This month, our CEO, Jay Judas, talks to Susan Kasser, Head of Private Debt, Neuberger Berman. The pair chat about the ins and outs of private debt, why PPLI and private debt pair well together, and a new first for our restaurant question. Read on to learn more!
JAY: Susan, I am thrilled you could participate in the Tier One Interview Series. Our readers might be surprised to hear how we came to know one another. Last year, one of my individual consulting clients was purchasing several private placement life insurance policies and was looking for an investment manager who could deploy his $50 million in premium in a private debt strategy. After interviewing two dozen managers and checking off requirements on the client’s exhaustive checklist, you and your team at Neuberger Berman were selected.
From there, Neuberger Berman worked with an administrator specializing in insurance dedicated assets and the broker, Jordon Katz, in creating an insurance dedicated fund, and had it onboarded at the life insurance company so that the client’s policies could invest in that fund. We will discuss the advantages of combining private debt and life insurance in a bit but, first, tell me about Neuberger Berman and your role there.
SUSAN: Thank you, Jay. Neuberger Berman is honored to serve your client, and we appreciate the opportunity to share our perspectives on the private debt market.
First and foremost, I believe Neuberger Berman is a very special and collegial place. As a fully employee-owned firm, we are accountable only to our investors, not to public shareholders or a corporate parent. We think that structure allows us to be thoughtful, deliberate and long-term stewards of our clients’ capital, which essentially defines our mission at Neuberger Berman Private Debt.
Private debt is a form of senior secured investing, which means capital preservation is paramount. While equity investors might choose to take on additional risk to generate potentially higher returns, senior secured lenders want a reasonable coupon with a very high probability of return of principal—so stretching for higher yields, or lending quickly, is not worth the risk of losing clients’ capital.
It turns out that doing the right thing, at the right pace, has been a good formula: Eleven years after launching our private debt business, our team of 35 professionals manages more than $18 billion for investors and maintains a low annualized default rate of 0.03% and an even lower annualized loss rate of 0.01% since inception[1].
JAY: If I am not mistaken, you had a bit of a mobile childhood in that you grew up between Maryland and Israel before going to college in Massachusetts and starting your finance career in New York. What I find interesting is that you did not start out concentrating in private debt but eventually found yourself there. I am curious to learn more about your upbringing and your path to running a business at Neuberger Berman.
SUSAN: Maryland, Israel and also England, to visit my grandparents—so, yes, my family was very mobile! Looking back, I think all that moving around gave me multiple perspectives and helped me think independently.
In Israel, for example, children often have more autonomy and responsibility than in the U.S. In second grade, I rode two public buses to school. One day, I realized I could walk the route of the second bus, so I asked my parents if I could keep the money for that second ride. I would like to say that I invested that money, but my second grade self bought stickers and candy with it!
I think living in different environments cultivates curiosity: You ask more questions, make fewer assumptions and take less for granted. That has helped me think as a professional investor.
My path to Neuberger helped, too: I started my career at Goldman Sachs in equity research, where I discovered a love of analyzing companies and industries. After stops in private equity fund investing and leveraged finance banking, I joined a newly formed private debt business within the Carlyle Group, where I focused on lending for ten years.
Everything came together at Neuberger, where I had the opportunity to launch a private debt business alongside the firm’s market leading private equity fund of fund and co-investing platform. It is a powerful model: private equity funds buy the companies that are our borrowers— and they prefer working with lenders who are also fund investors, as opposed to lenders affiliated with other private equity funds, who are their competitors. We have informational advantages as we typically know the private equity owners of the companies (as Neuberger Berman is an investor in over 750 private equity funds[2]) as well as the portfolio companies themselves. Understanding the culture, capabilities, track record and economic incentives of the private equity owner of the business we are lending to is a significant contributor to our track record of minimal losses.
JAY: From my experience, those working in the high-end of the life insurance industry have their own language and culture and might not understand private debt as an asset class. What is private debt and why is it such a hot topic?
SUSAN: We find, diligence, price, structure and hold privately negotiated loans to performing businesses, owned by private equity sponsors, with privately raised capital from sophisticated investors. Our senior secured loans are floating rate, comprised of a variable base that moves relative to interest rate levels and an agreed-upon fixed spread paid by borrowers on top of that base rate. Returns in the asset class are largely generated by contractual cash coupons that are paid by the borrower to the investors quarterly. There is minimal volatility and little reliance on capital appreciation.
The asset class gained momentum following the Great Financial Crisis when banks tightened their lending criteria as regulatory pressures increased. That shift led many businesses to seek alternative financing solutions, and that is when private debt really took off.
