Credit fund managers, limited partners and advisors gathered this week for Private Debt Investor’s annual New York Forum amid a precarious time for the industry.
The event was marked by discussion of the proliferation of covenant-lite loans along with other ominous signs of an over-exuberant deal market.
Panellists agreed that the sponsor market has become significantly overheated. Henry D’Alessandro, managing director and chief investment officer at Morgan Stanley Credit Partners, voiced a preference for deals without a private equity sponsor, saying the investment bank’s private debt deal pipeline is almost exclusively non-sponsored transactions.
While the non-sponsored deals require more effort to source, diligence and close, the incentive of additional yield for those efforts does attract some managers and investors. One panellist noted there were two main types of non-sponsored companies that a debt investor could back: those owned by entrepreneurs and those owned by families.
Each presents different challenges. For entrepreneurs, there may be an asymmetric risk profile, in that any equity upside could be significant and it’s important for debt investors to receive additional incentive beyond the coupon. For family-owned entities, meanwhile, governance and diligence are among the top concerns. From a governance standpoint, the board may not have independent directors – rather those spots may be held by family or friends. In addition, records kept may not be as thoroughly as those kept by private equity-backed businesses, making accurate diligence more challenging.
Jon Marotta, a managing director at Crescent Capital Group’s mezzanine practice, agreed the sponsor market is becoming aggressive, adding that the credit world at one point could have been divided into the “haves” and “have-nots” – or those that could access the capital markets and those that couldn’t. With the frothy markets, some companies are getting debt investments that in tamer markets they may not otherwise access.
Unfortunately, managers won’t get every transaction right, so the effort involved in a workout is key to recouping as much money as possible on an investment as well as winning support from investors. Aiofinn Devitt, chief investment officer at the Policemen’s Annuity and Benefit Fund of Chicago, noted that the managers that are intricately involved in salvaging their investments are often the firms that show integrity.
Joe Lazewski of NXT Capital presented his firm’s investment in Coyne International Enterprises as a successful effort to restructure and exit an investment gone awry. NXT provided the Syracuse, New York-based laundry service and uniform rental company a loan with 3.25x leverage.
After negotiating a forbearance and unsuccessful efforts to refinance the loan and sell the company, NXT backed Coyne with a debtor-in-possession financing as it moved through the Chapter 11 process, which the company initiated in July 2015, according to bankruptcy court papers.
NXT teamed up with Coyne’s senior management team to provide a stalking-horse bid for a majority of the company’s assets, while two strategic buyers made offers on specific locations and customer routes, court filings also showed. The assets ultimately went for more than the stalking-horse bids and NXT received cash consideration that exceeded its secured claim.
Covenant-lite loans were a hot topic at the Forum as well, with many managers aghast at how loose the terms have become. Generous EBITDA addback provisions were often pointed to as the poster child for the excesses of a frothy deal.
David Golub, the president of Golub Capital, also called out “fake covenants”, or maintenance covenants so loose they essentially aren’t covenants at all, such as a leverage maintenance covenant with a sky-high limit.
The takeaway of the GP’s view of the deal market was one succinctly summarised as follows: tread carefully.