Capital Talk – THL Credit

There are are barely perceptible traces of a Texas twang in Jim Hunt’s voice. THL Credit’s chief executive and chief investment officer is in New York for the week when Private Debt Investor meets him. He works in Boston, having moved there from Los Angeles, by way of San Francisco. He spent some time in Indonesia, but originally he’s from El Paso, hence the accent. It’s a cosmopolitan backstory for a man whose firm is also going places.

He’s a voluble character when Private Debt Investor sits down with him in mid-May. “Do you like the office? We got it when we acquired McDonnell Asset Management’s Alternative Credit Strategies Group … Nice building right?”

THL’s New York home is found in a classic New York building: the 28th floor of 570 Lexington Avenue, the old General Electric Building, (formerly the RCA Victor Building), it’s an art deco icon right in the heart of midtown.

Hunt’s affable demeanour reflects his view on the importance of borrower / lender relationships. “We want to know our borrowers,” he says. “We’re really comfortable with borrowers knowing their lenders. We want borrowers that have gotten to know us, understand what value we can bring to the table, and want the kind of partnership where if there’s adversity down the road, we have the relationships to work things through most constructively.

“It’s such a relationship or people business. Once you’ve consummated one, two, three transactions with folks, they know exactly what the stripes of the tiger are.”

Getting started 

Hunt launched THL Credit – an affiliate of buyout firm Thomas H Lee Partners – in 2007 after spending six years sourcing unsponsored credit deals with Bison Capital, a Los Angeles-based asset management firm he co-founded in 2001. He claims his decision to transition to Boston-based THL from the West Coast – he counts his years in Boston by winters – was motivated by a desire to work on more sponsored-backed transactions, something of a THL Credit specialty.

At the time of its formation, THL Credit was a $500 million private vehicle structured to invest in debt or equity securities across a variety of transaction types. The decision to launch in 2007 wasn’t exactly propitious, however, given the severity of the credit crisis that ensued.

 “In the fall of ’07, credit spreads were tightening, metrics were widening, it was a goofy time,” Hunt says. “It wasn’t until the first quarter of ’08 that broadly syndicated assets broke. We wanted to mitigate the J-curve, invest in durable credits but significantly discounted. We started being concerned about their prices, because any asset class where price was predicated on the availability of leverage we thought was fragile.

“We sold the majority of those investments in the summer of ’08. We went into the heart of the credit crisis with half the private fund’s capital called – but sitting in banks – and half uncalled. Luckily we had resolute investors who honoured their capital call commitments and it wasn’t until spring ’09 that we actually saw durable enough investments to start deploying capital [again].”

The firm continued to do so through 2010, at which point an opportunity arose for THL Credit to go public as a Business Development Company (BDC), which would enable Hunt and his team to invest and manage their relationships without having to deal with some of the fund life obligations inherent in traditional private credit vehicles.

Private equity-style mezzanine funds rely on realisations and exits for their returns, which then enable fund managers to initiate fundraising for follow up vehicles – a process that can be as challenging as it is taxing on a firm’s resources. As a BDC, THL Credit’s track record is judged more on the performance of the vehicle as a whole, rather than that of the most recent realisation, Hunt says.

“It’s not unusual to hear from private peers, ‘I’m going to go raise money as soon as I have two more realisations’,” he says. “Those private funds are actually looking to affirmatively exit a credit, whereas our interests go the other way: how can I hang onto this great credit?”

Hunt considers that element of their structure beneficial to borrowers, as it attaches them to a permanent capital vehicle, rather than a transitory fund. BDC structures eliminate the need to exit portfolio companies on a timely basis, which creates more stability in the relationship between the borrower and the creditor.

On the other end, THL doesn’t rely on fundraising efforts to refresh its pool of capital.

“A traditional mezzanine-only fund has a much tougher row to hoe in this world because pension funds – as traditional big supporters of mezzanine funds – have [labeled] credit as  ‘That’s where I’m going to be liquid’. And illiquid? That’s where I’m going to have private equity,” he says. “It’s really left mezzanine in a little bit of a no-man’s land. And that’s why I feel like we took the correct route by going down the BDC route, and accessing public capital.”

Accessing the public market 

Of course, just because it was the right route doesn’t mean it was an easy one.

According to Hunt, THL Credit’s underwriter characterised the opportunity to go public as “A window in the needle in this haystack”. Furthermore, the underwriters made the IPO contingent on a 50 percent buy-in from institutional investors – it was the only way they were willing to expose their retail systems to a BDC at the time, says Hunt. That required certain concessions on terms that the firm feels set the bar for future BDC offerings.

THL offers institutional investors a 1.5 percent management fee with no incentive fee on unrealised income, which they accompany with a high-water mark set on a 36-month basis. Wells Fargo Securities equity research department characterised the terms as a “very shareholder-friendly incentive fee structure tied to credit performance”.

“It was the right thing to do,” says Hunt. “But also it was what the market was demanding at the time we went public. As a consequence though of our having done that, and of analysts liking it, and of institutional [investors] liking it and understanding it, it’s really set a new bar in the industry. So to not follow the lead we set three years ago makes it harder for folks.”

“We came out of the box heavily institutionally-held, and have remained so,” says Hunt. “The good consequence of that though is that we ended up with a very high quality institutional shareholder base that has proven to be very loyal and supportive of the performance that we’ve had.”

There was also the matter of rolling over investors from the private vehicle into the BDC. According to SEC filings reviewed by sister publication Private Equity International at the time, the IPO allowed limited partners in the private fund to cancel their participation in exchange for purchasing shares of THL Credit.

“I would like to think the private fund investor were very pleased with our prudence and patience mid-2007 until the ‘new era’ of credit opportunities we saw beginning in late Spring 2009.  IPOing as a BDC was the plan since THL Credit’s inception and I hope they regard our successes as execution of the plan,” Hunt told Private Debt Investor  in an email, when asked how limited partners in the private vehicle responded to the IPO.

“It’s very difficult to get institutions into a BDC without the shareholder protections we’ve created,” he says. “So in some respects you can either be less magnanimous, or less aligned with the shareholder and maybe the IPO can be done in a purely retail distribution. But that’s a path that’s hard to ever [do].”