Private Markets 360° | Episode 44: Enduring Fundamentals in Global Private Credit

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Jocelyn Lewis [00:00:01]:
Welcome to Private Markets 360, your insider's guide to the world of private investments. Today we're thrilled to have Matt Harvey, global head of middle market direct lending at PGIM, joining us. With 22 years of experience entirely in private credit and leading PGIM's middle market direct lending business, Matt has been instrumental in shaping PGIM's strategy in this critical sector. His deep expertise spans the evolution of private credit from its historical roots in investment grade lending to focus on sub investment grade opportunities. Matt, welcome to Private Markets360. It's a pleasure to have you with us today. How are you?

Matt Harvey [00:00:44]:
Very well, thank you. It's a pleasure to be here. Look forward to discussing the topic at hand today.

Jocelyn Lewis [00:00:49]:
Excellent. We are too. So to kick things off with your 22 years of experience entirely in private credit and lead PGIM's middle market direct lending business, could you describe PGIM's core investment philosophy in the space and what sets it apart?

Matt Harvey [00:01:08]:
Sure, happy to do that. The 22 years of history for myself is just a fraction of the decades of history PGIM and Prudential generally have in private credit, which really dates back to the 1940s in the United States, believe it or not. And that history is one of the things in effect that sets it apart. It sets it apart for two reasons. And generally you see this being more common among the most experienced managers. Number one is the reason of origination access in private credit. Generally what you're doing is you're financing companies that otherwise are not active participants in the capital markets. They don't have a listed or liquid Persona in that way.

Matt Harvey [00:01:50]:
And that means by definition they're difficult to find, they're difficult to understand, to underwrite, to develop relationships with. And all of that takes time, right, and decades of history and avails itself to the time it takes to go find all of these companies. So for us it starts with origination access. We can talk a little bit more how we go about that mechanically, but safe to say it takes a lot of time and a lot of effort to do properly at scale. The other thing that is a fundamental aspect of private credit that often and get sort of misplaced when people think about the asset class is that in many ways, fundamentally what we're doing is no different than what banks have always done. We are finding good companies with a capital need to lend to and to provide a capital solution to. And lending is the quite simple proposition of just simply getting your money back to finance a productive effort for the company. And over Time in terms of how we underwrite and identify those situations.

Matt Harvey [00:02:54]:
We've developed quite a bit of machine learning, I would call it internally, and how we identify to underwrite those risks, how those risks evolve in ways that could impact the investment strategy, could impact how we lend, how we price credit, how we structure credit, and so forth. But suffice to say that again is something that's honed over decades and also in many ways is fundamental. It evolves, but it's not radically different. And it's not as if the rise of the private credit asset class has necessarily changed those fundamentals at the basic lending level when we engage with the companies that we work with. So a lot of history and it's funny, when I started my career, private credit was very much a more obscure part of finance. Now it's very well publicized. But the point that I would leave the audience with is in many ways the fundamentals have not changed. We are lending to companies and seeking to get our capital back plus a small return for something that is a solution for the business that takes the capital.

Chris Sparenberg [00:03:52]:
And over PGIM's history, and indeed your history with the firm, we've seen a lot of evolution in strategy and focus. One really important point to call out is the shift from investment grade to now emphasizing sub investment grade credit. Could you take us through how that strategic shift occurred over the last two decades and what factors drove that change for pg?

Matt Harvey [00:04:12]:
Sure. Happy to. That's an accurate progression over time that you just outlined. We are one of the few, I would argue, larger firms, private credit, indirect lending anyway, that actually started as an investment grade credit investor. Many these days, some of the largest managers that are very well known started as private equity investors and moved up into private credit. We like to say we started as investment grade credit investors and moved down into a sub investment grade sphere as an addition to our platform, not a substitute for our platform. And that goes back to the history that I alluded to. But what drove that was essentially the opportunity set enlarging.

