The Exchanges

Q What was the attractiveness of doing this at Invesco?

A It starts with big institution. At the time, we were a mere trillion dollar asset manager. Today, we're approaching two. We had a really large private credit platform. The private credit platform had been in existence for 20, 25 years. We were known in the industry. Invesco has great brand recognition, and importantly, the infrastructure was in place. When I thought about what it would take for me to build a successful direct lending platform, one of the key things that I believe you must have is sector expertise. The beauty of this platform that had been built was they had one of the largest private side sector teams in the market. We have 22 dedicated sector research analysts who focus within their dedicated sector on everything today from distressed to liquid to direct. As I thought about coming in, I could build the origination execution team We could leverage off this built-in wealth of knowledge, IP, via existing portfolio companies and experience across all the sectors. I came on board. I brought a handful of my partners from RBS, all of whom are with me today. Great sponsor coverage folks with tremendous credit skills. We put the business in place as if we'd never stopped working together, and we called up all of our old relationships and picked up the business right where we left off.

AI assessment note: “It starts with big institution. At the time, we were a mere trillion dollar”

Q You mentioned that when you came here, there was within Invesco these sector coverage with deep expertise, and you had to build out the origination. How have you built out the sourcing of these opportunities in the private markets?

A First component is I brought with me my three senior partners that I'd worked with for the past 20 years. Between the four of us, we had built Businesses together on banking platforms and non-banking platforms. Not only do we know how to do this, but we had a fairly broad base of core sponsors that we knew we could rely upon. This was the other attractive dynamic as relates to our coming onto the Invesco platform. Across the Invesco private credit platform, we have over twenty five billion dollars of capital invested in the portfolio companies of more than 200 private equity firms. There was already More than just name recognition, tremendous connectivity with a wide swath of private equity firms, many of whom crossed both broadly syndicated and what we were doing in the middle market. In many cases, the name partner at these private equity firms was an associate when we were associates, 25 years ago, so there's history there, and as long as you treat these relationships like partnerships and understand their needs and can address those, you should have an annuity of opportunities across a fairly wide base of them.

AI assessment note: “First component is I brought with me my three senior partners”

Q I'd love to take a step back and talk some about direct lending as an asset class. Hear a lot more about it now. You've been at it really for the whole time. What are some of the things you've seen in changes and evolution of this sub part of the market?

A I often get asked, this is a pretty new asset class. How do you think it's going to perform with the market cycles, things like that? To that, I always say, this is not a new asset class. What has changed is the constituency that provide those capital solutions. If you go back before the GFC, middle market finance was the purview of banks. They dominated it. They were great at it. They had tremendous relationships. Post the GFC, the OCC leveraged lending guidelines came in place, and Basel III was put in place. The intent of those regulations Was to make it more difficult and more expensive for banks to participate in that asset class. So what you saw happen was simply a shift in the providers of that capital from the regulated banking side to the non-regulated private capital providers. The reason for that is when you think about the world we live in today, the volatility in the markets, this is an asset class that across cycles has demonstrated stability, consistency, low default experience. Initially was treated as a nice asset hedge for investors across a, or a liquid portfolio, but as the asset has grown, it's become just a key component in many individuals and many entities' portfolios.

AI assessment note: “what you saw happen was simply a shift in the providers of that capital”

Q So you bring all these forces together, you have to set out an investment strategy. Where did you come out and say, okay, this is a strategy that we're going to pursue here in your building?

A So when I joined Invesco, I put a lot of thought behind this, because when I joined We were in a benign interest rate environment. Skies were blue. Nothing was going wrong. Lenders were being fairly aggressive in terms of how they were approaching opportunities. We looked at the investor base at Invesco. We looked at what Invesco had done across the private credit platform. We decided out of the blocks to skew very much towards the conservative end of direct lending. It starts with structure. Everything we're going to do is going to be senior secure. First lien, Unitrons. Second lien, we're not doing mezzanine. We're gonna be top of the cap stack. We're gonna have our money attached to dollar .1. We're gonna have full collateral, and all the hard assets, all the IP of the businesses we lend to. So structurally, that's how we thought about it. The second piece of it was, we said everything we're gonna do, we're gonna do with private equity. We want partners, folks we know, folks who are putting significant risk capital in these businesses in front of us. That's a way to mitigate risk. And then we thought about, from a sector perspective, myself, my partners, we've spent our careers in the middle market. It didn't even occur to us to think about going up market. This is the market we knew. This is where we knew we could generate compelling returns. So we focused on the middle mar…

AI assessment note: “We decided out of the blocks to skew very much towards the conservative end”

Q If you look at the universe of sponsored companies and industrial companies that are known by a private equity sponsor, what are some of the subtle differences between the two?

