRock and Churchill were calculated by first calculating a cumulative loss ratio, given by dividing the sum of realized and unrealized losses for investments held below cost by total capital invested. The resulting cumulative loss ratio was annualized by dividing it by the age of the track record in years.5Deerpath’s loss rate is an equal-weighted average of quarterly, annualized loss rates on its full portfolio, which included equity investments of less than 5%.6Golub’s loss rate is for first-lien middle-market loans only, from 2004 through March 31, 2020. All other Golub statistics shown are as of June 30, 2020 and do not include 2004-2005.7The text in the chart is the annualized loss rate, gross unlevered IRR, and number of portfolio companies. Bubble sizes are based on the number of portfolio companies.
250.00%0.50%1.00%1.50%2.00%2.50%3.00%3.50%4.00%Estimated Fee1Hypothetical Gross IRR2Estimated FeesBlackRockChurchillDeerpathGolubPerformance & Fee Comparison1Estimated annual management fee, administrative fees paid to the asset manager and carried interest as a percentage of the candidate fund’s assets. Since each candidate fund is expected to use leverage, fees would be higher as a percentage of investor equity. Carried interest was assumed not to be assessed on returns that were less than the sum of 1) the Hypothetical Gross IRR, 2) the Management Fee and 3) the Administrative Fee associated with each manager. When the gross IRR was in excess of those fees, each additional basis point of gross return was assumed to be assigned to the general partner (GP) at the GP Catch-up rate shown until the GP had received the share of total Carried Interest shown on all returns in excess of the Management Fee and Administrative Fee. Once that point was reached, the GP was assumed to receive the Carried Interest shown on each additional basis point of gross return.2The hypothetical gross IRR is an arbitrary assumption intended to show the relationship between the IRR and expenses. The IRRs shown may not be achieved.3Estimated administrative fees are shown when the asset manager assesses one on top of its management fee. Third-party administrative expenses are not included.Assumptions BlackRock Churchill Deerpath GolubManagement Fee 1.15% 0.50% 1.00% 1.00%Administrative Fee30.00% 0.00% 0.35% 0.15%Carried Interest 15.00% 10.00% 15.00% 20.00%Preferred Return 7.00% 7.00% 8.00% 8.00%GP Catch-up 85.00% 90.00% 100.00% 100.00%
26BlackRock Direct Lending Performance – June 30, 20201Total Realized value for Vintage Year Performance and Fund Performance is calculated as the value of closed investments as of June 30, 2020.2Total Unrealized value for Vintage Year Performance and Fund Performance is calculated as the value of open Investments as of June 30, 2020.3The Fund Level Performance includes only investments included in the U.S. Direct Lending strategy. Prior to 2012, Tennenbaum Capital Partners (TCP) raised capital and invested in both direct lending and special situations investments from the same vehicle. In 2012, TCP raised its first dedicated direct lending vehicle (Tennenbaum Senior Loan Fund I). Subsequently, due to investor demand, TCP has bifurcated its capital raising and investing into two separate and distinct strategies.Vintage Year Performance (Investment-Level)Portfolio In USD MillionsVintage Year Companies (#) Total Invested Capital Total Realized1Total Unrealized2Total Value MOIC Gross IRR2005 and Prior 19 $ 1,037.5 $ 1,491.3 $ - $ 1,491.3 1.4x 17.2%2006 11 $ 629.7 $ 819.0 $ - $ 819.0 1.3x 10.6%2007 13 $ 964.4 $ 1,090.4 $ - $ 1,090.4 1.1x 5.8%2008 3 $ 158.5 $ 196.9 $ - $ 196.9 1.2x 20.5%2009 5 $ 120.7 $ 162.3 $ - $ 162.3 1.3x 20.3%2010 20 $ 907.0 $ 1,201.6 $ - $ 1,201.6 1.3x 19.2%2011 15 $ 408.5 $ 363.0 $ 175.6 $ 538.6 1.3x 6.7%2012 39 $ 975.2 $ 1,012.4 $ 219.1 $ 1,231.5 1.3x 12.0%2013 63 $ 1,376.0 $ 1,539.8 $ 60.1 $ 1,599.9 1.2x 7.6%2014 73 $ 1,598.9 $ 1,683.3 $ 286.1 $ 1,969.4 1.2x 10.7%2015 56 $ 1,475.2 $ 1,279.1 $ 435.1 $ 1,714.3 1.2x 12.1%2016 56 $ 1,646.1 $ 1,538.6 $ 400.4 $ 1,938.9 1.2x 11.9%2017 93 $ 2,434.6 $ 1,693.8 $ 1,156.1 $ 2,849.9 1.2x 7.6%2018 101 $ 3,163.6 $ 1,033.6 $ 2,434.1 $ 3,467.7 1.1x 8.6%2019 134 $ 3,502.0 $ 381.3 $ 3,335.3 $ 3,716.6 1.1x 7.2%2020 39 $ 918.2 $ 2.0 $ 953.6 $ 955.5 1.0x 17.9%Total 740 $ 21,316.3 $ 15,488.2 $ 9,455.5 $ 24,943.6 1.2x 11.4%Fund Performance3In USD Millions Investment-Level Fund-LevelFundVintageYearPortfolioCompanies (#)Total Invested Capital Total Realized1Total Unrealized2Total Value MOIC Gross IRRLeverage(Debt / Equity) Net IRRTennenbaum Senior Loan Fund I 2012 228 $ 1,064.0 $ 913.0 $ 284.6 $ 1,197.6 1.1x 13.0% 2.5x 10.3%Tennenbaum Senior Loan