What does PE think about Credit Investors
High yield research analyst here covering a few industries in the leveraged loan and high yield bond markets. As private, loan-only issuers start to report Q2 results (most credit agreements require #'s within ~45 days of quarter end) and I review presentations, update my models and prepare to talk to management teams, it got me thinking a bit more about the other side of this market, the PE firms. How do PE firms view those supplying the capital for LBO's and dividend recaps - as respected partners in the investment community? Or simplistic credit analysts willing to underwrite pretty much anything? Fully acknowledge that this is a very open-ended question but curious to hear any / all perspectives from the PE side of things regarding the HY credit markets.
Side note: this post was inspired by seeing some pretty egregious "pro forma adjusted ebitda" figures in recent weeks and over the past few years.
Bump
Private credit capital (and really private equity capital too) is a commodity. Generally not much thought given other than who can provide the most advantageous terms / largest quantum of dollars. Obviously for some firms institutional relationships matter more than others.
Broadly, I would guess that most PE professionals don't understand in depth how the credit side really works and the type of work that is involved. The nature of the work is also very different - the work on the PE side is extremely, extremely deep given their position in the cap structure. On the credit side - the lack of time, significantly less access to information, and the seniority in the cap stack makes the nature of the work much shallower by comparison (and that's totally fine if you know you're going to make L+900 and 2 points of OID and the Company would have to wipe out 4 turns of equity before your investment gets impaired).
Partially disagree. Credit work for sponsor-backed deals is time compressed due to the transaction date, and diligence materials often only include a CIM, modest data room, and banker / mgmt / sponsor access. It is fairly apparent after a quick pass whether or not the credit side of the equation has obvious value or not. Just because a sponsor is paying 10x does not mean the Company is worth 10x which changes the LTV calculus for the credit - the 4x or whatever of equity below you should not be thought of as "real". "Just L+900 plus 2pts OID" (which is a respectable credit return, btw) does not mean you can just read the CIM exec summary and toss in for an allocation. Context matters. Back when 1L + baby 2L tack-ons were popular structures, it wasn't uncommon to have that exact return profile for the 2L. Problem is, the 1L itself was probably questionable and the 2L is really equity risk, not credit risk. Are you ok taking equity risk for L+900 + 2pts OID? Sounds pretty bad in my opinion. Of course, these deals still got done because people need to put $ to work and "maybe" it'll work out. The way I think about it for most sponsor deals is that, from the credit side, I'm lending somewhere between a 65 - 100% advance rate in a stressed scenario with the equity probably significantly out of the money once multiples compress. But the equity upside in that case is high enough to warrant the risk of funding the equity side of the structure. The equity creation multiple matters a lot here for the sponsor, which is why you see guys like Apollo, HIG, etc. who understand this dynamic pushing 6x and below deals and are aggressive. I've met other sponsors who really think their 10x multiple is bottom barrel and their downside is protected because of that.
You are correct that credit capital is a commoditized business in the majority of cases. Sponsors push the envelope with the credit profile because there is always money to fill it up (in good times). As a lender, I prefer to find more stressed / distressed illiquid opportunities where the tables are turned and I can dictate terms to the Company in exchange for my capital. That same L+900 with 2pts OID? First lien or super-priority security package, penny warrants, 60% or below LTV, tight covenants and probably some milestone requirements as well. Companies will take this in these situations because they either agree or go out of business.
Can you consistently find decent businesses with that need outside of extremely stressed times like some sectors are experiencing today? I agree that those situations are interesting, but I feel like the business quality of situations like that I saw last year was very low. How do you avoid adverse selection in frothy times?
Repellendus velit reiciendis quas architecto quam excepturi rerum. Quo aut unde aliquid necessitatibus illo. Vitae aut est qui architecto. Ea totam consequatur possimus quis tenetur omnis temporibus repellendus. Voluptates illum dolores sit ab non quisquam. Eligendi dolor aut dicta similique.
Molestias ut quaerat incidunt dolores illum ut. Sit magnam enim eius rerum et incidunt eligendi doloribus. Nihil suscipit maxime aut quasi.
A voluptates laudantium consequatur reprehenderit officiis illo. Eum amet consequatur voluptatem asperiores. Et quas est quod rerum. Eos at est minima eos. Excepturi ipsam qui dolore harum itaque ipsam necessitatibus. Velit ipsa id reprehenderit labore et.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...