A Today, at least 70% of all direct lending is sponsored. Why is that, and what are the differences? Well, sponsored by its nature means you're working with a private equity firm, a private equity sponsor, and the attraction of doing deals with private equity sponsors is, number one, they bring governance, they bring sector expertise, they bring best practices, and most importantly, they invest significant sums of equity in these businesses in front of your Debt. Typically, loaned values today are running in the mid-forties. If you're aligning with some of whom you think are the smarter private equity investors in the U.S., and you're lending senior secured debt, they're providing more than half the value of these businesses in first loss equity. And so, when you think about it from a risk perspective, things have to go pretty bad before your senior secured loan starts to be at risk for being impaired. And typically, what happens when you work with a sponsor, if a company does Have some type of operating performance challenges. Unless these are truly dynamics where the business is permanently impaired, your sponsor is going to come up with a solution because they've got to protect their significant investment. Now you contrast that with a non-sponsor deal. Typically there you're dealing with private companies, family owned businesses. There is no equity coming in beneath you. The…

AI assessment note: “Now you contrast that with a non-sponsor deal. Typically there you're dealing with private companies”

Q What are some examples of things that you thought were going to be a deal you're going to be happy to lend to, and you found something that had it fall away?

A Typically, when you start a process, you'll get a SIM, a document that sells you on the deal. It's written by a sell-side banker, so it's generally pretty positive. You'll look at this business and you'll see, you know, revenue grew nicely, and EBITDA grew nicely, and The ask on leverage is pretty conservative, and you start out thinking this could be a really nice business. Most often, where we walk away from something, there's this thing called quality of earnings, which is, there are all sorts of adjustments that go into EBITDA. I'll pick the gym business as an example. If a sponsor's buying a gym, they will ask, when we first break ground on a box, we spend money on it, we may want pro forma adjustments to reflect the EBITDA of that box When it becomes mature. And we say, well, that's great, but today it's doing zero. As we go through our diligence process and we go through the quality of earnings, you start looking at all the adjustments. This is what they're telling you EBITDA is what was EBITDA. And then it's always a primary discussion for us in any of our credit meetings. What do the adjustments look like? And all too often what you discover is the actual EBITDA is materially less than what's being portrayed. And sometimes those adjustments are legitimate, but other times they're not. Most often, We'll look at something and optically it'll look great, but when we start…

AI assessment note: “I'll pick the gym business as an example. If a sponsor's buying a gym”

Q How have you thought about leverage on the funds?

A Leverage is a really interesting element in the direct lending space. To some extent, it's driven by investor risk tolerance. We have some investors that very early on said, look, we don't want leverage on the vehicles. And part of the thinking was you're in the double digits. That's all we need. We don't want to take the incremental risk associated with adding leverage on top of these vehicles. And then we have other vehicles and other investors that have asked for leverage. Across all of our vehicles, even where we have leverage, we tend to be more conservative. We won't put more than a turn of leverage on a vehicle. And you will see some direct lenders go as high as two turns of leverage on their vehicles. And I don't think it's a bad strategy. A turn of leverage will generally afford you somewhere in the neighborhood of 300 basis points plus of incremental yield. So it's not inconsequential. Of course, the problem with leverage is the obvious one. If things go wrong, you've leveraged the negative. We look to our investors, some want it, and we're happy to provide it, and many don't. I don't worry about it in the context of our portfolios, because I know what's in those portfolios, I know how we're selecting those assets, but the investor drives that decision and will accommodate them either way, whether they want it or not.

AI assessment note: “Across all of our vehicles, even where we have leverage, we tend to be more conservative.”

Q Why don't you take me back to your very first job?

A When I graduated college, I went to work as a systems engineer for a company called Electronic Data Systems. EDS was Ross Perot's company. It was a technology company that provided IT facilities management and business process outsourcing to companies across a wide variety of industry sectors. And the model was one where you co-located with your clients. So when I got out of the Systems Engineer Training Program, I was positioned at a regional bank on the East Coast. By the end of three years, what I'd figured out is I was much more interested in the finance side than I was the technology side, and so I decided to try to make a change. But without the benefit of traditional finance training prior to that, it was very difficult to move into investment banking, so I decided to go back and get an MBA. And at the time, the two best schools, if you wanted to focus on finance, were Wharton and the University of Chicago. I was fortunate enough to have the opportunity between the two, and I decided to go to the University of Chicago. I absolutely loved it there. You got to study with legends in finance, guys like Merton Miller and Eugene Fommer. These were the guys who actually wrote corporate finance theory. I had a great two years there, and then when I graduated, I got a job at Chase Manhattan Bank in the leverage finance business, so I made the transition. But while I was in the tr…

AI assessment note: “When I graduated college, I went to work as a systems engineer for Electronic Data Systems”

Q How do you think about capital solutions for the middle market businesses? On the larger end, you see all different types of financing structures and the large alternative asset managers. You're just focused on the senior secured piece. How's the team thought about, oh, there should be a different risk reward opportunity below that into the equity?