Matt Harvey [00:04:54]:
And although it did exist pre financial crisis in 2008, what really accelerated, obviously the ability and the demand for sub investment grade borrowers to access private credit away from the banks was of course the financial crisis and the regulation that tightened bank lending that ensued. And then you had a marketplace that developed very quickly. The adoption curve increased. Companies became aware of the benefits of using a non bank private credit solution to finance in particular events, which arguably is the best utility of a flexible non bank solution. Leveraged buyouts, acquisitions, recapitalizations, Et cetera. Of course, that started with private equity sponsors and again has more broadly penetrated the full issuer marketplace, which would include non sponsor privately held companies. And so for us, given our long term access point to these non sponsored privately held companies, starting with investment grade, we simply saw that market as an adjacency to our core market that shared many of the common fundamentals in terms of A origination access that I started with and B the fundamentals of underwriting credit. Whether you're underwriting a triple B investment grade credit that you would rate quality yourself, or you're underwriting a single B credit quality, many of the fundamentals are the same.

Matt Harvey [00:06:22]:
And for us that opportunity coincided with the adjacency of having access to these types of issuers over time. What has created a very symbiotic critical mass as we think about it, in the organization is frankly the ability to do both. The ability to finance both investment grade and non sponsored privately held companies alongside subinvestment grade, either private equity sponsored or non sponsored companies, creates an origination point that when we're in marketplace essentially just elevates our relevance to more issuers and allows us to repeat the process at scale. When you get down to it in private credit, again, if the idea is you're mining inefficiency to deliver value to both issuers and your investors at the same time, the more you can repeat that process at scale and increase the origination funnel as we call it, find more companies simply that are lending opportunities, which is then enabled and amplified by your ability to provide more capital solutions, then it creates what we think of as a beautiful cycle. It's scalable, it's repeatable, it's sustainable through cycles, and it allows us to increase selectivity and finance a broader part of the market. So sub investment grade credit has grown dramatically for us. Again, it's been an extension of our core offering, which is private credit, to companies that are seeking alternatives away from the banks for various reasons.

Jocelyn Lewis [00:07:53]:
Appreciate that perspective, Matt. And one of the things that is unique about what you're doing at PGIM is that, you know, you mentioned that you're really looking at fundamentals. You're looking at those fundamentals across a variety of investment opportunities and not only across those investment opportunities that you just mentioned, but also across geographies, so spanning North America, Europe and Australia, which are all creditor friendly jurisdictions and where you have to be familiar with not only the cultural norms, but some of the legal nuances that exist in those differing jurisdictions. So I'd love for you to elaborate a little bit on how the core principles of investing that you've developed over the years are applied in practice, especially when identifying value within the mid market

Matt Harvey [00:08:57]:
across these jurisdictions, sure, therein lies a scenario that creates opportunity again for the investor, but as well to provide a solution to the issuer. And you mentioned the key geographies that we participate in North America, Europe and Australia. Twenty years ago, direct lending and private credit was principally a US driven market. About 10 to 15 years ago, the UK market emerged post financial crisis as a model that sort of anglicized naturally the US model in terms of shift from bank to non bank credit investing and really sub investment grade event driven financing. And then of course over the last 10 to 15 years that trend has exp across all developed markets really. And so from our perspective, if we can find that commonality of strong private company that is growing and seeking financing options for event driven transactions, whether they sit in Nebraska, in the United States or the middle of Germany or Sydney, Australia, those commonalities exist in the same types of companies in various geographies. So what we then have to do is we have to determine a to your point, are these jurisdictions where the lending criteria and regulatory environment is creditor friendly. And clearly we tend to only lend in jurisdictions where that is the case.

Matt Harvey [00:10:25]:
But secondarily, given this is mid market, how do you develop the origination access? It comes back to that original point of you can find an asset attractive academically in one of these markets because the market opportunity is large. But if you don't have localized origination and you're essentially just a buyer of what that market produces, it is a lot harder to build and scale a properly disciplined, properly diversified credit portfolio. Especially as you get down into sub investment grade and you're clearly taking more credit risk at the individual loan level. So for us again, it comes back to that origination. We've got 15 offices around the world. We've always been very focused on starting in these markets with an investment investment grade credit approach, becoming very comfortable with the lending jurisdiction in the origination channels, understanding the opportunity set of the types of issuers that we see in those markets, honing the experience and the depth of our local investment teams. And then we simply start to go down balance sheet as I call it, in terms of risk. We find incrementally the next borrower that in this case may be sub investment grade, maybe financing an event that demands a non investment grade solution.

