Direct lender Varagon pinpoints portfolio resilience

The private lending market is built on trust, relationships and research -- all three of which are key at mid-market specialist $13.4 billion Varagon Capital Partners. Varagon Partner and Head of Sponsor Coverage Charlie Riceman said there was a point right before the current COVID-19 surge that he fully anticipated that deal flow may hit the pause button again, but generally he has maintained a positive outlook on the investment methodology he and his team have built to weather the current economic uncertainty. A New York-based lender to U.S. middle market companies, the firm says that its lending model is relationship based, with a focus on building partnerships and offering flexible financing solutions to mid-sized companies. Riceman has more than two decades of leveraged lending experience across a variety of industries and joined the firm in 2015 from Golub Capital. Varagon now has over 70 professionals focused exclusively on directly originated middle market loans. Senior members of the team have, on average, more than 20 years of experience investing across credit cycles. “A unique approach Varagon takes is in being transparent and collaborative with our investors, sponsor relationships, and borrowers and management teams,” said Riceman in a recent interview with Alternatives Watch. “All asset classes in the current COVID environment have been tested. I think there will be evidence of differentiation, but at the same time the private credit asset class has proven resilient,” he added. In the spring many debt specialists focused on areas such as distressed debt, but Varagon has maintained its more measured approach in originating loans to companies with long-term potential. Pre-COVID, the team aimed to stay in front of and work closely with private equity firms to be their go-to financing partner. For Riceman, many of these relationships go back decades. “Before the pandemic, we were always doing a lot over the phone and remotely too. In that regard, the transition to working from home has been relatively seamless and we have experienced minimal disruption to our investment and portfolio monitoring processes,” he added. The bulk of the work since has been done via video conferencing, especially for early meetings where there is maybe an auction process and an initial meeting with executives. “We are not trying to do anything outside of our disciplined investment philosophy,” added Riceman. “We know what we like and we seek to be measured and thoughtful in what we do.” It is part of their ongoing call of duty, he said. When COVID hit, there was great communication with all the constituents about what was happening and how the businesses were being affected. Since its launch in 2014, Varagon has invested over $15.5 billion in over 185 borrowers. The firm was established with backing to the tune of $1.5 billion from the investment committee of American International Group (AIG) and affiliates of Oak Hill Capital Management. In January 2020, Aflac Global Investments acquired the interests in Varagon held by the affiliates of Oak Hill Capital Management and made a new multi-year investment commitment of up to $3 billion to Varagon to invest in middle market loans. Varagon’s focus is on performing, sponsor-backed companies with $10 million to $75 million of EBITDA. And while M&A has slowed, activity on the part of investors in these smaller companies continues. “We are debt investors and we like stable consistent, defensive industries,” Riceman said. Varagon last month completed a senior secured credit facility to support the acquisition of US HealthConnect, a digital educations strategies and engagement data solutions company working with pharmaceutical, biotech, diagnostic and device companies. The acquisition was done by investment funds managed by Morgan Stanley Capital Partners. The team also recently led the debt financing for Alvarez & Marsal Capital Partners’ acquisition of BrightPet Nutrition Group, a premium pet food brand. Morgan Stanley Private Credit also served as joint lead arranger of the deal along with Varagon, which was also the administrative agent and joint bookrunner on a senior secured credit facility of an undisclosed amount to support the transaction. Besides BrightPet, Varagon has served in a similar capacity in early September with a senior secured credit facility to support the acquisition of Sila Heating & Air Conditioning, by Astar Heating and Air LLC, which is based in Middletown, NY. Riceman added that from the investor perspective, he believes the returns in private credit should prove compelling going forward. Varagon’s loans too are all senior secured, which means they are the first priority in the capital structure. When it comes to looking at which businesses hold the most potential going forward, the Varagon team is not one to speculate or make short term bets on specific sectors. For instance, they have worked with dental businesses, which of course were in a unique situation due to the shutdowns earlier in the year. Riceman said he would like to see the dental practices to come back and be at full capacity, but of course there may be some caution going forward with businesses so directly impacted by COVID. Still, he added that he and the team stick with what they know – and that is a market that is less likely to make headlines but more likely to generate consistent income. While the deal activity is not at the level it was this same time last year, Riceman said that there will be sectors that take some time to recover, but ultimately come back. “As far as a shutdown, I think it will be no worse than it was in March,” he added. “We could have the same repeat of businesses closed again, but it’s not the first time we have seen this. We won’t be so shocked by it either. Our hope is that we have put in enough guard rails to allow our portfolio to continue to perform well, irrespective of the market environment.”

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