Eric Lloyd, the Charlotte, North Carolina-based chief executive of recently rebranded Babson Global Private Finance, is a gregarious personality with a genuine passion for his work. His thought process drives him to ask questions – the awkward, or the difficult ones – but with more than enough charm to coax out the contrarian analysis he’s seeking.
Babson has been in the credit business since 1992, but in May 2013, it took a clear step to drive the strategy forward with an internal reorganisation to establish a distinct credit entity: Babson Global Private Finance, until recently known as Babson Capital Finance.
Lloyd came on board a few months later in October, and the platform has just wrapped up a successful first full year of operation, closing 64 deals and committing over $1 billion in capital.
This year will be a key test for the new business. The firm has opened discussions with investors for a new global private loan strategy. It is targeting around $500m to $750m for the direct lending fund and is approaching potential LPs, Private Debt Investor was told by sources familiar with the plans in January.
Babson declined to comment on fundraising
Lloyd is a banking veteran. In that, he’s far from alone within the private credit professional community. But his banking career had a twist: he’s been both poacher and gamekeeper.
He was head of leveraged finance at Wachovia, where, significantly, the portfolio remained part of his profit and loss reporting. Or as Lloyd puts it: “Guess what, you have to eat the sandwich, you can’t just sell the sandwich.”
It was a role he relished until the focus shifted away from his favourite borrowers, mid-market companies, towards the larger end of the leveraged loan market.
After Wells Fargo absorbed Wachovia during the financial crisis, Lloyd was asked to head up its securities risk management before taking on the larger role of market and institutional risk for the bank. And so he somewhat reluctantly swivelled to look at the banking landscape from a completely different perspective, with a heavy emphasis on Basel III and stress testing.
“Those aren’t things that naturally I wake up and love to do, but the skills and insights it brought me have been incredibly valuable,” he explains.
But at Babson, driving a growing credit business, Lloyd is back to his early passion, doing deals for mid-market companies. And he’s enjoying both the return to deal-making as well as the flexibility offered by joining a new mould of lender.
“We can be creative too. I probably drive people nuts with asking, ‘What about this? Why isn’t there a unitranche market here? Well then, let’s partner with these folks and go do that,’” Lloyd says.
Though the Babson approach differs materially from the ‘do the deal at any cost’ attitude that the bank market often breeds.
The increasingly benign economic environment and continued low interest rates inevitably led to tighter terms and looser structures in leveraged finance deals in 2014. For Babson that meant a small decrease in the number of deals closed last year versus 2013, because the firm has no incentive to compromise on returns or terms.
“The key part of the market for us is, we don’t really have an AUM target that we have to hit,” says Lloyd. “We’re going to do as many good deals that we find with an attractive risk return for our investors.”
He also notes that Babson’s portfolio is free of coventant-lite deals.
ABLE TO SAY NO
The Babson team are keen to emphasise that they are not a bank. Loans are not a loss leader funded by cheap central bank or depositor money to tie companies into a relationship where returns for the lender come from other business lines such as currency hedging and cash management.
“We’re not a bank, investors don’t want us to think of this as a transaction business, this is an underwriting business where you have to have a long-term view of that business. You’re underwriting to a company where you want to get your money back,” explains Neil Godfrey, head of UK distribution and a key member of the team explaining Babson’s story to investors.
Relieved of the pressure of AUM targets, if an opportunity isn’t right for his team, Lloyd’s quite happy for it to find a home elsewhere within Babson. “If we find good assets that are well priced, we’ve got somewhere to put them,” he insists.
The ability to say ‘no’ is something pretty unique in credit markets. And Babson saw some froth in the market in 2014, and the number of deals executed fell somewhat as a result. The 64 deals closed last year was down from the 2013 figure of just over 70.
All very sensible, but with a dogfight for market share on the horizon, it raises the question of how Babson will walk the line between being risk-aware and overly cautious.
IF NOT A BANK, THEN WHAT?
Babson is 100 percent indirectly owned by US insurer Massachusetts Mutual Life Insurance Company. There is a growing level of crossover between the asset manager activities of Babson, and the banking business of its joint-venture with Jefferies, something that leads to questions about the relationship between the two and why MassMu has two units actively competing with each other.