Matt Harvey [00:11:40]:
And we are able to access that. But again, many of the fundamentals are the Same we're focused on entry leverage, loan-to-enterprise value, cash flow coverage and having structures and documents where because we're trading liquidity in private credit, right. We don't have the ability to transact away from the issuer. Once we're in the deal, we have to work on a primary basis. We have to have strong covenants in terms protections and how you do that, that in any given market it is different in France than the United Kingdom, which is different than Germany and Australia. Right. That's where you have to have the localized presence, but the fundamentals of underwriting the credit first and then using the local jurisdiction to structure around it. That's where having the larger platform but with localized origination is very helpful.

Chris Sparenberg [00:12:30]:
It's very interesting you mentioned some of those jurisdictional nuances and it's an interesting way for us to pivot into a discussion around where these jurisdictions fit on the maturity continuum. You mentioned Europe is less mature in private capital compared to the US Australia is an emerging jurisdiction. How do you see these regional differences impacting your investment approach? And are there specific opportunities or challenges unique to these markets?

Matt Harvey [00:12:54]:
There certainly are and there are impacts. The first order impact, frankly, is aligning what we see as origination opportunity, investment opportunity with investor demand and investor capital. Because as you can imagine, if you're a US pension fund with a US dollar liability, you want to match that with the US dollar asset. And it's not the most natural thing to say, well, let's match that with an Australian dollar asset for a mid market direct lending loan in Australia. There are ways you can do that within portfolios. You can put on derivatives, you can hedge off the currency risk. You can do things that then we would argue, create good diversity for those investors in a suitable way to access those credits. But again, it's not a natural extension for the majority of capital.

Matt Harvey [00:13:43]:
So the first thing we have to do is identify the opportunity set, prove it out with enough investment capital that creates track record that's underwritable if you're an institutional investor and then go create the demand for it. Right. And that tends to be circular over time. But to your point, maturation is a key part of this because what's happened over the last 10 to 15 years is the U.S. in fact, especially for sponsored lending activities. So traditional direct lending is financing leveraged buyouts for private equity sponsors in the United States. Most managers would acknowledge that is a quite mature market. It is competitive whether you look at the lower end or the upper end.

Matt Harvey [00:14:25]:
Yet at the same time it's a deep market, there are many participants, there's a lot of transaction activity and many managers can carve out and create their own angles. If you go across that continuum, as you said in Europe, you really have to separate the UK from the continent. The UK was the first mover, it looks most like the US and it is reasonably mature, I would say in a pretty comparable way. Across the continent though, you see as you go from north to south and from west to east, you see less and less penetration. And I always take Germany as an example. Germany is the largest economy in Europe. Yet the reporting that I see would suggest it's the fourth largest issuer of direct lending among European countries. And that intuitively doesn't make a lot of sense.

Matt Harvey [00:15:14]:
Over time, the adoption curve in places like Germany and more broadly across the continent should be upward sloping. And that's what we see. Because what we see is the benefits of private credit being better understood and more available to European issuers, no different than they've been taking up by US and UK issuers over time. Australia is the, I would say the last port of call in the developed market. There are other markets that are of course changing when you look across Asia and so forth, but in the traditional developed market, and that's a market that's really grown over the last five or six years coming out of COVID principally where the dynamics of literally being an island economy but having a strong and thriving middle market again support a private credit alternative. If you can be local and compete alongside the Australian banks, putting investor capital around that again and how you do that in a global portfolio versus a dedicated geographic portfolio, that's really the trick. So what it will enable penetration in places like Australia and in fact across Europe, we'll be continuing to align investor capital and structures that can invest in those products with what we see as the origination opportunity. But we're quite bullish on that trend.

Matt Harvey [00:16:29]:
And the additional thing we haven't really talked about yet that sort of accelerates the market share penetration, if you will, of direct lending is again, we focus a lot on private equity sponsored activity generally for the direct lending asset class. But it's often reported that there are many multiples in terms of opportunity set of non sponsored issuers. And so again, if you can access these family owned privately held companies that are not entertaining private equity transactions, which is the majority of the issuer set, then that penetration curve only stands to increase over time. And that is fundamentally our strategy that we can access an increasing penetration curve in places like Europe and Australia. Continue to do that in the US because you can originate into both the sponsored and non sponsored markets. And again, that creates the symbiotic, beautiful cycle that I referenced of better selectivity, better underwriting, better information and all that ultimately in a more diversified portfolio that makes sense for investors.

