Spotlight on James Kirby, Principal, President, Deerpath Capital
Global Thought Leader Spotlight
James Kirby, Principal, President, Deerpath Capital
“In my role as the Principal at Deerpath Capital my primary responsibility is akin to that of a chief investment officer. I sit on the investment committee alongside the other three partners in the business and twice a week we review the investment proposals that come from the twenty plus members of Deerpath’s origination and underwriting team, who work with more than 400 private equity sponsors across the US to source appropriate investment opportunities that meet our strict investment criteria.
“Scale is a vital factor for any direct lending manager but it is especially important for Deerpath who focus on the lower middle market of US direct lending, where loan sizes range from ~US$25 million up to ~US$100 million. To be able to deploy appropriate amounts of capital for institutional investors, our investment committee review more than 1,200 potential investments a year to invest in less than 5% of those transactions.
“The investment environment for all asset classes has changed materially over that last 18 months as developed market central banks raised reference rates, in attempts to bring generationally high inflation under control. These changes to base cash rates have cascaded through all interest rates and subsequently saw asset classes with high interest rate sensitivity sell off materially in 2022, including traditional bonds and equities.
“In the short-term higher reference rates have been a relative positive for the direct lending market, as loans made are almost exclusively floating rate in nature, and, therefore, the impact on existing loan portfolios rolls through in the form of higher returns to investors, albeit at a lag.
“Additionally, new loans are now attracting all in yields at levels not seen in the last decade. With reference rates and credit spreads likely to remain elevated, the outlook for direct lending in the near term is a strong one, as investors will receive attractive compensation for the level of risk taken.
“However, over the last decade the core direct lending market has witnessed a material reduction in the scope and quality of traditional structural protections afforded to lenders, as large amounts of capital entered the sector via a plethora of new institutionally funded private credit managers, increasing the competition for deals.
“This increased competition manifested in acceptance of “cov-lite” loan structures by newer lenders, together with higher levels of leverage and credit risk for each unit of return.
“Should the macroeconomic environment worsen materially, institutional investors that have allocated to the core and upper middle direct loan market, (ie loan sizes of US$100 million to US$500+ million), over the last five years could well experience outcomes that are not consistent with their expectations of the asset class.
“A slowdown in economic growth combined with persistent inflation puts strain on the earnings of underlying portfolio companies. This scenario, combined with higher rates and leverage carried by larger companies, as well as weakened lender protections, could result in default rates and recoveries, in the event of default, being materially worse than historical levels.
“A less supportive economic environment for companies looking to source debt funding should prompt institutional investors to examine the companies, sectors and structures they are exposed to and focus their attention on ensuring they have appropriate diversification, protections and compensation for the risk they are taking on.
“At Deerpath our focus has always been on the lower middle market, a part of the direct lending opportunity set that still enjoys full covenant loan terms, other lender protections and lower leverage at the company level.
“We have deliberately avoided the temptation to raise larger funds and allocate to larger loans, despite the obvious operational leverage and profitability benefits, preferring to stay in the lower middle market where the returns and protections are highest.
“The ultimate question for institutional investors to consider is whether their interests and those of their direct lending managers aligned?”
James will present on the developments across the US lower-middle direct lending market, at Global Investment Institute’s upcoming Private Credit Roundtable, taking place on Thursday, 4 May 2023 at The Residence - Grand Hyatt Melbourne, Victoria.
To register your interest in attending, click here or for more information email zlatan.kapetanovic@globalii.com.au.
James Kirby, Principal, President, Deerpath Capital
James co-founded Deerpath in 2007. He was previously a Managing Director and Portfolio Manager in credit investing at Dune Capital Management, LP and its predecessor fund at Soros Fund Management LLC from 2004 to 2006. He was a Managing Director in private equity investing at Madison Dearborn Partners where he was part of the communications industry investment team from 1996 to 2003. James is a graduate of Harvard Business School (M.B.A., 1993) and Princeton University (A.B., 1989).
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