Fund II 2012 251 $ 1,422.1 $ 1,145.6 $ 481.7 $ 1,627.3 1.1x 8.1% 0.0x 7.2%Tennenbaum Senior Loan Fund III 2013 146 $ 713.2 $ 735.5 $ 91.8 $ 827.3 1.2x 10.5% 0.8x8.2%Tennenbaum Senior Loan Fund IV-A 2013 72 $ 193.7 $ 209.4 $ 12.8 $ 222.2 1.1x 5.9% 0.0x4.6%Tennenbaum Senior Loan Fund IV-B 2013 136 $ 141.2 $ 151.4 $ 23.0 $ 174.4 1.2x 11.4% 0.0x 9.4%Tennenbaum Senior Loan Fund V 2014 223 $ 975.3 $ 602.3 $ 473.7 $ 1,076.1 1.1x 7.5% 0.0x 6.5%Tennenbaum Enhanced Yield Fund 2015 116 $ 488.1 $ 446.2 $ 130.6 $ 576.8 1.2x 13.0% 0.5x 8.9%Tennenbaum Energy Opportunities Fund 2015 41 $ 174.5 $ 139.9 $ 67.9 $ 207.8 1.2x 11.3% 0.0x 8.9%TCP Direct Lending Fund VIII (unlevered) 2016 126 $ 649.5 $ 309.3 $ 417.1 $ 726.5 1.1x8.7% 0.0x 5.9%TCP Direct Lending Fund VIII-A 2016 128 $ 464.9 $ 229.5 $ 291.0 $ 520.5 1.1x 10.0% 0.0x 7.5%TCP Direct Lending Fund VIII (levered) 2016 143 $ 735.9 $ 261.4 $ 531.9 $ 793.3 1.1x 8.2% 1.0x 5.9%BlackRock DLF IX 2019-G CLO 2017 75 $ 166.5 $ 37.8 $ 134.0 $ 171.8 1.0x 3.9% 0.0x 2.8%TCP Direct Lending Fund VIII-S 2017 100 $ 177.6 $ 57.6 $ 132.1 $ 189.8 1.1x 8.1% 1.0x 4.8%TCP Direct Lending Fund VIII-T 2017 98 $ 354.4 $ 115.8 $ 263.4 $ 379.2 1.1x 8.3% 1.0x 5.5%TCP Direct Lending Fund VIII 2018 CLO 2018 83 $ 297.4 $ 99.3 $ 222.5 $ 321.8 1.1x 7.2% 0.0x 5.4%BlackRock Direct Lending Fund IX-U 2019 14 $ 17.6 $ 1.9 $ 16.7 $ 18.5 1.1x 11.5% 0.0x 6.3%BlackRock Direct Lending Fund IX-L 2019 15 $ 56.1 $ 5.8 $ 53.3 $ 59.1 1.1x 11.1% 1.0x 7.3%BlackRock Direct Leding Fund IX 2019-CLO 2019 24 $ 47.4 $ 5.0 $ 45.0 $ 50.1 1.1x 8.8% 0.0x 7.3%BlackRock Middle Market Senior Fund 2018 25 $ 243.2 $ 24.6 $ 232.6 $ 257.2 1.1x 3.3% 1.0x -0.6%Total $ 8,382.7 $ 5,491.5 $ 3,905.7 $ 9,397.2 1.1x
27Vintage Year Performance (Investment-Level)1Portfolio In USD MillionsVintage Year2Companies (#) Total Invested Capital Total Realized Total Unrealized Total Value MOIC Gross IRR2015 25 $ 576.6 $ 624.2 $ 15.9 $ 640.0 1.1x 6.1%2016 43 $ 1,433.5 $ 1,149.9 $ 443.3 $ 1,593.2 1.1x 6.3%2017 44 $ 2,058.0 $ 1,249.6 $ 981.9 $ 2,231.5 1.1x 5.2%2018 47 $ 2,131.2 $ 922.0 $ 1,336.6 $ 2,258.7 1.1x 4.9%2019 50 $ 2,209.9 $ 342.4 $ 1,905.8 $ 2,248.2 1.0x N/M2020 19 $ 924.7 $ 72.2 $ 838.2 $ 910.4 1.0x N/MTotal 228 $ 9,333.9 $ 4,360.3 $ 5,521.7 $ 9,882.0 1.1x 5.1%2Fund PerformanceIn USD Millions Investment-Level Fund-LevelFundVintageYearPortfolioCompanies (#)3Total Invested Capital Total RealizedTotal Unrealized Total Value MOIC Gross IRRLeverage(Debt / Equity) Net IRRTIAA SMA 2015 2015 25 $ 358.8 $ 355.5 $ 55.9 $ 411.4 1.1x 6.6% N/A 5.8%TIAA SMA 2016 2016 36 $ 478.7 $ 415.0 $ 130.5 $ 545.5 1.1x 6.5% N/A 5.6%TIAA SMA 2017 2017 43 $ 772.9 $ 470.2 $ 379.0 $ 849.2 1.1x 5.6% N/A 4.7%TIAA SMA 2018 2018 46 $ 931.5 $ 446.1 $ 561.0 $ 1,007.1 1.1x 6.3% N/A 5.3%TIAA SMA 2019 2019 50 $ 754.7 $ 128.9 $ 629.7 $ 758.6 1.0x 0.7% N/A -0.4%TIAA SMA 202042020 14 $ 362.8 $ 16.4 $ 341.9 $ 358.3 N/M N/M N/A N/MThird Party SMA I 2017 94 $ 376.3 $ 144.2 $ 257.2 $ 401.4 1.1x 5.4% N/A 4.3%Third Party SMA II42019 60 $ 98.7 $ 14.4 $ 86.9 $ 101.3 1.0x 3.7% N/A N/MChurchill Middle Market Senior Loan Fund 2016 150 $ 887.1 $ 514.2 $ 444.6 $ 958.8 1.1x 5.6% 1.4x 4.4%Churchill Middle Market Senior Loan Fund Offshore 2016 151 $ 243.8 $ 121.6 $ 136.3 $ 257.9 1.1x 5.1% 1.3x 3.0%TGAM Churchill Middle Market Senior Loan Fund K 2016 104 $ 232.5 $ 142.6 $ 103.8 $ 246.4 1.1x 5.2% 0.6x 2.4%Churchill Middle Market Senior Loan Fund II K-UL52018 66 $ 87.5 $ 27.9 $ 62.3 $ 90.2 1.0x 4.2% N/A 2.6%Churchill Middle Market Senior Loan Fund II - Master42018 86 $ 578.4 $ 54.0 $ 521.0 $ 575.0 N/M N/M N/A N/MChurchill Middle Market Senior Loan Fund II - European62018 82 $ 451.1 $ 87.9 $ 376.7 $ 464.6 1.0x 3.4% N/A 2.1%Total $ 6,614.8 $ 2,938.9 $ 4,086.8 $ 7,025.7 Churchill Performance – June 30, 20201Excludes Churchill's CLO vehicles.2Churchill’s gross unlevered IRR was calculated by AndCo using quarterly portfolio company-level cash flows and June 30, 2020 valuations that Churchill provided.3The number of portfolio companies in each fund is as of March 31, 2020.4Churchill did not report performance metrics marked "N/M" for TIAA SMA 2020, Third Party SMA II and Churchill Middle Market Senior Loan Fund II - Master. Given the short term of the vehicles since inception, these metrics are not considered meaningful.5The IRR reported for Churchill Middle Market Senior Loan Fund II K - UL, LP was made using pro-forma cash flows that would have occured if Churchill called capital to efficiently manage cash needs, rather than calling capital according to a schedule.6The IRR reported for Churchill Middle Market Senior Loan Fund II - European Fund is pro-forma for expenses unrelated to the operation of the fund.