A So we talk a lot about it. Earlier in my career with my partners, we ran mezzanine funds. We did a lot of aggressive equity co-investing. It was somewhat a function of the market. The path we've set ourselves on at Invesco for now certainly is to stick at the top of the cap stack. We look at our investors and we say in the context of your overall portfolio of investments, you should think about us as that very safe, secure, low double digit opportunity. You can tuck it away. You're going to get quarterly distributions from us. You're going to sleep well at night. With respect to what we're doing for you, and we like doing that. Is there an opportunity down the road to play in different parts of the cap stack? Maybe. I think it would really be more a function of what the market opportunity looks like. For example, if we went into a significant recession and you saw valuation start to plummet, maybe there'd be a better opportunity to play at some of the junior capital and take more of the equity upside. But I think in the current environment, sticking to our mandate, which is orienting around capital preservation, being great stewards of our investors' capital is where we're going to focus.

AI assessment note: “The path we've set ourselves on at Invesco for now certainly is to stick at the top”

Q I want to make sure I get a chance to ask you a couple of closing questions. We started with your first paid job at EDS. What'd you learn from that job?

A When you join EDS, the first thing they do is they send you down to Texas for this EDS training program. It's 10 or 12 weeks of really intense training to develop your skills, but the model for that training program is to challenge you from a multitasking perspective, a resource-constrained perspective. You go down there, there were 40 of us in the training program, and you'd have eight hours of classroom training, and then you'd have the equivalent of eight hours of project work to do. It was pretty intense. You'd come into class some mornings, and a seat would be empty, and the instructor would come up to the front of the room, and very matter-of-factly say, you know, so-and-so has been terminated for performance reasons. Over the course of those 10 or 12 weeks, 22 made it through the program. I was reasonably convinced if any day someone was gonna tap me, I was gonna be the next one out the door, but what it taught me was we all underestimate what we're capable of doing when put in challenging environments. To this day, that was probably the most difficult 10 or 12 weeks of my career. I so clearly remember how stressed I was and how difficult it was You come out the other end of it, you feel pretty good about yourself, and you can pretty much take on anything. I learned a lot about myself in that process and what I was capable of.

AI assessment note: “what it taught me was we all underestimate what we're capable of doing”

Q How has the nature of the capital providers and competition changed within that? You have the movement from the banks to asset managers. What's happened in the market for lending among the asset managers?

A Post the GFC, your direct lending for the first 10 years was singularly focused in the middle market. Banks were still doing the large syndicated deals. There was this huge gap in the market to be able to provide capital to middle market sponsors, middle market companies. You started to see capital come in, and it was very successful. If you look at the entities that were dominant in the middle market 10, 15 years ago, They don't play in the middle market anymore. As their AUM, their capital base has grown, deployment pressures become so significant that they've had to find more efficient ways to deploy that capital. The evolution of this market is whereas maybe for the first five, 10 years, it was predominantly focused in the middle market. When we now talk about direct lending, we sort of talk about the core middle market, and we talk about the large end of direct lending. And the large end of direct lending today is probably comprised of eight or 10 huge, very sophisticated lenders. Who are managing massive sums of capital and don't spend any time worrying about the middle market because it just doesn't work for them. And instead, what they've done is they've set their sights on the banks. I remember the first couple of times we would hear about a billion dollar unit tranche. Everybody scratch your head and go, oh my God, how are they going to do that? Today, I mean, you kno…

AI assessment note: “the large end of direct lending today is probably comprised of eight or 10”

Q How do you use all of the data that comes from all these reports from companies across both your portfolio and thinking about what's going on in the markets and opportunities?

A We do a fair amount of analytics and sensitivities across our portfolios. On a quarterly basis, We run all sorts of sensitivities. We look at what's going to happen if interest rates go up, what's going to happen if margins go down. We look at it on a name-by-name basis. We look at it systemically across the portfolio. We also look at all sorts of analytics. What's happening at the top line across the portfolio? What's happening at the margin side? When we sit in front of investors, everybody's got the sound bites of what's going on on the market. We can tell them what we think is happening vis-a-vis our access to the middle market. In many cases, we can sort of front end what we're going to ultimately hear. If something's going to go wrong, we're going to see it earlier, and perhaps we're going to see it across the broader market. The key thing for me on the portfolio management side is you just don't want to get caught by surprises. If you can get out in front of problems, if you can understand where things are going, you have a far better chance of fixing them, putting yourself in a position for a successful outcome.

