A Canadian flag waves in the financial district in Toronto.Mark Blinch/The Globe and Mail
The hunt for higher returns is luring more investors to the private debt space, prompting an increase in Canadian firms and funds that can do this specialized lending.
Connor, Clark & Lunn Financial Group Ltd. is the latest to add such a team. The Toronto-based asset manager is set to announce Thursday that it will launch a private lending arm through a new partnership with MidStar Capital Corp.
Midstar, formed by four leveraged-finance specialists formerly of GE Capital, will underwrite and manage loans to mid-sized Canadian companies that are doing deals, looking to grow or need to refinance their existing debts.
The private loan market, where borrowers and lenders work directly outside the publicly-traded debt market, has changed rapidly around the world since the financial crisis. This was driven in large part by new regulations and capital requirements, which caused banks to exit the space, particularly in the U.S. and in Europe. That has made room for new entrants.
At the same time, institutional investors such as pension funds, sovereign wealth funds and others have been looking to invest in alternative assets that offer higher returns. Combined, these two trends have led to a wave of new private lenders.
"There's a growth and acceptance of private debt as an alternative, and that's being driven by the U.S.," said Tanya Taggart, managing director of MidStar Capital. "So I think people are are much more aware of it as an alternative asset class than they once were."
In Canada, the market is less developed. TD Asset Management Inc., which launched two private debt funds last year, says about $8-billion in investment-grade private market loans come to market annually. TD identifies private loans designed to complement institutional investors' existing fixed income portfolios, targeting projects such as renewable energy and public infrastructure that come with less risk. That differs from strategies that pay a higher yield in return for added risk, such as those targeting the mid-market, distressed debt, or stressed European banks.
Bruce MacKinnon, head of private investments at TD Asset Management, agrees that institutional investors such as pension funds are becoming more aware of the private debt asset class.
"They're kind of early days in the process of understanding how it fits within their portfolio. They've certainly started to go down the road of alternatives... where they focused on infrastructure equity and other real estate strategies," he said, adding that investors must also decide how much risk they are willing to take.
TD's funds have $1-billion in commitments to invest across North America, and the managers have already made about $360-million in loans since launching in 2016.
Private lending comes in many forms, but investors can generally expect less liquidity in the private debt market than public bonds, and sometimes less disclosure. And borrowers can expect to give lenders more control, often being subjected to stricter contracts and reporting requirements.
Ms. Taggart said that when GE Capital was at its largest, its designation as a Systemically Important Financial Institution (SIFI) in the U.S. limited the different types of loans it could offer in Canada. GE Capital, an arm of industrial giant General Electric Co., sold its leveraged finance business to Wells Fargo in 2015 amid an international effort to unload $200-billion in assets and create a smaller, simpler organization without the SIFI label.
"When we were regulated we had to pull back, but the demand existed from our borrowers," Ms. Taggart said. "We saw it was being filled by U.S. companies, which made it difficult for Canadian borrowers, because their funding had to largely be in U.S. dollars. Yet their sales and revenues were all in Canadian."
CC&L and TD's move into the private debt space follows other Canadian players. CPPIB bought GE's lending arm Antares Capital in 2015 and it has done more than $120-billion (U.S.) in financing over the past five years, particularly for middle-market private equity-backed transactions.
In November of 2016, the pension fund sold 16 per cent of Antares to Toronto's Northleaf Capital Partners, the former private equity arm of TD Bank, which was also looking to expand its asset management business after moving into infrastructure investing.
Stuart Waugh, managing partner at Northleaf, said at the time of the deal that investors in his fund had asked about investment opportunities in private credit for months. "They see what the larger players are doing and are really looking for alternatives to what they can get in the traditional fixed income market," he said.
Ms. Taggart's team had been part of the sister company to Antares in GE Capital's leveraged finance group, targeting private lending to companies not backed by private-equity. It was a smaller group, originating $15-billion in loans over 10 years in Canada.
Ms. Taggart said the team will aim for a five-year goal of $500-million in assets under management with CC&L. They'll be targeting the same borrowers as they did working at GE -- companies with positive cash flow and enterprise value of more than $25-million. High net worth investors will be able to invest in private debt through their portfolios with CC&L. Once the portfolio is up and running, returns are expected to be 7 per cent to 9 per cent per year.
"Typically where private debt or leveraged lending plays well is event-driven situations where there is an acquisition, refinancing, or a dividend [recapitalization]," Ms. Taggart said. "Those are situations where a little bit of more structured capital is very helpful to the borrower."