28Vintage Year Performance (Investment-Level)1Portfolio In USD MillionsVintage Year2Companies (#) Total Invested Capital Total Realized Total Unrealized3Total Value MOIC Gross IRR2009 4 $ 41.9 $ 61.2 $ - $ 61.2 1.5x 19.8%2010 10 $ 118.2 $ 154.8 $ 0.4 $ 155.2 1.3x 14.1%2011 10 $ 200.0 $ 257.6 $ 2.1 $ 259.6 1.3x 14.3%2012 11 $ 206.3 $ 237.5 $ 8.6 $ 246.2 1.2x 11.9%2013 13 $ 207.4 $ 233.3 $ 17.2 $ 250.5 1.2x 9.6%2014 23 $ 270.2 $ 288.5 $ 26.0 $ 314.5 1.2x 10.3%2015 16 $ 265.0 $ 283.8 $ 40.1 $ 324.0 1.2x 10.2%2016 10 $ 262.9 $ 144.6 $ 183.8 $ 328.4 1.2x 10.5%2017 15 $ 240.7 $ 147.2 $ 128.9 $ 276.1 1.1x 8.2%2018 27 $ 650.4 $ 151.4 $ 562.4 $ 713.8 1.1x 7.2%2019 37 $ 447.1 $ 75.7 $ 394.3 $ 470.0 1.1x 6.0%2020 12 $ 110.7 $ 8.2 $ 102.6 $ 110.8 1.0x 0.5%Total 188 $ 3,020.7 $ 2,043.9 $ 1,466.3 $ 3,510.3 1.2x 10.6%Fund Performance1In USD Millions Investment-Level Fund-LevelFundVintageYearPortfolioCompanies (#)4Total Invested Capital5Total Realized5Total Unrealized5Total Value MOIC Gross IRRLeverage(Debt / Equity) Net IRRFund I 2008 54 $ 88.2 $ 162.0 $ 10.6 $ 172.6 1.3x 13.4% 2.0x 12.6%Fund II 2011 46 $ 41.4 $ 75.1 $ 2.3 $ 77.4 1.2x 11.9% 2.0x 11.2%Fund III-A 2013 69 $ 77.6 $ 101.8 $ 3.1 $ 104.8 1.2x 9.7% Unlevered 5.9%Fund III-B 2013 56 $ 74.4 $ 100.3 $ 2.4 $ 102.7 1.2x 9.7% 1.0x 7.6%Fund 4A 2016 35 $ 45.5 $ 4.4 $ 45.6 $ 50.0 1.1x 7.7% Unlevered 4.5%Fund 4B (US) 2016 106 $ 139.0 $ 16.8 $ 132.4 $ 149.3 N/A6N/A62.0x 4.2%Fund 4B (Cayman) 2016 114 $ 129.5 $ 6.0 $ 124.0 $ 130.1 N/A6N/A62.0x 0.3%Fund 4C 2016 59 $ 78.6 $ 18.0 $ 76.8 $ 94.8 1.1x 8.2% 2.0x 8.7%Fund 5A 2019 15 $ 26.0 $ - $ 26.0 $ 26.0 1.0x 3.9% Unlevered 0.4%Fund 5B (US) 2019 106 $ 55.0 $ - $ 56.2 $ 56.2 N/A6N/A62.0x 6.1%Fund 5B (Cayman) 2019 114 $ 21.9 $ - $ 17.2 $ 17.2 N/A6N/A62.0x -14.5%Fund V-B (Cayman) 2019 61 $ 60.9 $ 1.5 $ 60.7 $ 62.2 1.0x 6.0% 0.4x 2.7%Total $ 838.0 $ 485.9 $ 557.3 $ 1,043.2 8.4%Deerpath Performance – June 30, 20201The Vintage Year Performance table includes all Deerpath Investments in non-separately managed accounts. The Fund Performance table is each fund’s unique investment in a portfolio company. Because of add-ons and affiliate transfers, returns in the same investments may vary.2The vintage year of a company is defined by the year of its initial transaction. Transactions subsequently made with that company, such as delayed-draw term loans or draws against revolving lines of credit, are shown in the total for the year that the investment in that company began and not the year that the cash was invested in, or received from, that company. 3In the top table, accrued interest is included in the unrealized value. In the bottom table, accrued interest is included in IRR calculations but not the unrealized value column.4Each investment may be allocated across multiple funds.5In the Invested Capital and Realized Proceeds columns, affiliate transfers are netted if they are for seasoning purposes, otherwise figures are grossed higher.6Fund 4B (US) and Fund 5B (US) invest indirectly through a master fund of which they collectively own 100%. Fund 4B (Cayman) andFund 5B (Cayman) invest indirectly through a separate master fund, of which they collectively own 100%. Investment-level MOICs and gross IRRs are not available for these feeder partnerships because transaction-level cash flows occur inside the master funds and the feeder funds’ fractional ownership of each master fund varies with the relative sizes of the partnerships over time.
29Vintage Year Performance (Investment-Level)1Portfolio In USD MillionsVintage Year2Companies (#) Total Invested Capital Total Realized Total Unrealized Total Value MOIC Gross IRR2005 and Prior N/A N/A N/A N/A N/A N/A N/A2006 59 $ 934.1 $ 1,137.1 $ - $ 1,137.1 1.2x 8.2%2007 62 $ 1,315.2 $ 1,553.3 $ - $ 1,553.3 1.2x 6.2%2008 28 $ 620.8 $ 789.9 $ - $ 789.9 1.3x 10.7%2009 13 $ 381.9 $ 460.8 $ - $ 460.8 1.2x 11.6%2010 43 $ 1,374.7 $ 1,618.6 $ 31.9 $ 1,650.5 1.2x 9.5%2011 57 $ 2,351.0 $ 2,780.5 $ - $ 2,780.5 1.2x 9.3%2012 73 $ 4,449.6 $ 5,067.5 $ 319.7 $ 5,387.2 1.2x 9.1%2013 59 $ 3,763.5 $ 4,283.1 $ 44.3 $ 4,327.4 1.1x 7.8%2014 58 $ 7,227.9 $ 7,267.2 $ 1,082.6 $ 8,349.8 1.2x 7.3%2015 78 $ 11,324.0 $ 9,326.0 $ 3,790.9 $ 13,116.9 1.2x 7.8%2016 56 $ 9,610.3 $ 6,701.6 $ 4,238.9 $ 10,940.5 1.1x 7.5%2017 52 $ 10,736.6 $ 6,961.9 $ 5,029.5 $ 11,991.4 1.1x 7.3%2018 65 $ 9,877.8 $ 4,400.5 $ 6,343.7 $ 10,744.2 1.1x 6.3%2019 77 $ 11,368.5 $ 2,954.9 $ 9,357.8 $ 12,312.7 1.1x 5.4%2020 15 $ 2,393.3 $ 1,107.6 $ 1,310.0 $ 2,417.6 1.0x N/MTotal 795 $ 77,729.2 $ 56,410.4 $ 31,549.2 $ 87,959.6 1.1x 8.1%3Fund PerformanceIn USD Millions Investment-Level Fund-LevelFundVintageYearPortfolioCompanies (#)Total Invested Capital4Total Realized4Total Unrealized4Total Value4MOIC Gross IRR5Leverage(Debt / Equity) Net IRR6Golub Capital Partners IV, L.P. 2004 N/A $ 207.3 $ 412.1 $ - $ 412.1 2.0x N/A 2.0-2.5x 14.4%Golub Capital Int'l, Ltd. 2005 505 $ 378.7 $ 669.5 $ 378.7 $ 1,048.2 N/A N/A 2.0-2.5x 9.9%Golub Capital Partners V, L.P. 2006 N/A $ 234.9 $ 502.3 $ - $ 502.3 2.1x N/A 2.0-2.5x 11.9%Golub Capital Partners International VI, L.P. 2008 N/A $ 50.7 $ 76.8 $ - $ 76.8 1.5x N/A 2.0-2.5x 11.7%Golub Capital Partners VI, L.P. 2008 N/A $ 117.5 $ 230.4 $ - $ 230.4 2.0x N/A 2.0-2.5x 11.2%Golub Capital Partners International VII, L.P. 2010 N/A $ 131.2 $ 209.9 $ - $ 209.9 1.6x N/A 2.0-2.5x 10.5%Golub Capital Partners VII, L.P. 2010 N/A $ 330.5 $ 559.0 $ - $ 559.0 1.7x N/A 2.0-2.5x 11.1%Golub Capital Partners International VIII, L.P. 2012 N/A $ 310.5 $ 454.0 $ - $ 454.0 1.5x N/A 2.0-2.5x 10.2%Golub Capital Partners VIII, L.P. 2012 N/A $ 420.4 $ 644.7 $ - $ 644.7 1.5x N/A 2.0-2.5x 10.6%Golub Capital Partners 9, L.P. 2014 532 $ 368.0 $ 191.5 $ 340.4 $ 531.9 1.4x N/A 2.0-2.5x 8.0%Golub Capital Partners Int'l 9, L.P. 2014 505 $ 481.1 $ 219.1 $ 473.4 $ 692.5 1.4x N/A2.0-2.5x 8.9%Golub Capital Partners 10, L.P. 2015 532 $ 649.3 $ 214.8 $ 617.4 $ 832.2 1.3x N/A 2.0-2.5x 8.0%Golub Capital Partners Int'l 10, L.P. 2015 505 $ 885.5 $ 251.7 $ 872.2 $ 1,123.9 1.3x N/A2.0-2.5x 8.4%GC Int'l Ladder, Ltd. 2016 505 $ 1,081.0 $ 40.3 $ 1,081.0 $ 1,121.3 N/A N/A 2.0-2.5x 6.8%Golub Capital Partners 11 Rollover, L.P. 2017 532 $ 384.5 $ 105.0 $ 360.8 $ 465.8 1.2x N/A 2.0-2.5x 7.6%Golub Capital Partners 11, L.P. 2017 532 $ 988.6 $ 132.7 $ 914.0 $ 1,046.7 1.1x N/A 2.0-2.5x 3.8%Golub Capital Partners Int'l 11, L.P. 2017 505 $ 1,520.0 $ 174.6 $ 1,534.7 $ 1,709.3 1.1x N/A 2.0-2.5x 8.1%Golub Capital Partners 12, L.P. 2018 532 $ 496.6 $ 9.0 $ 461.5 $ 470.5 0.9x N/A 2.0-2.5x 4.8%Golub Capital Partners Int'l 12, L.P. 2018 505 $ 723.2 $ 6.1 $ 636.2 $ 642.3 0.9xN/A 2.0-2.5x 6.3%Golub Capital Partners Int'l Rollover Fund 2, L.P. 2018 505 $ 179.8 $ 20.1 $ 181.0 $ 201.1 1.1x N/A 2.0-2.5x 8.0%Golub Capital Partners Rollover Fund 2, L.P. 2018 532 $ 239.4 $ 36.0 $ 225.0 $ 261.0 1.1x N/A 2.0-2.5x 4.5%Total $ 10,178.7 $ 5,159.6 $ 8,076.3 $ 13,235.9 1.3xGolub Performance – June 30, 20201This data summarizes all transactions executed by Golub Capital's Middle Market Lending business from January 1, 2006 through June 30, 2020 based on the original transaction vintage year. It does not include transactions executed by Golub Capital’s Broadly Syndicated Loans business.2The vintage year of a company is defined by the year of its initial transaction. Transactions subsequently made with that company, such as delayed-draw term loans or draws against revolving lines of credit, are shown in the total for the year that the investment in that company began and not the year that the cash was invested in, or received from, that company. 