AI assessment note: “We do a fair amount of analytics and sensitivities across our portfolios.”

Q You've built out this business over the last bunch of years. How do you think about growth where if you raise too much money, you'd almost take yourself out of the mid market where you like playing?

A It's a huge challenge. Throughout my career, it's always been the dynamic. The more successful you are, the more capital you raise, The harder it is to continue within your strategy. Now that said, we have a lot of private equity investors that have been doing this for 25 years, and they have consistently said, look, we could raise more, but we like this segment. We're sticking to the middle market. This is where we've been successful, and this is where we're going to stay. We have a similar philosophy. I don't aspire to go bang heads with the entities that are deploying five, ten billion a quarter. It is a different market. It's not where my expertise lies. It's not where we have fun. It's not where our clients are. We're just going to be really careful and measured about the capital we raise, the capital we deploy. Maybe someday it becomes a problem. I guess it's a high class problem if it happens, but it's not something we're trying to do. One of the terms you'll often hear when you get to a certain size, you become an asset gatherer versus an asset investor. We want to be investors. We like investing. We'd have to raise a whole lot of money before that will be a problem for us. We've got a long road ahead of us in terms of making hay within the middle market.

AI assessment note: “We're just going to be really careful and measured about the capital we raise”

Q What's been your favorite deal that you've worked on?

A I did a deal a handful of years ago. It was a gym business. The sponsor was somebody I'd known for probably 10 or 15 years. We got in a van with the management team, and we literally drove for two days from site to site, and we'd get out, and you'd just watch the interaction. These guys were just incredible. You'd get out, and he'd look at that, you gotta clean the window there, or he'd go in, he'd hug the lead trainer, I hadn't done a gym deal prior to that, and they are really unique animals. The thing about gym businesses, on average, you lose 40 to 50% of your clients every year. What business in the world would you lend to or invest in where half your clients quit every year? But notwithstanding that, when you look at the macro dynamics in the U.S., gym membership grows every year. These guys were just incredible operators, and from start to finish, I was in that business for 10 years through three financings, Through multiple sponsors and including COVID, which was for gym business, not a great environment, but it came through the other side of it perfectly. We actually just exited the business last year. It was sad to see it go, but it went to a large cap direct lending strategy without a covenant. For us, that was sadly the point where we shook hands and we said goodbye, but it was a real fun opportunity.

AI assessment note: “I did a deal a handful of years ago. It was a gym business.”

Q When a sponsor that you have a relationship with is doing a new deal, you have this balance of you want to be accommodative, you want to be relationship. You also want to win the deal in a competitive market. How do you navigate that?

A Competition is a fact of life in our business. So much capital has come into the market, whether you're looking at the middle market, whether you're looking at the upper end of the market, there are a lot of participants and it's competitive. I think there's a subtle difference, though, between the competitive dynamics in the middle market relative to the upper end of the market. If you look at the middle market, the word you'll often hear used is clubby. With maybe the exception of one or two, on every deal we do, we will partner up with one or two other direct lenders. I like doing that for a variety of reasons. We know most of the other middle market direct lenders because we've all been in the business so long. In many cases, we worked together earlier in our careers at banks. But equally, It's never a bad thing to have more eyes looking at the same transaction and looking at it each with your own unique vantage point as a means to make sure you mitigate risk. But the point on competition is one where you're not really incented to be too aggressive where it comes to things like rates. Because at the end of the day, what I want to do is lead every deal I can. If you think about your private equity clients, they may have two or three direct lenders that are their core relationships. So they're going to rotate you. Invesco, you're going to lead this deal. You're not going to l…

AI assessment note: “You compete on things like relationship. You compete on things like sector expertise.”

Q When you had that breadth of looking across the capital stack, a lot of different businesses, what did you find most resonated for you in the types of investments that you were most drawn to?

A Maybe it's part personality, maybe it's part going through intense credit training, but we support private equity. There's a very different risk when you're a private equity investor than when you are a senior debt lender. What was unique about this opportunity is we could pick our spots. We could decide, you know, we don't want to lend senior here. We're going to do junior capital. We're going to do mezzanine. We're going to do equity. When I make an investment, I want to be able to sleep at night and not worry about it. What types of businesses did I tend to lean in on? The stable businesses, the businesses that were predictable, were less volatile, the businesses that lent themselves to traditional senior debt lending.

AI assessment note: “The stable businesses, the businesses that were predictable, were less volatile”