LP Profile: New Mexico Wants To Help Fill The Debt Void

Gary Bland, state investment officer for the New Mexico State Investment Council, likes opportunities right now in the mezzanine, senior debt and distressed debt markets for one overriding reason. “Because the money is not available from the usual suspects,” he said.

And where there’s a vacuum of capital, there will always be investors like New Mexico, with $16 billion in assets under management, rushing to fill it. Bland said he’s well aware of the risks, such as a deep recession that puts more companies than expected into default. “We hope we can diversify enough and also be correct enough on our analysis going in that we can minimize our exposure to those things. We’re not naïve. We know that things go wrong,” Bland said.

Surveying the menu of options, Bland continues to like mezzanine debt, which New Mexico has been backing for the past few years. “You get your money back fairly fast, and the investment rate’s pretty good,” Bland said. He expects to generate a return of 12 percent to 18 percent with mezzanine investing, and he’s been getting it. And so far he has not had any bad experiences with mezz.

This month, New Mexico is likely to make a fresh commitment to Falcon Investment Advisors, which seeks $800 million for Mezzanine Partners Fund III to make mezzanine investments in the lower middle market. New Mexico pledged $20 million to the predecessor vehicle in 2005. Bland said he is considering additional commitments, including to a couple of other mezzanine firms for re-ups, as well as to firms the state hasn’t backed before—although the state plans to be especially selective with the latter.

“A lot of people are coming out of the woodwork today that really don’t have experience, especially in the mezzanine area,” Bland said. “I’m not sure that all of the people marketing funds today are as experienced as they’d like you to believe.” Indeed, Bland said he and advisory firm Aldus Equity do a lot of background work on investment professionals, talking to other limited partners and executives at the companies the firms have invested in “to see what kind of characters they are.”

Since 2007, New Mexico has put at least $55 million to work in mezzanine funds, including The Carlyle Group’s Mezzanine II Fund ($30 million commitment), a $600 million middle-market mezzanine fund; and Gleacher Partners’ Mezzanine II ($25 million), a $350 million fund earmarked for investments in middle-market companies via subordinated debt, preferred stock and non-control common equity securities.

Altogether, the LP has $350 million in the mezzanine sector with at least six managers, while the value of is separate structured debt portfolio, a mix of debt investments including limited partnerships, funds, CDOs and CLOs overseen by the fixed income group, is now $450 million, including commitments to fund managers Babson Capital, Axa Investment Managers and Zais Capital.

Apart from mezzanine funds, Bland feels that the biggest opportunity in the debt market now may well be in providing bank loans to finance leveraged buyouts. “That’s an area that I’m probably a lot more optimistic about than others,” Bland said. “People come out with a flavor-of-the-day approach. As soon as [a market] starts to move and get liquidity in it they rush in. We want to be there ahead of the rush so we can help share the wealth with them.”

Bland said the state plans to be opportunistic when it comes to backing specific senior debt funds. “There might be some great opportunities to fill the traditional role that the banks had with private equity and related spaces,” Bland said. “It’s time to be creative and to step into the void. We don’t have to be there first, but we don’t want to be the last guys there.” That said, Bland noted the state would never commit to a private debt fund like the one Goldman Sachs just raised. (Goldman Sachs recently closed its debut $10.5 billion debt fund that will provide secured loans for leveraged buyouts, recapitalizations and acquisitions.)

“We don’t do those large funds, ever,” Bland said, adding that he prefers backing sidecar vehicles or funds in the $500 million to $3 billion size range. “You get up around $10 billion and that’s a commodity fund, and I’m just not excited about that,” he said. Bland added that backers in mega-funds do not get any personal attention, and that in a very large vehicle, the selection criteria are not as tight as in a smaller fund.

Meantime, distressed debt, turnaround funds and restructuring funds remain on the New Mexico radar screen. Bland likes strategies in which firms add value to a struggling company by folding it in with another company, turning it around on its own, or in some cases, just providing growth capital. “People that buy smaller companies tend to do well coming out of recessions,” Bland said. Small companies “can be more flexible and quicker than the big guys, and it’s an area where you can make a lot of money.” Next year, New Mexico will probably make three to five commitments of $25 million to $50 million in turnaround and restructuring funds, looking for returns of 12 percent to 18 percent as a minimum range, especially in the current environment, where opportunities abound and pricing is down.

In the past several months, New Mexico has backed several funds in this sector, including Ares Capital’s Distressed Securities Fund LP ($25 million), which seeks $800 million to invest in a variety of securities, including first-lien loans, high yield opportunities and second-lien opportunities, mostly publicly traded; and Levine Leichtman’s Deep Value Fund ($25 million), a special situations fund targeting $500 million for positions in deeply discounted debt securities of middle market companies in stressed or distressed situations.

Modus Operandi

What is it like to work with New Mexico as an investor? Expect to negotiate fees, which is the norm for New Mexico. Bland’s determination to get the best fee structure and more personal attention is why he likes sidecar vehicles and shies away from funds of funds, which add a second layer of fees. “Sometimes larger funds, because of the terms and conditions, will set up a side fund just for us so we can meet our terms and conditions, and they don’t violate their favored nation clauses,” Bland said. “It gives you a lot more protections and flexibility.”

Bland also prefers to stay in familiar territory. “We know a lot of the players, and we know the ones we like, and we tend to stick with them when they raise a new fund,” said Bland, who’s been investing in private equity since 1991. Of the 10 commitments the state made this year to private equity funds, eight were re-ups.

Aside from various types of private equity debt commitments, the LP likes buyouts and venture capital, with roughly 75 commitments to each of these subsectors; according to the Directory of Alternative Investment Programs, the 74 buyout funds listed add up to $806 million, whereas the VC portfolio totals $647 million. Recent buyout pledges include $40 million to Apax Europe VII, a pan-European vehicle targeting financial/business services, health care, media, retail and consumer and technology and telecom; $30 million to Intermedia Partners VII, a media industry private equity fund; and $60 million to Lightyear Fund II, a financial services buyout fund.

The state also places a good deal of emphasis on the amount of money the general partner commits to its own funds. Bland likes to see partners ante up a significant portion of their net worths in a fund. “If you have somebody that’s worth $500 million, and they put $50 million in, that’s memorable to them,” he said, meaning that the alignment of interests will encourage the GP to invest as carefully as possible.

Interestingly, Bland also takes stock of who the other backers of a fund will be, not wanting to be put at a disadvantage if other backers get scared and default on their commitments. “We like to be with strong hands. We like to be with people that have done this before so that they’re not going to panic out if a problem does develop.”

As with most LPs, Bland’s office is flooded with pitches. At least one opportunity a day comes through his door. In evaluating these offerings, Bland and Aldus Equity look at who has the experience, the track record, and the terms and conditions they like. Bland is not shy about rejecting an opportunity if he deems the terms and conditions unacceptable. “It’s our money, and we tend not to sign blank contracts that everybody else has signed. We’ve walked away from a number of deals because they didn’t have terms and conditions that we found acceptable.”