3An aggregate IRR using pooled cash flows is not available. The IRR shown in the "Aggregate IRR" row for Golub is an equal-weighted average of the vintage-year returns shown as calculated by AndCo.4In the bottom Fund Performance table, Total Invested Capital, Total Realized, Total Unrealized, and Total Value are each shown at the limited partner level. They are not adjusted upward to account for leverage.5Golub Capital does not calculate or provide gross-of-fees fund returns. 6All IRRs are calculated with respect to an indicative first close, full promote limited partner except for Golub Capital International (“GCIL”), GC International Ladder (“Ladder”) and Golub Capital Partners International 10 (“GCP 10i”). GCIL’s IRR is calculated with respect to an indicative Class A Series 1 third close, full promote shareholder. GCIL held its first close on November 23, 2005. However, no first or second close shareholder remains in GCIL. The starting date for GCIL’s ITD IRR is therefore its third close, January 1, 2007. GCP 10i’s IRR is calculated with respect to an indicative second close, full promote limited partner. GCP 10i held its first close on July 1, 2015. However, no first close limited partner remains who did not also make an additional commitment in a subsequent closing. Therefore, we have chosen a second close limited partner, which we believe is generally representative of the fund's performance. The starting date for GCP 10i’s ITD IRR is therefore its second close, October 1, 2015. Ladder IRRs are calculated for each fund’s shareholders or limited partners, respectively, taken as a whole. The IRRs for Ladder do not necessarily represent the actual returns of any investor in such funds. See Important Investor Information for a detailed definition of IRR.
30Investment Manager and Fund Narratives
31Firm OverviewBlackRock was founded in 1988 as a risk management and fixed income asset manager.The firm expanded through a series of mergers, most notably with Merrill Lynch InvestmentManagement in 2006 and Barclays Global Investors in 2009. BlackRock went public in 1999(ticker NYSE:BLK). Currently 22.0% of the shares are owned by PNC Financial ServicesGroup and 78.0% by the public or employees. The firm is headquartered in New York andhas offices in more than 30 countries. BlackRock managed $7.3 trillion in a broad variety ofasset classes as of June 30, 2020.Team OverviewBlackRock’s approximately 50-member Direct Lending Team (DLT) manages the fund. Theteam is organized in 19 overlapping industry-specialist verticals. All members of the DLT areon the investment committee (IC), but only seven are Voting Members at any time. FiveVoting Members are permanent, and two voting positions rotate among the remaining seniorteam members. Most of the team came from Tennenbaum Capital Partners (TCP), whichBlackRock wholly acquired in August 2018. TCP was founded in 1996 and managed twostrategies: special-situations (or turnaround-oriented) private equity investments and directlending, which remain the DLT’s sole strategies. The direct lending strategy was inceptedwithin the firm’s special-situations strategy in 2000.Strategy OverviewThe strategy makes first-lien, second-lien and unitranche loans to complex or overlookedNorth American middle-market companies with $15-80 million in EBITDA, which we classifyas core middle-market. Historically, about half of the loans made were to companiessponsored by private equity (PE) firms. Functions within the investment process are carriedout in a “cradle-to-grave” format wherein the same deal team that originates a lendingopportunity underwrites, monitors and, when necessary, works out the loan.Senior members of the team seek to originate lending deal flow from networks includingindustry advisors, regional investment banks and intermediaries, private-equity buyout firms,past management teams of earlier loans and existing portfolio companies, as well asBlackRock’s centralized sourcing network. Due diligence is performed by two-to-three-member deal teams, who consider the company’s financials, capital structure, competitiveand industry positioning, quality of management and loan terms, such as covenants andother creditor protections. Deal teams present lending opportunities to the IC for approval.The IC meets at least weekly and is chaired by Rajneesh Vig. A simple majority of the sevenVoting Members of the IC is needed to approve loans and to decide on actions in workoutsituations. No member of the IC holds veto power. Monitoring is conducted by the loan’sassigned deal team. If a portfolio company experiences challenges, the situation isdiscussed in the weekly IC meeting unless the situation requires a sooner, ad-hoc meeting.The team has extensive experience in navigating bankruptcies and restructurings, havingparticipated in more than 100 as part of its special-situations strategy. This experienceenables deal teams and the IC to handle workouts directly, without the use of separateinternal or external workout groups, but they also have latitude to engage external counselwhen deemed appropriate.ExpectationsFund IX is offered in unlevered (Feeder IX-U) and levered (Feeder IX-L) partnerships.Feeder IX-U will target a 6-8% net IRR. Feeder IX-L will target a 9-11% net IRR. We thinkthe two partnerships’ return targets are achievable. The funds’ net IRR targets are on thehigher end for core middle-market senior lending strategies at their levels of portfolioleverage, which we attribute to the inclusion of non-PE-sponsored loans and the team’sfocus on more complex transactions.Underlying loans held by both partnerships are expected to have coupons of 6-8% overLIBOR, with additional potential return coming from original issue discounts and prepaymentpremiums for loans repaid early, and deductions from return for credit losses. Feeder IX-L isexpected to issue debt equal to its equity (one-to-one leverage) in the collateralized loanobligation (CLO) market. We think it is reasonable to expect the levered fund to earn 2-3%more than the unlevered fund, net of the cost of its leverage, which we expect to be 2-3%over LIBOR. However, we would also expect Feeder IX-L to underperform Feeder IX-U if theportfolio earns a lower return than the cost of its leverage.Points to ConsiderThe team aims to be a flexible capital provider. Sector allocations may lean into areas ofstress or dislocation, such as energy in 2015 and health care in late 2016. We expectBlackRock to be more understanding than most lenders when management teams needflexibility, such as covenant waivers, in order to successfully execute their businessstrategies. These factors may contribute positively to deal flow by adding to the DLT’sreputation as a patient lender. While they could also detract from recoveries when businessstrategies are unsuccessful, we have not observed this to date. The strategy achieved a low0.07% annualized credit loss rate from its 2000 inception through June 2020. This ratecompares favorably to the 0.5% average for senior middle-market loans.There has been a material increase in the pace of the DLT’s deployment. From 2013-2016,TCP generally invested less than $1.75 billion in direct loans annually. The firm deployedover $2 billion in 2017 and $2.5 billion in 2018. We think that its broad deal flow, whichincluded investing in only about 5% of the about 1,300 investment opportunities the teamsreviewed in 2018, will enable the DLT to continue successfully executing its strategy at thisaccelerated pace.Recommendation SummaryWe recommend the strategy as a core allocation in a private debt portfolio. Due to the lesscyclical nature of senior direct lending and the strategy’s breadth within that category, it canbe used as a foundational, anchor position to which diversifying satellites can be added. Thestrategy covers most of the middle market in which direct lending strategies typically investand can flexibly invest in both the plentiful opportunities to lend to PE-sponsored companiesthat most competitors in the category target and non-sponsored companies that tend to beriskier and more difficult for managers to source.BlackRock, Inc. – BlackRock Direct Lending Fund IX
