Senior Loans: Why Investors Should Stay Focused On Stable Industries

Private loans have been a success story for institutional investors over the last decade with the asset class growing steadily and providing strong risk-adjusted performance.

The asset class has grown by more than 200% over the last 10 years and shows few signs of slowing.


However, higher interest rates create a risk of higher default rates, in a challenging economic environment, emphasizing the importance of a conservative approach to portfolio construction.

Part of this conservative approach, according to MV Credit, one of the independent affiliates of Natixis Investment Managers, should be a focus on long-term factors such as Environmental Social and Governance and an emphasis on larger companies which typically are more resilient and provide better management information systems.

Market conditions are positive for senior loans

Until recently, the private credit market was borrower friendly. This changed in early 2021 as global inflation picked up and interest rates followed suit. Power has shifted back towards investors, says Murtaza Merchant, managing partner of MV Credit, which invests in European private equity-backed, mid-cap companies.

“Lower leverage, higher yields and the resulting risk profile mean 2023-2024 vintages are likely to be very strong in both credit quality and return profile,” says Merchant.

Although investors have regained some power in the market, they have to contend with lower issuance overall as the M&A activity takes a pause amid higher rates. Equity owners are facing lower multiples at exit, so some are waiting on the sidelines for market conditions to improve.

This brings into perspective the relative experience of credit managers in sourcing investment opportunities. “If you have a large number of relationships with sponsors forged over many years, this undoubtedly helps with origination in times like this,” Merchant says.

In addition, credit managers with resilient private equity-owned portfolio companies looking to consolidate their markets or finance expansion plans will be well positioned to provide them with the corresponding incremental financing.

On a 12-24-month view, loan origination is likely to regain momentum amid a wave of maturing loans and an overwhelming volume of private equity dry powder.

There was some $1.266 trillion of sponsor dry powder at June 2023, and a wall of maturing loans from 2025 onwards that will require refinancing. These drivers are likely to ignite the origination pipeline.



A cautious approach is better suited to a higher rate environment

The higher interest rate environment has not yet led to an uptick in defaults, but investors should be wary. Central to MV Credit’s strategy, is the focus on conservative and cautious portfolios and has a 0.0% loss rate across its senior track record since the firm’s inception in 2000¹.

“A long track record and experience of multiple economic cycles is helpful in times like these,” says Merchant. “Default rates are likely to increase and we will see differentiation between credit managers.”

Covid was a notable test of credit resilience. MV Credit supported a number of portfolio companies through the pandemic, including a healthcare company which had a temporary dip in performance at the onset of covid as all surgeries globally were impacted.  The healthcare company was recently successfully divested by its private equity sponsor. Merchant says: “This shows the importance of commitment in lending – you help companies and their private equity owners through tough times to promote recovery which in turn creates a successful outcome.”

MV Credit’s default position is to be prepared for adverse macro events by focusing on stable sectors such as healthcare and IT software, which often have subscription-based repeatable revenues.

A typical strategy focused on senior secured debt would have a highly-diversified portfolio containing around 50 companies across carefully chosen industry sectors. François Decoeur, Chief Credit Officer, says: “We strive to ensure no single position has a disproportionate impact if things go wrong.”

Investing in larger mid-caps provides a further degree of security – MV Credit’s portfolio companies have typical Ebitda of €30m-€100m. Larger companies often have higher credit quality, with revenues diversified geographically across Europe or globally, and diversified by product type too. Larger balance sheets help these companies to absorb shocks more comfortably.

In addition, larger companies tend to have more robust corporate structures and governance and are therefore more likely to provide the level of information investors require to assess ongoing performance.

Non-financial analysis is a key element of a conservatively-managed portfolio

A conservative approach entails sound analysis of non-financial risk. MV Credit has incorporated ESG in its portfolios since its inception in 2000. Since then, its ESG analysis has undergone formalisation and is performed on all its investments – examining the policies of sponsors, assessing governance and diversity and screening for regulatory and legal breaches.

Where MV Credit differs from most other debt investors is that its recent flagship strategy ties its ESG performance directly to compensation. The MV Credit team is only entitled to the full carried interest when all ESG key performance indicators (KPIs) are met. If none are met, only half of the carried interest is due.

“We think we were one of the first in the market to implement something like this and it shows we put our money with our mouth is, so to speak,” says Decoeur. “It shows commitment to ESG principles and alignment with the ESG policies of our investors.”

DNA doesn’t change, but opportunities do

While its investment approach is consistent – and the way it analyses financial and non-financial risks has remained broadly the same for nearly a quarter century – MV Credit regularly updates its views on the market.

“We don’t play the cycles, and we remain focused on non-cyclical companies, but we are very much alive to structural market change,” says Decoeur.

This has led MV Credit to focus on healthcare and information technology/software companies with business-to-business models and a subscription-based client base with recurring revenues. “Despite the strong rally in tech stocks over recent years, we think there will be still more demand for IT and more growth,” says Decoeur. “We are also looking at AI with interest. AI is not just about new businesses, but its potential impact on existing portfolio companies, both positive and negative.”

Other evolutions of MV Credit’s approach include taking part in club deals to allow it to participate in larger transactions. “There is more collaboration in the mid-market now as sponsors seek multiple lenders in their financing package, and this can allow us to further diversify and improve our risk-return profile,” adds Decoeur.

Published in October 2023