Jocelyn Lewis [00:17:32]:
Appreciate that perspective, Matt. And as we think, think about how PGIM navigates regional nuances across Europe, the US and the emerging markets like Australia, it becomes clear that adapting to local market maturity is only one part of the equation. With another critical dimension being understanding how the investor base itself is changing. So shifting from geography to capital formation. And with the investor ecosystem evolving significantly, you have clients becoming more sophisticated and the growing inclusion of retail and private wealth channels. How is PGIM adapting its strategy to engage with these diverse investor groups? And what is the importance of investor education within this environment?

Matt Harvey [00:18:34]:
That's a great question. It underpins a lot of the thematic issues that surround direct lending and private credit today. I'll start with our perspective and really my perspective, I should say I've always felt we have great privilege at PGIM in that we are integrated fully into a permanent balance sheet, a very large life insurance company balance sheet that is a long term investor into assets that match their liabilities. And that gives you a perspective. In private credit that's really important. That starts with the idea of long term perspective. And in privates, finding relative value after illiquidity. It's a really simple but important concept.

Matt Harvey [00:19:18]:
And where I go to that very quickly then is as an investor, how do we find, manage structure, underwrite, et cetera, a asset that has illiquidity. And we are focused purely then first and foremost on the asset level return and dynamics. Right. If you have that as your sort of guiding principle, then what you have is you have the ability to produce scarce assets that produce interesting returns after illiquidity. And you should be able to avail that portfolio to other types of investors that may have similar objectives. And the objectives can come for different reasons. The average private wealth investor these days generally has the objective of I have a fixed income replacement opportunity in my portfolio. I'd like to seek higher dividend yields than is traditionally available in, let's say high yield or leverage loans or something like that.

Matt Harvey [00:20:18]:
And I can do that in a diversified pool of private credit assets. That's one opportunity. Another opportunity in investor segment is I may not want to be the equity owner of those returns, I. E. Make the whole loan myself. I may want bits and pieces of that. I may say I'm really comfortable with the top risk portion of that, I. E.

Matt Harvey [00:20:39]:
The safest piece of that loan. And increasingly in private credit like has been innovated many years ago in liquid credit, you can create structure out of these middle market CLOs, rated feeder notes, et cetera, et cetera, where certain investors can buy certain pieces of the risk reward of the underlying loan. As a pm, what it does is, and it's very welcome this way is it gives us more diversity and therefore with diversity in theory, more stability of capital to deploy. Because again, a lot of what we talked about in terms of the maturation opportunity to originate into comes from having the capital and aligning the capital to that opportunity. Right. So the more we can create diversity and stability and independence of capital to meet that origination opportunity, we see that as a win win for all parties, especially for the investors in the end. But secondarily, what you have to do to your point, and this is the risk in expanding this investment strategy outside of these traditional long term institutional allocators who buy the entirety of the loan, so to speak, it's the education. These are illiquid.

Matt Harvey [00:21:51]:
These assets will cycle similarly to any other asset. Just because it's private doesn't mean it doesn't have drawdown risk. It doesn't mean you have individual credit risk. You will have traditional asset class cycle risks. And investors need to really understand in the structure of these products, in our view, the best way to maximize that return opportunity, which we see again as relative value after illiquidity, is to understand the illiquidity dynamics, buy it for what it is and be able to hold that through a longer period of time. Right. And when you get into the various channels today, you know, the products are reasonably well structured. The tolerances of the investor really is what dictates the risk taking.

Matt Harvey [00:22:41]:
And that relies then on education on distribution teams that are in the marketplace speaking to the right investors and positioning the product the right way. And so that evolution is ongoing. But it's really important for the industry to get that right and to do it responsibly with a set of best practices that are suitable for the underlying investors, which the industry by and large is doing. And if you do that well, then what you're doing is you're delivering on this idea democratization of finance where all investors have access to the same types of products that traditionally were reserved for only the very large institutions.