32Churchill (Nuveen) / Churchill Middle Market Senior Loan Fund IIIFirm OverviewChurchill Asset Management LLC (Churchill) specializes in making debt and equityinvestments in private equity (PE) owned middle-market companies. The firm was foundedwithin Teachers Insurance and Annuity Association of America (TIAA)’s wholly owned assetmanagement division, Nuveen, LLC, in 2015. TIAA is a not-for-profit stock life insurancecompany. Churchill is owned 75% by Nuveen and 25% by Churchill senior management.Churchill manages more than $20 billion in committed capital. Senior members of theChurchill team previously founded Churchill Financial (CF) within Bear Stearns in 2006. Thepredecessor firm also made loans to PE-owned middle-market companies. It was acquiredby Olympus Partners in 2010 and The Carlyle Group in 2011.Team OverviewChurchill was integrated with Nuveen’s middle-market private capital division in 2020. Thedivision comprises more than 75 investment professionals who make senior loans, juniorloans or equity investments in PE-owned companies or PE funds. As a senior lendingstrategy, the fund will primarily be managed by the senior lending team, which comprisesabout 25 investment professionals. The fund’s investment decisions will be made by aninvestment committee comprising Ken Kencel (CEO/co-founder of CF), Randy Schwimmer(Head of Origination/co-founder of CF), Christopher Cox (Chief Risk Officer/co-founder ofCF), Mathew Linett (Head of Underwriting and Portfolio Management/joined in 2015) andShai Vichness (CFO, joined in 2018).Strategy OverviewChurchill Middle Market Senior Loan Fund III, LP (the Fund) will primarily invest in senior loans to PE-owned U.S. middle market companies with $10-100 million in EBITDA, which we classify as a core middle-market strategy. The portfolio is expected to include 50-100 portfolio companies, which we consider a common level of diversification in this category. Churchill’s investment process follows a functional-specialist model. This model is expected to increase process consistency but can result in more touchpoints for PE sponsors, which can reduce deal flow relative to the cradle-to-grave model. The firm’s origination and capital markets team seeks to source deal flow from leading PE firms across the U.S. Opportunities identified are underwritten by a separate underwriting and portfolio management team.The Fund is expected to focus on stable companies in non-cyclical industries that have strong management teams, customer diversification and competitive advantages. The strategy of which it will be a part has historically lent an average of 4.3x debt/EBITDA for senior loans made between 2015 and March 2020. This is on the conservative side of the 4.0-5.0x range that we typical for a middle-market senior loan. The loans in which the fund will invest tend to have 2-10 co-lenders. This “club loan” structure may allow for more holdings with less capital, increasing diversification, but tends to lead to investing in loans originated by other firms more often. That may cause the Fund to earn lower origination and similar fees than it could have on loans it originated.ExpectationsThe Fund will seek a 9-10% net IRR. We think this return target is achievable. We consider net IRR targets of 10-12% more common for products of the style discussed in the Strategy Overview that use up to 2.0x debt/equity fund-level leverage, which is on the upper end of the 0.0-2.5x range we have observed for senior direct lending funds.At present, credit spreads are wider than normal, a benefit that we and Churchill expect to be temporary. After stress eases, underlying loans are expected to have coupons of 4-6% over the greater of LIBOR (currently about 0.25%) or a loan-specific LIBOR floor (currently about 1.00%), with additional potential return coming from original issue discounts and prepayment premiums for loans repaid early, and deductions from return for credit losses. The Fund is expected to borrow debt of up to twice the amount of its equity (two-to-one leverage) using one or more bank credit facilities. Churchill expects the cost of long-term financing to be 2.75% over LIBOR.Points to ConsiderThe loan-level track record Churchill shared with us began in June 2015. Annualized credit losses through March 31, 2020 were 0.2%. This is better than the 0.5% we consider typical in the category, but investors should be aware that credit conditions were generally benign during that period. A major dislocation could affect the firm’s historical credit-loss rate.From June 2015 through March 2020, Churchill invested $9.0 billion in 228 companies. Those transactions earned a since-inception unlevered gross IRR of 5.2%, which we consider low. However, of those investments, 142 (62%) were unrealized at the end of March. Consequently, lower valuations at the end of March, which coincided with a decline in loan prices, are likely to have had a larger than normal effect on the IRR.Churchill managed two prior PE-style funds in the 2016 and 2018 vintage years. The 2016 fund earned a 5.4% net IRR through March 31, 2020, which was below the 6.1% median for direct lending funds in that vintage year as of the same date, according to Preqin. The 2018 fund is too new to be meaningfully benchmarked.Increasing AUM may cause the team to be less selective. Churchill originates more than $3 billion annually, which is more than double its pace when the prior fund was raised. Churchill closed on or committed to 6% of about 700 opportunities identified in the 12-month period ended June 30, 2020. The closing rate is within the 4-8% range we consider typical for established direct-lending firms, but the opportunities seen are on the lower end, implying that Churchill may need to identify more opportunities to stay selective.The Fund will assess a management fee of 0.50% on gross assets, which we consider low. The fee is assessed on assets bought using debt as well as equity, which would result in a 1.50% management fee as a percentage of equity at its targeted 2.0x debt/equity leverage.Recommendation SummaryThe product offers the opportunity to invest with an experienced team at a relativelylow cost. Churchill’s focus on keeping leverage low and lending to stable, PE-owned companies reduces risk. Leverage enables the strategy to offer attractive total returns.The strategy complements the other middle market manager we have approvedin the space (e.g. lower revenue, no PE sponsor).