In 2022, the asset class gained further momentum after a lending pullback by banks. The pullback came as banks had underwritten loans that became difficult to syndicate following an increase in risk aversion by investors. Because the banks were unable to sell these loans as planned, they were forced to hold the liabilities on their balance sheets, and drastically reduce their lending activities. During this time, many borrowers turned to private debt, and the asset class captured a meaningful portion of market share within the lending sector. Even as banks have come back to the market in 2024, the U.S. Private Debt market has retained market share at or above 2021 levels – when the banks were aggressively underwriting loans to syndicate[3].
Today, private companies and private equity sponsors of all sizes partner with private debt providers, and the asset class has grown to roughly $1.4 trillion under management[4].
JAY: When I hear “debt” as a part of an investment, I know there must be both borrowers and investors involved. Why do investors like private debt and, likewise, why do borrowers like it?
SUSAN: Investors like private debt for a host of reasons, including its attractive yields and contractual cash coupons, which can provide consistent cash flows for investors. Private debt has also historically demonstrated lower volatility and lower default rates than broadly syndicated loans.
As for borrowers, although higher priced than other financing options such as broadly syndicated loans, private debt is attractive because it offers a one-step process with a select few lenders, rather than a complex two-step process with first the investment banks and then potentially hundreds of loan funds and Collateralized Loan Obligation (CLO) funds. Other benefits for borrowers include price certainty; flexibility; faster execution; and closer collaboration with lenders, which often can foster valuable long-term relationships. We are reliable financing partners in all environments.
JAY: I would imagine because of your and Neuberger Berman’s reputation, your team is approached with potential deals left-and-right. What factors go into selecting good private debt investments?
SUSAN: It’s not a complicated formula, honestly—the key is having the discipline to stick to it.
We look to lend to companies that are market leaders with good growth prospects, solid business models, competitive differentiation, strong and predictable financial performance and seasoned management teams, in recession resilient sectors which may include parts of healthcare, business services and software and technology.
Then you have to look at the quantum of debt relative to the free cash flow generation across multiple possible risks, including recession, inflation, margin compression, slowing growth, etc. We look for industries, companies and capital structures where there is a margin of safety against our loan. One way to illustrate that is the growth in both revenue and EBITDA that our portfolio companies continued to demonstrate through a global pandemic, supply chain issues, labor shortages, inflation, slowing consumer demand and higher freight costs.
We focus on partnering with high-quality private equity sponsors with proven track records of investing in and growing companies. In many cases, Neuberger invests in the private equity sponsor’s equity funds via our private equity fund of funds business. The strong relationships developed by these partnerships enable our private debt group to be highly selective when performing diligence on investment opportunities. We can say “No” to opportunities and private equity sponsors will keep showing us deals because we are a Limited Partner in their Funds. These relationships grant us unique access to information by allowing us, as Limited Partners, to obtain an abundance of data on sponsors and their investments.
Finally, 100% of our portfolio companies are owned by private equity sponsors. This is important because private equity firms—which sit beneath us in the capital structure—dedicate themselves to enhancing equity value in these businesses over time. These private equity sponsors work tirelessly to ensure their portfolio companies perform well, and that makes us feel good as creditors when lending them capital.
JAY: Before we bring life insurance into the conversation, let me play Devil’s Advocate for a moment. Private debt is a popular investment right now but is this a bubble that could burst? Is there a downside?
SUSAN: All investments carry risk, but in our view, much of the chatter about the “private debt bubble” misses the mark. On this topic, three common themes tend to come up: defaults, the resurgence of banks, and an overabundance of capital.
First, on defaults. It is reasonable to ask if current high interest rates have squeezed company cash flows and triggered an uptick in defaults. But, as of the first quarter of 2024, U.S. Broadly Syndicated Loan defaults sit at 3.6%, below 2024 forecasts of 4%[5]. Moreover, defaults in U.S. Private Debt remain exceptionally low at 0.4% by the close of the same quarter[6]. Even if you take a more conservative view—by lumping U.S. Private Debt loans in default plus non-accruals (loans that have not defaulted but managers have identified them as potentially at risk) plus loans with interest modification (loans where borrowers struggling to service their debt will work with lenders to adjust interest payments)— risk levels are still modest at 2.9% at the close of the same quarter6,[7].