Chris Sparenberg [00:23:22]:
I want to lead from that conversation on investors and their changing preferences and increasing sophistication into the market structure and what you might see is the enduring fundamentals in private credit. We're in a moment now where this asset class has experienced dramatic growth and with it very recently an increase in maybe the segmentation of specialized credit funds. How is PGIM navigating that complex and almost fragmented market structure to identify the most promising opportunities for clients?

Matt Harvey [00:23:55]:
Yep, it's, you know, it's a really important philosophical point for the managers to get right, ourselves included and by the way, in that there's no one size fits all. There's no single answer to this. But I'll explain how we approach it, which is a very productive approach for our investors because of that segmentation and the growth of the market over the last decade. Plus one of the biggest risks investors can take is strategy creep. Right? You start in an investment product that is meant to do one thing and because frankly the market evolves around it over time, it ends up doing something else. And that's where you see this classic segmentation opportunity. Again you take cash flow direct lending in sub investment grade. What started in a very constrained middle market format dealing with companies, you know, we use the same definition many do, under 50 million of EBITDA operating profit per year, under a billion dollars of revenue now has transferred across really the entire company set from public to private, up to, and in some cases actually now including large cap listed companies.

Matt Harvey [00:25:05]:
So it really is pervasive. But again, if your strategy as an investor, your idea of where you like value is to be in a quote unquote middle market direct lending strategy, you probably don't want to see your manager suddenly taking different forms of risk in a different part of that segment. Equally, cash flow lending is where private credit started. But now you have very large and prominent segments of the asset class that focus on things like infrastructure, credit, highways, toll roads, ports, et cetera, et cetera. You have of course this, this very large and growing, sometimes esoteric and hard to define asset based finance asset class ABF, where we're really first and foremost, you're financing pools of assets and you're again delivering ideally relative value to investors after illiquidity or with structuring capabilities and so forth. So, so those have all grown in popularity and they've grown in popularity because there is a market to originate those assets and provide value to the issuers away from the traditional capital markets or the banks. As a manager, again, the point is, and what we do that is we don't create all weather or all caps. We call it credit strategies generally, unless the investor really wants it in a very self Intentional way, self selecting way.

Matt Harvey [00:26:30]:
We can do that if that's what the investor wants. But when we organize the investment teams, we create teams that are very focused on one part of that segment and then can stand the best chance of delivering the best return and the best risk character in that single segment. And if investors want that single segment, they can, they can look at those segments as an investment opportunity on a standalone basis. And if rather they want to commingle or leverage the capabilities of the manager to do many different things within this broader private credit asset class, then those portfolios can be assembled. But again, it starts with the idea of underwriting relative value on at the specific part of the strategy that you focus on. In my case, that's middle market direct lending. And that gives us an area of an advantage, really of focus that allows us to do that very well. And the investors get to choose then where they want to place their exposure.

Jocelyn Lewis [00:27:29]:
Thank you for that, Matt. And as PGIM works through an increasingly segmented and specialized private credit landscape within the middle market, it raises an important point. So even as the market evolves and products become more complex, the foundational principles guiding sound underwriting haven't really changed. And you've noted that credit fundamentals remain the same despite assets being packaged differently today. And for those less familiar, could you explain, explain what these enduring credit fundamentals are indirect lending and why they remain so crucial to pre and why they remain so crucial to PGIM's approach?

Matt Harvey [00:28:17]:
Yeah, so this comes back to the segmentation. And so what I would argue are the crucial fundamentals of middle market cash flow. Direct lending may be a little bit different if you're running an ABS strategy or investing across different segments. But if we start with the idea of basic cash flow lending, which again, the banks have always done, and private credit provides an alternative to a bank structure for many different reasons, we really focus on the following. First and foremost, of course, you have to find companies that have reasons to exist, right? And not only reasons to exist, reasons to thrive over time. And as simple as that sounds, as you go down market in terms of risk and then you introduce balance sheet risk with, in the form of leverage, that is a more and more crucial thing to get right up front. You have to have a strong free cash flow profile and enough earnings visibility and revenue visibility and stability to service a more leveraged balance sheet. Right.