33Deerpath Capital Management – Deerpath Capital (Advantage) VFirm OverviewDeerpath was founded in 2007 by president James Kirby, principal John Fitzgibbons andchairman Gary Wendt, who comprise its management committee and are the firm’sprincipals. The firm manages $1.3 billion in a single strategy. It launched its first fund in 2008and funded its first loan in May 2009. Since inception, the firm has grown from a sole officeof seven people in New York to comprise 40 professionals in five offices: New York,Chicago, Boston, Los Angeles and Fort Lauderdale. Messrs. Kirby, Fitzgibbons and Wendtor trusts they or their respective families control own 40%, 30% and 20% of the firm,respectively. Partner and investment team head Tas Hasan owns the remaining 10%.Team OverviewDeerpath comprises 40 professionals. The three co-founding principals are its managementteam, which leads its business operations. Under the management team’s oversight are aninvestment team of 15 professionals, a finance & operations team of 17 professionals andfive marketing professionals. Deerpath’s investment decisions are made by a five-memberinvestment committee (IC). Messrs. Kirby, Wendt, Fitzgibbons and Hasan are permanentmembers of the IC. The fifth seat is held by a rotating managing director on the investmentteam. Actions are decided by a simple majority of the investment committee, which mustinclude a majority of the three principals.Strategy OverviewThe strategy primarily makes first-lien, senior-secured loans of $10-40 million to lowermiddle-market, private equity (PE)-owned U.S. companies with $5-15 million in EBITDA andtotal enterprise values of $35-75 million. We consider the strategy a conservative option dueto its focus on low leverage relative to borrowers’ enterprise values and cash flow, as well asits emphasis on companies whose owners Deerpath expects to provide support duringadverse circumstances. The funds are expected to invest in 75-100 companies.Functions within the investment process are primarily carried out in a “cradle-to-grave”format, wherein the same deal team that originates lending opportunities underwrites,monitors and, when necessary, works out troubled loans. The size and five diverse locationsof the origination effort help Deerpath to originate investment opportunities from PEsponsors, banks and existing portfolio companies located around the U.S. The team seesabout 1,500 opportunities annually, of which they seek to invest in about 30 (2%). Weusually see close rates of about 4% for established direct lenders, which suggests Deerpathis particularly selective. Deal teams are selected by the IC when origination opportunities areconsidered worthy of underwriting. The firm conducts quality of earnings reviewsindependently from PE sponsors and develops its own opinion of the prospective borrower’senterprise value. The typical portfolio company has 15 years of operating history. The firmtypically lends 3.0-4.0x EBITDA, which is 0.5-1.0x less than we typically see for directlending strategies and aims to lend less than 50% of the borrower’s enterprise value. Thismay provide protection when cash flow declines or PE firms pay multiples that are toogenerous. Monitoring is supported by the firm’s deep finance and operations team, whichcollects monthly financial statements from every portfolio company. Troubled portfoliocompanies are added to a watch list and head of portfolio management Mauricio Reyes isadded to their deal teams. Credit workouts are implemented by the deal team but thedecisions are made by the IC, with Messrs. Reyes, Kirby and Hasan serving as liaisons.ExpectationsDeerpath Capital V will target a net IRR of 6-9%. Deerpath Capital Advantage V (US) andDeerpath Capital Advantage V (Cayman) are expected to add 2x debt/limited-partner equityleverage to target a net IRR of 10-15%. We think each fund’s net return target is achievable.The strategy’s focus on lower middle-market companies adds to its targeted return versusthose focused on larger capitalization ranges, while its focus on conservatively levered, PE-owned companies detracts from both expected return and expected risk.Deerpath targets gross IRRs of about 10% from its underlying loans, comprising coupons ofabout 6% over one- or three-month LIBOR and one-time fees of 2.0-2.5%, with the potentialfor additional fees for loan modifications or default charges. The Advantage funds areexpected to issue debt in the collateralized loan obligation (CLO) market. We expect thecost of their leverage to be 2-3% over LIBOR at current interest rates. Net of that, we think itis reasonable to expect the Advantage funds to earn 4-6% more than the unlevered loanportfolio. The Cayman fund is intended to limit UBTI and ECI; we expect it to underperformAdvantage V (US) by at least 0.3% due to the implications for its investment process.Points to ConsiderWe think there is key-person risk in James Kirby, 52. While they are both active in twice-weekly IC meetings, co-founders Gary Wendt, 77, and John Fitzgibbons, 50, only spendabout one-third of their business time on Deerpath. In the unlikely event that Mr. Kirby wereto leave or become incapacitated, we would expect Tas Hasan to provide day-to-dayleadership and stability.As the firm grows, its professionals are expected to gradually transition from the “cradle-to-grave” coverage model to a function-based structure with specialists in origination,underwriting, monitoring and credit workouts. The latter structure may allow for greaterprocess consistency and skill specialization as the team’s size increases. However, thistransition could affect deal flow if it is not handled well.Deerpath will administer the funds internally and charge them for these services. We expectthese costs to be 0.3-0.4% of invested capital. We think that internal administration providesan incremental benefit by allowing the team to directly observe changes in portfoliocompanies’ financial performance relative to their business plans, which may protect capitalby enabling quicker responses when credit workouts are needed. Deerpath’s statedmanagement fee (1.0%) plus the amount we anticipate for fund administration is less thanthe 1.5% average management fee Preqin reports for peers.Recommendation SummaryWe recommend the strategy as a diversifying allocation in a private debt portfolio. Its focuson lower middle-market companies may complement exposure to senior direct lendingstrategies focused on the larger core or upper middle-market. As a conservatively managedstrategy, it may also serve as a lower risk diversifier to complement more aggressivestrategies such as distressed debt, mezzanine or lending to non-PE-owned borrowers.