Next, investment banking activity within the U.S. Broadly Syndicated Loan market has resumed after the 2022 lending pullback we discussed earlier. As mentioned, even as banking activity resumes in 2024, the U.S. Private Debt market has retained market share at or above 2021 levels. We think many borrowers and private equity firms appreciate the benefits of private debt and that it is a permanent financing option.
Then there is the speculation that private debt providers have raised too much capital. To that, we’d point out that the increase in U.S. Private Debt dry powder since 2020 is not a staggering figure. As of June 2024, $283 billion of U.S. Private Debt dry powder stands available for deployment, compared to $214 billion at the end of 2020. Further, the $641 billion of U.S. Private Equity buyout dry powder available is more than double that of U.S. Private Debt, and many private equity sponsors will need financing for deals[8]. Adding the fact that private debt has a greater share of the lending market than it did prior to 2022, we are not all that concerned about too much capital in the space.
JAY: Earlier, I mentioned that when my consulting client wanted his private placement life insurance policies to invest into private debt, Neuberger Berman formed an insurance dedicated fund, or IDF. Why was an IDF used?
SUSAN: An IDF allows private debt returns to compound tax-free—which makes a huge difference as returns in private debt are taxed as ordinary income. A 40-year investment in private debt held within an IDF would generate a return seven times greater than if held in a taxable account.
At Neuberger Berman, we pride ourselves on innovating for our investors, including high-net-worth and ultra-high-net-worth investors. We have a “if you come, we will build it” mindset, and the IDF is an exciting addition to our toolbox. We are equally thrilled to partner with such a sophisticated and knowledgeable investor, an opportunity we immensely value.
JAY: In May, I saw you speak at a life insurance conference in Las Vegas, and you mentioned that private placement life insurance and private debt married well together. What did you mean by that?
SUSAN: Many of our private clients say they love our private debt strategy, but they don’t like the tax treatment of private debt. Or they love the income generated but wish the principal invested in private loans would recycle and compound for longer. With an IDF structure, they can access our flagship institutional strategy in a tax-advantaged wrapper in the form of a private placement life insurance contract. If structured properly, investors can defer or completely eliminate both income and estate taxes.
Additionally, an IDF perpetually recycles an investor’s capital within an evergreen structure. This blends well with an IDF investor’s long term, even multi-generational, outlook. Being fully invested all the time is a powerful compounding tool.
Ultimately, if an investor decides an IDF is not a good fit or they want to rebalance on a tax-free basis, they are able to periodically exit with certain lock up periods. IDFs offer more liquidity options than a traditional closed-end fund, which generally locks up capital for over eight years and returns capital as assets are realized.
JAY: As much as I want my consulting client to think you are working 24/7 on managing Neuberger Berman’s private debt business, I hope that is not the case and you can share a bit about how you spend your leisure time. Given that you live in Colorado, I bet there might be at least one outdoor activity you pursue!
SUSAN: I like any sport that takes my mind off work into the present, with manageable risk…I am a creditor, after all. I enjoy skiing and snowboarding, but only in-bounds. I love to rock-climb, but only for half of a day, in clear weather, and with an AMGA-certified guide who is also a wilderness first responder. I took up downhill mountain biking about five years ago, but I ride in full armor and stay off the black runs (mostly). If you couldn’t tell, I spend almost all my free time outdoors!
JAY: Before I ask you our popular “restaurant question”, Susan, I wanted to thank not only you for doing this interview but to also give credit to your Neuberger Berman colleagues who continue to support my client and other private placement life insurance investors in the private debt IDF. I remain very impressed by Matthew Bird, Josh Chmara and Amy Liu on your team and enjoy working with Brian Hahn and Will Proctor in their client-facing roles.
Without naming a steakhouse or a steak dish, what are some of your favorite places to eat and what should I order when I visit?
SUSAN: Truth? I’d much rather eat at a friend’s home—or host in mine—than go to a restaurant. When you eat out, there’s pressure to turn the table; you can’t control the volume; and you can’t decamp to the couch. Sure, the food matters, but not as much as people tend to think. And at my house, if the babysitter cancels, it is no issue to bring the kids along!
[1] Calculated as the cumulative default or loss rate divided by the total number of years since the inception of the strategy. July 2024.
[2] As of December 31, 2023.
[3] Source: S&P LCD. There can be no assurance historical trends will continue or lead to profitable outcomes.
[4] Source: KBRA.
[5] Source: JPM Default Monitor. Defaults include distressed exchanges.
[6] Source: Proskauer Private Credit Default Index. There can be no assurance historical trends will continue or lead to profitable outcomes.
[7] Source: KBW Equity Research.
[8] Source: Preqin.
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.