Matt Harvey [00:29:22]:
Very simply, sub investment grade, among other things, means you have higher leverage, you have higher debt service on these companies, there's a lot less room for error in terms of the operating model, year to year. So what does that mean? Well, first and foremost, we look at things like fixed charge coverage ratio. A company has to cover things like taxes, interest, expense, capital expenditures, et cetera, et cetera, every year, no matter what happens to their earnings generally. And so we want to make sure as we underwrite these credits that we're stress testing the ability for the company to service all those obligations without creating a default event on our loan or a liquidity event at the company level that compromises the value of the business and therefore the value of our asset, our loan. We also look, of course, to things like valuation and asset prices, but generally in cash flow direct lending, those are secondary and frankly, those can be illusory. And one recent example of that, of course, is there's a lot of well publicized stress or at the minimum, negative sentiment in software lending. Many years ago, software lending was done principally on the basis of recurring revenue multiples and very comforting levels of loan to enterprise value. Because the asset prices were inflating.

Matt Harvey [00:30:47]:
Software companies with SaaS models were viewed as very strong recurring earnings and revenue generators that could support high levels of leverage, even if in the short term the cash flow was not aligned with that. Well, companies cycle, all companies do, all sectors do. And over time you have to make sure you're not just relying on the asset price because the asset price can change. And that's just one recent example. So for us, it starts with cash flows. It starts with fundamentals of how the business evolves through stress cycles. You can't identify what those stress cycles always are, but you can stress test the operating models of the business in the event of cycles. And you want to make sure that in any case you have strong free cash flow coverage.

Matt Harvey [00:31:34]:
And in the case ultimately the event occurs at a given asset where that's broken or you have a default, that you have a strong ability to recover based on default. And that in large part then is dictated by the one thing we haven't talked a lot about today yet, which is covenants and terms. How quickly as a lender can you bring forward the event of default and the stress to allow you to exercise remedies and to protect the value of your loan before it's too late? And I would argue in middle market direct lending, the good managers and the good lender that rely on these fundamentals do a good job of structuring those protective mechanisms. So you have the chance, given default, of generating strong recoveries and eventually par back on the loans you've made. Even in the more stressed part of your portfolio.

Chris Sparenberg [00:32:24]:
So let's look through another lens at the market and that's the structured growth of middle market CLOs and the increased collaboration with banks. Against that backdrop, how does PGIM leverage these developments within the broader private credit ecosystem to enhance its investment strategies and even its sourcing capabilities?

Matt Harvey [00:32:41]:
That's a great question because I just want to say to start that oftentimes there's a little bit of a misplaced paranoia between banks and direct lenders on this sort of idea of an existential crisis almost and battle for superiority in these lending circles. And we simply do not see it that way. To your point, it is an ecosystem. We are very collaborative. We partner with banks all the time, we do it at the asset level and we're lending to companies. Oftentimes we provide long term capital, they provide short term capital. They have very attractive opportunities for agency and other service line of business that we do not pursue as an asset manager and vice versa. But to your point here, we also increasingly do it at the portfolio level when it comes to how we finance and service our own portfolio of credit and a big picture.

Matt Harvey [00:33:34]:
This idea of do you have more systemic risk in credit and the development of private credit comes back to the idea of what creates systemic risk and who are the natural owners of these assets. I would argue a bank lending to a diversified pool of direct lending leveraged loans, in effect at a loan, the value of those loans that is very well structured from a risk standpoint, let's say 50% loan to value of a pool of loans that for me as a manager I already think are well covered because they generally have 40 to 50% loan to value at the asset level. I would actually argue that's a deleveraging transaction for the banks and places those assets and those credit relationships into parts of the ecosystem the market more suited to own that risk. Just as an editorial to start noted the growth of middle market CLO and you could extend that to other forms of, I'll call it structured credit and financing around the direct lending market. It's the same case in the wealth market with BDCs and so forth. BDCs can be issuers of CLOs and fixed rate notes and so forth. And the banks are active in arranging those transactions. So it's a very attractive, growing and lucrative part of the investment banking model for many of those banks.