34Firm OverviewGolub Capital was founded in 1994 by Lawrence Golub to provide loans to small to medium-size private companies. The firm is a recognized leader in the middle-market lending spacewith one of the longest track records and more than $30 billion in AUM as of June 30, 2020.In addition, the firm manages several business development companies (BDCs) that arepublicly traded (NASDAQ:GBDC, GCIC). Golub employs more than 500 professionals,including more than 100 that are focused on the investment process, with offices in NewYork, Chicago, Charlotte and San Francisco.Team OverviewGolub’s middle-market lending team is managed by a four-member team consisting ofLawrence Golub, David Golub, Andrew Steuerman and Gregory Cashman. Steuerman andCashman serve as the day-to-day PMs of the strategy with support from Golub’s team ofloan originators and credit underwriters. Steuerman has served as Head of Golub’s middlemarket and late stage lending programs since 2004. Prior to his arrival, he was a ManagingDirector at Albion Alliance where he originated and supervised subordinated debt and equityinvestments for two private partnerships. Cashman joined Golub in 1996 and serves as amember of the firm’s Investment and Watchlist Committees.Strategy OverviewGolub originates senior-secured loans to middle-market companies located primarily in theUnited States. The strategy seeks to use Golub’s sourcing and underwriting capabilities tolimit credit losses and provide investors with high single digit to low-teen net IRRs. Theunderlying GCP Limited portfolio is broadly diversified with more than 400 loans that arediverse in terms of size, company industry, geography and asset type. The team targetscompanies with EBITDA between $10 million and $100 million and revenues between $25million and$250 million. Historically, Golub has focused on private equity sponsor-backedloans based on the belief that the sponsor provides an added layer of due diligence.The team has two key differentiators: sourcing and underwriting. The origination team atGolub is deep and averages more than 10 years of experience. The team has developedsignificant industry relationships which act as the primary source of deal flow. As evidence,Golub derived more than 75% of new deal flow from repeat business since 2012. Thebenefit to both Golub and the sponsors is a deeper level of understanding about thecompany and their business which facilitates better pricing and faster underwriting. Forunderwriting, Golub employs a rigorous fundamental approach to underwriting loans that isdesigned to identify borrowers with low probability of default. The process begins with a “pre-screen” of the transaction details and offering memorandum. The team will screen on theborrower’s financial statements, historical operating results, management, competitiveadvantages in order to formulate a viewpoint and identify potential risks. The output is aninitial screening memorandum with a go/no-go decision for underwriting. The team thendevelops a detailed diligence plan which can include detailed financial models, industryresearch and analysis, management presentations and onsite due diligence. If the initialmeetings and due diligence calls are positive, the next step would be to express interest tothe sponsors in the form of a preliminary term sheet which is subject to review and approvalby the investment committee. Investment committee members are given the opportunity tovet and debate the merits of the transaction. After approval from the committee, acommitment letter is prepared outlining thetransaction including terms and fees.ExpectationsGolub targets an IRR between 10% and 13% on a levered basis, net of fees. Previousiterations of the strategy have delivered inception-to-date IRRs consistent with expectationsbeginning with GCP IV incepted in 2004. The conservative nature in which the investmentteam sources and underwrites loans, in addition to the cash flow predictability from the poolof performing loans, should result in lagged performance in rising interest rate markets.Conversely, given the structure of the underlying pool of loans, we would expect the strategyto protect to the downside during market dislocations compared to similar sequential fundsthat invest in recently issued loans that tend to suffer in those environments.Points to ConsiderGrowth in the middle-market lending space has been exponential in recent years and Golubis no exception to the rule. Firm AUM has grown from nearly $10 billion in 2013 to more than$30 billion. Capital raising continues to be on a torrid pace with more than $100 billionhaving been raised for private credit strategies during the previous eight years endingDecember 2017. Industrywide AUM totaled more than $650 billion as of December 2017, upmore than 200% over the previous 10-year period. In looking at Golub’s performance, therehas been some slight degradation in IRRs in recent funds within the series. Given thesethings, it is reasonable to expect that managers may increasingly face headwinds inachieving their stated performance objectives.The Golub Middle Market Lending Team has experienced 11 departures of investmentprofessionals at the VP level or above over the past five years: three managing directors,four senior VPs, two VPs and two Principals. Four of the departures were a result of industrycoverage realignments within the investment team. The remaining departures were due toopportunities with competitors. It is not uncommon to see the frequency of departuresexperienced at Golub or other similar large teams. We remain comforted by the fact thatSteuerman and the senior leaders of the underwriting remain. Should any of those seniorprofessionals depart, we would be forced to reevaluate our recommendation.Recommendation SummaryWe recommend GCP 12 to clients as a higher quality, differentiated approach within thecrowded direct lending space. With more than $30 billion invested in a mix of public andprivate loans, and a track record dating back to 1994, Golub is one of the largest andexperienced managers in the space. As a result of Golub’s scale and depth of knowledge,the team of experienced originators and credit underwriters have developed significantindustry contacts which allow them to source a majority of new loans issued from pre-existing sponsors. As a result of the firm’s familiarity with the sponsor, underwriting andfunding times are shortened which can result in more competitive pricing and beneficialterms. The key differentiator for the strategy is the unique structure which invests in a pooledvehicle that holds the loans. This approach provides investors with immediate exposure tothe pool of performing loans while diversifying default risk.GC Advisors – Golub Capital Partners 12
35Glossary
36Alternative Investments: Broadly, investments in assets or funds whose returns are generated through something other than long positions in public equity or debt. Generally includes private equity, private debt, real estate, and hedge funds.Bankruptcy: One of several federal court procedures that debtors may invoke to protect them from their creditors.Broadly Syndicated Loans (BSLs): Senior term loans that are held by a large or potentially large group of investors. BSLs are originated by an agent bank who assigns participations in the loan to a group of investors (a “syndicate”) in a manner similar to the initial public offering for a stock. There is an established secondary market for BSLs, which allows them to be held in more liquid vehicles such as mutual funds. BSLs are also commonly called “bank loans.”Buyouts: Investments made to acquire majority or control positions in businesses purchased from or spun out of public or private companies, or purchased from existing management/shareholders public equity shareholders in “going private” transactions, private equity funds or other investors seeking liquidity for their privately –held investments. Buyouts are generally achieved with both equity and debt. Examples of various types of buyouts include: small, middle market, large cap, and growth.Carried Interest: Also known as “carry” or “promote.” A performance bonus for the GP based on profits generated by the fund. Typically, a fund must return a portion of the capital contributed by LPs plus any preferred return before the GP can share in the profits of the fund. The GP will then receive a percentage of the profits of the fund (typically 15.0-20.0%). For tax purposes, both carried interest and profit distributions to LPs are typically categorized as a capital gain rather than ordinary income.Capital Commitment: The total out-of-pocket amount of capital an investor commits to invest over the life of the fund. This commitment is generally set forth on an investor’s subscription agreement during fundraising and is accepted by the GP as part of the “closing” of the fund.Catch–up: A clause in the agreement between the GP and the LPs of a fund. Once the LPs have received a certain portion of their expected return, often up to the level of the preferred return, the GP is entitled to receive a majority of the profits (typically 50.0%-100.0%) until the GP reaches the carried interest split previously agreed.Co-investments: Investment made directly into a company alongside a General Partner’s investment, rather than indirectly through a fund.Covenant: A condition in a corporate loan agreement that requires the borrower to fulfill certain conditions (“maintenance covenant”) or prohibits the borrower from undertaking certain actions (“incurrence covenant”).Covenant-Lite:A loan that does not have any maintenance covenants. The term’s spelling is by industry convention.Creditor: The lender of a loan, who gives one or more debtors money in advance in exchange for later payments of principal and/or interest.Debtor:The borrower of a loan, who receives money from one or more creditors in advance in exchange for later payments of principal and/or interest.Default:This occurs when the borrower does not meet the terms to which it committed in a loan agreement. Default can occur from failingto meet covenant conditions as well as failing to make principal or interest payments.Glossary
