Say ‘no’ quickly and often
Private Credit, and its Private Placement subset, covers a broad waterfront of different risk categories and return brackets. As a firm, we have typically focused on the investment grade part of the spectrum and developed a strong capability in identifying, underwriting and pricing assets in this area. This has helped us to be very clear with the community that introduces deals about what we can and (maybe more importantly) what we can’t do. Of course, over the years, the scope of “can do” opportunities have gradually broadened and it is vital this is understood. The other thing that banks and brokers find especially helpful is to “say no early”. This can save everyone a lot of time and we have found that it can also help deepen our relationships with the introducer community.
Beware Stockholm Syndrome
Some transactions happen quickly, but others can take many months to come to fruition. Often this entails a lot of work from our side in terms of understanding, calibrating and modelling credits. There can be a risk then that as some deals turn into bigger projects, that there may be a sense of wishing to see things through to some sort of successful completion, resulting in a sort of Stockholm Syndrome effect. Of course, this creates potential risks to investment discipline, so being aware of this and looking to counter this is important. In this regard, having a strong governance process that focusses objectively on documentation and credit, structuring and pricing risks, is essential. It can be painful, after a lot of work, to step back from a deal with nothing to show and say ‘no’, but ultimately this is what putting clients first demands.
Knowing where the premium is coming from
Our aim, in general terms, is to harvest a spread premium over publicly traded credits that derives from their illiquidity or complexity. It is therefore critically important to have analytical capacity to identify if that premium is coming from other sources, such as incremental credit risks. That means that underwriting models need to precisely define the credit risks within an investment. These models need to have the same kind of rigour as those applied by the major rating agencies, with the inputs for these models coming from industry and sector research specialists.
Staying in touch
Many of the investments we make are long term in nature. Over long periods many things can change including borrower profiles and economic conditions. It is therefore vitally important to keep monitoring borrowers, with regular periodic updates. Covenants, while not designed to entrap borrowers, can provide an important locus of communication. Staying in touch with borrowers during the pandemic period for example, proved invaluable for both sides. By working collaboratively with borrowers and their shareholders we were able to help them and reduce the risks for our clients’ capital at the same time.
Embedding ESG
Within private credit ESG factors should not be an afterthought or a “nice to have”. Indeed, many of the key risks are likely to be related to one of E, S or G. Those risks can come, for instance, from a regulated migration away from fossil fuels that might make a borrower’s assets obsolete. Similarly, any weakness in supply-chain management can create social risks that have direct economic impacts. Possibly most importantly for long term investments, having a strong governance framework is important for maintaining creditor confidence.
We have, over recent years, seen more engagement with borrowers on ESG factors and, indeed, a greater willingness to embed ESG-related terms into borrowing documents.
Don’t ask, don’t get
Agents and brokers often present deals claiming that the terms are “take it or leave it”. Our experience is that this is seldom really the case and that assuming that one can’t ask for additional things is a mistake. In this context, it is pretty important to understand that the agents are acting for the borrower and, while they want to maintain good relations with investors, they are duty-bound to get the “best deal” for their client – the borrower / issuer. This doesn’t mean that the relationship with agents should be mistrustful, rather it is a realisation that brings greater clarity to negotiations.
Indeed, we have found that asking for additional items such as additional disclosures or covenants, are often gladly accepted by borrowers. It is also worth noting that the ideal time to make requests is before a deal is closed, as following closure can sometimes be a less smooth process,
In short, over the last 10 years then, one of the key lessons of our numerous borrower interactions has been, ‘if you don’t ask, you (definitely) won’t get’.
Resilience is paramount
The above selected learnings are far from exhaustive, but we have tried to give a flavour of some of the more salient lessons from a decade of practice in private placement investing. Relative to every deal that is considered, only a handful ever make the grade, with the large majority failing at various hurdles. Perhaps the single most standout lesson from the investor perspective is the need for a resilient mindset that is disciplined and dispassionate in saying ‘no’ a lot, and as quickly as possible.