Matt Harvey [00:34:55]:
And depending on the lending dynamics and the structure, especially if you get to very high investment grade risk, as I said, if you can take the first out position against these diversified Pools of assets call that AAA or single a risk. Banks often own that risk. And it's very good spread lending for banks, right from a deposit standpoint and in how they manage their own lending books. So we see that as very collaborative, we see that as growing over time. And it's incumbent upon us then to work with banks that have the same perspective and view it as a partnership that we can again survey a growing need from the issuer market in alternative forms of capital and do it in a way that provides suitable leverage and efficient leverage into the system. It's the old idea of the money multiplier, right? If I raise a dollar of equity and I pair that with a dollar or two of bank debt, in this case, then I can provide $3 of solution to the issuer. And if you manage that risk properly, the equity owner of that risk, that is the long term institution, generates a very strong return on capital that they're comfortable with over time after illiquidity. And the lender to that risk, that is the bank in a diversified pool of loans gets very strong spread business that they can also generate fee business out of with the underlying managers.

Matt Harvey [00:36:18]:
That's a pretty symbiotic ecosystem and one that we continue to grow with our bank partners.

Jocelyn Lewis [00:36:23]:
It is important to understand that leverage plays a role and what role that plays. So appreciate you diving in a little bit there. And as PGIM taps into innovations like middle market CLOs and deepens your partnerships with banks to strengthen both sourcing and strategy, it naturally brings up another dimension of the firm's edge which is how the investment decisions get made themselves. And Matt, throughout your career you've chaired the investment committee at PGIM. And what are some of the key considerations or unique insights that guide your committee's decision making process, Especially given the nuances you mentioned within the mid market?

Matt Harvey [00:37:16]:
I would clarify. To start, I chair the Mid market direct lending investment committee. PGIM is a huge place with many great strategies and PMs and portfolios,. So I just wanted to clarify it said that there's no one IC. This gets back to the idea of investment committees that are assembled amongst professionals dedicated and experienced in their area of focus or asset class. And so using mid market direct lending as an example, it is a committee by definition. We have a global investment committee of nine individuals. These are all individuals that have 2030 years of private credit markets experience in the US and Europe and have a very well honed perspective on what it takes to produce attractive returns for our institutional investors and investors generally through Market cycles.

Matt Harvey [00:38:06]:
So in terms of the decision making process there, there's a lot to talk about here, but suffice to say the sort of starting point of the conversation around constant improvement, machine learning, et cetera, et cetera, I'm using those as euphemisms because the decision making process, if it's done well on the one hand, you balance consistency and discipline and you don't change that process just in reaction to a market development or a short term topic. That may be fleeting, but at the same time you have to evolve, of course, and you have to learn from opportunities, mistakes, experience, et cetera, et cetera, and apply that to your investment decisions. So what we do in private and in many ways this is fairly common across certainly the more experienced managers is on the front end of the origination model. One of the biggest risks we have is frankly opportunity costs. We have to talk to and consider many different transactions, meet many different companies to determine that reasonable cross section of it's an institutional investment grade worthy business with we can provide solution that actually that business also wants. Right? Because those two things have to happen together. We could love a company, but if they've got plenty of access to capital and we can't provide a solution that's unique in that way, it's going to be hard for us to transact and vice versa. Right.

Matt Harvey [00:39:37]:
So the first thing we do is we introduce mechanical process. We meet three times a week as an investment committee. We survey the origination pipelines that comes from our 50 deal teams around the world that are calling on companies and calling on sponsors every day. And the amount of data and information and the ability to triage that first stage of pipeline then becomes critical. We're trying to take 10 opportunities down to one or two very quickly and it's based on investment attractiveness crossed against our ability to provide a financing solution. If we can do that well then it's the classic 8020 rule. We could spend the vast majority of our time underwriting and focusing on and structuring the fundamentals of that particular transaction and ensuring then that we harmonize that with our investment strategy. And that's where it's really important.

Matt Harvey [00:40:26]:
In mid market credit we actually take an approach where investment committee sponsors we call it. And the reason why we have nine get assigned to the individual deal teams and they work with those deal teams to help underwrite, structure and manage the loan transactions. And it's not because our deal teams are not experienced and they need that level of management. It's actually the opposite. They are very Experienced, they're expert in their local markets at identifying an underwriting credit. But what we have to do then is we have to make sure the sort of conveyance of information and decision making between the portfolio decisions and what our investors want aligns then with that underlying transaction. And to do it competitively in marketplace to lend these scarce assets, we have to do that relatively efficiently. Right.