37Distressed Debt:Strategies that purchase the debt of companies that are troubled, have defaulted, are on the verge of default, or are seekingbankruptcy protection. Investors have been referred to as “vultures” as they pick the bones of troubled companies. Investment structures of focus include subordinated debt, junk bonds, bank loans, and obligations to suppliers.Distribution: When an investment by a fund is fully or partially realized, the proceeds of the realizations may be distributed to the investors. These proceeds may consist of cash, or, to a lesser extent, securities.Dry Powder: Capital that has been committed to a limited partnership and has not yet been called or may be called again (“recycled”).EBITDA: A measure of annual corporate cash flow defined as earnings before interest, taxes, depreciation and amortization. This measure of annual cash flow is intended to make comparisons between different industries more relevant. Multiples of EBITDA are a generally accepted method for valuing private companies and describing the amount of leverage in direct lending.Efficient Frontier:The set of portfolios that maximizes the expected rate of return at each level of portfolio risk.Fair Value: An estimate of the price at which an unrelated buyer and seller would exchange an asset in an arms-length transaction. For a publicly traded asset, fair value may be observed based on recent trades in the market. For assets that are traded less frequently or not at all, the value of an asset is often estimated by forecasting its future cash flows and discounting them based on assumed discount rates.General Partner (GP):A class of partner in a partnership. The GP makes the decisions on behalf of the partnership and retains liability for the actions of the partnership. In the private equity industry, the GP is solely responsible for the management and operations of the investment fund while the LPs are passive investors, typically consisting of institutions and high net worth individuals. The GP earns a percentage of profits.Gross Assets:The fair value of all the partnership’s holdings, including those funded using limited-partner equity and leverage.Insolvency: The state of not being able to pay amounts owed. This can result from not having enough assets to meet the borrower’s commitments or not having enough liquidity.Internal Rate of Return (IRR): The compound interest rate at which a certain amount of capital today would have to accrete to grow to a specific value at a specific time in the future. Basically, it is the average return on capital over the lifetime of the investment. This is the most common standard by which GPs and LPs measure the performance of their private debt portfolios and portfolio companies over the life of the investment. IRRs are calculated on either a net (i.e., including fees and carry) or gross (i.e., not including fees and carry) basis. J-Curve:The IRR of a private investment plotted versus time. The J-curve refers to the fact that net IRRs in the early years of a fund are generally negative, dominated by drawdowns for fees and investments. As investments accrete in values and are gradually liquidated, returning capital and profits, the fund works through the J-curve and begins to show positive IRRs and multiples of investors’ capital.Leverage:The use of debt to acquire assets, build operations and increase revenues. By using debt (in either the original acquisition ofthe company or subsequent add-on acquisitions), investors attempt to achieve investment returns beyond which they could achieve using equity capital alone. Increasing leverage on a company also increases the risk that assets and revenues will not increase sufficiently to generate enough net income and cash flow to service the increased debt load.Glossary
38Leveraged Buyout (LBO):The purchase of a company or a business unit of a company by an outside investor using mostly borrowed capital.Limited Partner (LP):A passive investor in a Limited Partnership. The General Partner (GP) is liable for the actions of the partnership, while theLPs are generally protected from legal actions and any losses beyond their original investment. The LPs receive income, capital gains and tax benefits.Loan-to-Value (LTV): The ratio of a loan’s balance to the value of the collateral that secures it. This is often used in asset-based lending.Management Fee:A fee paid to the Investment Manager for its services. For a senior direct lending strategy, the fee is generally assessed ongross assets, including assets purchased using leverage. Other types of private debt tend to have more variation in the denominator against which they assess fees, such as assessments based on the partnership’s aggregate committed capital.Mezzanine: An unsecured debt instrument that is subordinated to the senior debt in a company but ranking senior to any equity claims. The instrument may include equity features such as warrants or options.Middle-Market: Companies with $10.0-100.0 million in annual cash flow (EBITDA), which are generally considered established but not large enough to issue publicly traded debt. The middle market is segmented into lower, core and upper capitalization ranges. We typically see the lower middle-market defined as companies with $10.0-25.0 million in EBITDA, the core middle market defined as companies with $25.0-75.0 million in EBITDA and the upper middle-market defined as companies with more than $75.0 million in EBITDA.Multiple of Invested Capital (MOIC):The total return on an investment as measured by (Total Money Out)/(Total Money In). Multiple of cost and IRR are the two most common measures of performance in private equity-style Limited Partnerships.Net Asset Value (NAV):The value given by deducting an entity’s liabilities from its assets. This can refer to the estimated value available to all investors in a pooled vehicle or the value of a specific limited partner’s investment in it. The amount is different from gross assets because it includes an estimate for what it would cost to pay off the fund’s debt. This distinction is particularly meaningful for levered investments.Payment-in-Kind (PIK):Interest assessed as increases in the principal owed, rather than in cash. When the debtor has the option of paying in cash or PIK, this is called a “PIK toggle.”Preferred Return:The minimum return that the GP needs to achieve in order to receive carried interest. After the cost basis of an investment is returned to the LPs, they will also receive additional proceeds from the investment equal to a stated percentage, often 6.0-8.0%. Once the preferred return is paid, then the GP will be entitled to its carried interest on all profits realized from the investment in excess of zero (i.e. not limited to the portion above the preferred return).Private Equity: May refer to the non-exchange-listed common equity of a corporation or a set of investment strategies that generally invest in that type of asset. Since such investments are illiquid, investors must be prepared for investment horizons from 5.0 to 10.0 years.S&P/LSTA U.S. Leveraged Loan Index:A market-weighted index intended to track the performance of tradeable U.S. broadly syndicated loans (“bank loans”). The index represents a partnership of Standard & Poor’s (S&P) and the Loan Syndications and Trading Association (LSTA).Glossary
39Senior: Higher priority than other claims on the borrower’s assets. All else held equal, senior claims should receive higher recoveries in restructurings than subordinated claims.Special Situations: Strategies that flexibly invest in companies that are in complex, less understood and/or troubled circumstances. Subordination: Lower in priority than a more senior claim on the borrower’s assets. All else held equal, subordinated claims should receive lower recoveries in restructurings than more senior claims.Vintage Year:The year in which a private fund had its final closing.Glossary
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