Matt Harvey [00:41:17]:
We can't dither, we can't take time and say, well, I'm not quite sure or you know, the loan market spreads are out 50 basis points today, so we're out of the market. Come back to me in two weeks. These are things that are not suitable answers to the types of businesses we finance, which are attractive businesses and have alternative capital sources. Right. So the idea is we spend all of our time on those handful of transactions that we think are relevant and are attractive and then we throw the full cavalry at it. It's the investment committee sponsor all the way down to the deal team. And it's the idea of both underwriting and really trying to create what we call information advantage and making that evident in the transaction that we structure with frankly the deal capture side of it. It is a competitive market and we've got to convince these companies that our capital solution and working with us as an institution is advantageous.

Matt Harvey [00:42:11]:
But again, a lot of it comes back to that initial mechanical process of surveying your origination opportunity set and very quickly honing in on those things that meet the fundamentals we talked about earlier and produce the types of returns that we think our investors are after.

Chris Sparenberg [00:42:28]:
That brings us to our last question we've covered market structure, PGIM's evolution, your view on the market and how you're executing this middle market strategy. I want to turn to the look ahead. So what do you see as the most significant trends or potential disruptions that'll shape private credit markets in the coming years? And how is PGIM and really how are you preparing to capitalize on or mitigate some of those factors?

Matt Harvey [00:42:53]:
I'm a big believer in the long term idea of adoption curve and more and more companies very simply having access to and understanding the benefits of non bank private credit or direct lending capital in this case. And that is a very simple idea and very simple trend. But we talked about that earlier in the call. Whether you take the U.S. europe or Australia, there are parts that are mature, but there are many parts that are still increasing penetration. Whether it's non sponsored lending or it's continental Europe, access to companies that otherwise wouldn't have considered private credit options in long term, that adoption curve will continue to slope up and to the right. And it's driven principally by the fundamentals of who and what types of institutions are best placed to own these assets versus not. We talked about the collaboration with the banks and where we have natural ability to provide a solution that banks tend to not whether it's regulatory or commercially and vice versa.

Matt Harvey [00:43:57]:
They're good at doing certain things that we're not and we can compel that into good solutions for companies. That's number one. Number two, the biggest trend will continue to frankly be despite the current scrutiny on this, the access and development of the private wealth in the retail market into private credit. There are many different forums and segments that go well beyond what we talked about today, investment grade credit, infrastructure credit, abf, that are also very suitable for that discussion. And I continue to think sub investment grade credit, no different than the reasons why individual investors have allocated to things like high yield and leverage loans in their portfolios over time, will continue to play a prominent role. The industry's got to get that right. And there are things that are very specific to that market in terms of daily valuations, regulatory and sort of good principles of transparency and portfolio construction, et cetera, et cetera, that are really important and those have to be then well understood by the buyer. But when you consider the size of the defined contribution market and generally the retail investment marketplace, that is a megatrend that will continue in a manager's who have the ability to navigate that in a way that is responsible, but at the same time deals with the other side of it, which is potentially more capital against a supply base that isn't in any one day always available.

Matt Harvey [00:45:24]:
Right. That's really the trick and that's going to continue to drive the dynamics of private credit for some time, irrespective of any one short term market cycle.

Chris Sparenberg [00:45:33]:
Thank you for joining us for this episode of Private Markets360. We were delighted to have Matt Harvey, global head of middle market direct lending at PGIM share his expertise with us. Matt provided valuable insights into the dynamic landscape of private credit, explaining PGIM's core philosophy and its evolution towards emphasizing sub investment grade opportunities. He highlighted the importance of their geographic allocation strategy, recognizing cultural nuances and the significance of a local approach in regions ranging from North America to emerging markets like Australia. Matt also shed light on the evolving investor ecosystem and the necessity of educating increasingly sophisticated clients, including those in the retail and private wealth channels. He underscored that while the market structure has grown and specialized credit fundamentals remain enduring. We hope you found this conversation as informative and engaging as we did. Be sure to subscribe to Private Markets360 for more expert insights and the latest trends in private investments.

Chris Sparenberg [00:46:32]:
Until next time,