MassMutual and Jefferies has formed a 50/50 joint venture called Jefferies Finance, which targets middle market credit. It launched in 2004, with each partner increasing their capital commitment by $250 million in 2011.
But Lloyd dismisses the suggestion that there is tension between the two entities. He says it’s a very positive relationship where sometimes the two are competing but are just as often in partnership.
MassMutual is Babson’s largest investor. It comes into funds on the same footing as other LPs and demands strong performance, and it is that ownership structure and relationship with their parent that separates it from other players in the private debt space.
“We have our own money and capital at stake in every deal we do, as opposed to making a loan for the benefit of making a management fee. We fundamentally have more at stake and more of our return based on that loan,” explains Lloyd.
Lloyd says he’s fanatical about origination. In an environment where competition is growing as more funds chase credit opportunities and bank appetite for lending returns, it is key.
“There are some competitors who are in environments where they almost have to put money to work; those are scary people to compete with because you can get a false sense of what the market is. It [origination] is hard,” he says.
Neither is there a magic solution to the question of how to source deals, which is why Babson employs a number of approaches.
The firm manages $2.8 billion in LP commitments to private equity firms on behalf of MassMu and the credit arm taps into that network of contacts to help source deals.
It’s also been in the credit business long enough to have an established client base and the firm recognises the value of repeat business – especially when an early repayment is followed by a new facility with a fresh upfront fee – it all goes towards boosting returns a crucial extra few points.
Babson also has a number of loose partnerships and alliances with a variety of other firms including a number of asset-based loan providers.
With banks, Lloyd says he would be loath to enter any formal tie-up, but that they do often team up with more traditional lenders, especially in Asia-Pacific. The firm has outlined inter-creditor agreements with some lenders and finds the co-operation can be a win-win deal with the bank taking the revolver and other non-debt ancillary business, while Babson gets the longer term asset it’s looking for.
Of the roughly 1,000 potential deals that came Babson’s way last year, the firm did around 6.5 percent, deploying over $1 billion in capital.
Keeping clients happy is also an excellent source of deals and that’s what the firm set out to do for Ridgemont Equity Partners during its acquisition of Transportation Insight, a US-based logistics business. Babson had been doing due diligence in the months before with another sponsor before that deal fell through. So when Ridgemont – formed by the former Bank of America Capital Partners team – asked for a quick answer on whether Babson could back them in their move to take the company private ahead of a sale process, it stepped up.
“We had never done a deal with them before and we held a marketing call and told them: ‘Here’s what we’re good at and here’s what we’re not good at,’ ” says Lloyd. “And they told us at the end that we did exactly what we told them we’d do. And I think that’s as good a compliment as you get.”
After looking at the transaction, Babson told the sponsor that they could deliver $65 million in committed capital, and 30 days later, the deal was signed.
“It allowed us to get very attractive economics for our investors, while also having a new private equity relationship that I’m confident we’ll do more business with,” Lloyd rounds off.
The planned Babson Global Private Loan Fund, first reported by PDI in January, is global for a reason. Lloyd and his team want the flexibility to be able to invest where they see the best opportunities, whether it is a backing a buyout in Australia or refinancing in the UK.
Another reason for remaining fluid is that everything doesn’t always go to plan. When the assets weren’t there for its European Mezzanine Fund, the firm opted to approach investors and request permission to adjust the strategy. Return targets weren’t going to be met without enough assets, so the firm decided to supplement the fund with lower yielding unitranche deals while offering its investors a lower fee to offset some of the impact on their return.
When canvassed to give permission for the change, 100 percent agreed.
Perhaps it’s his risk background talking, but when you ask Lloyd what kind of deals he likes, he tells you which ones he avoids. Babson Capital Finance doesn’t often do energy – it’s too volatile and without the in-depth expertise specialist industries require, so the risk isn’t worth it, says Lloyd. Dabbling is a shortcut to getting burned.
“I’m a big believer in adverse selection and when you hobby in certain industries you’re going to get that adverse selection,” he warns.
Also on the ‘to be avoided’ list are complex businesses such as reimbursed healthcare. Similarly, deals where an equity cushion is the compelling aspect get nixed. This is because a sale at 11x cash flow is no guarantee that in harsher trading conditions the same business would go for anything close to the same enterprise value.
Babson’s debt portfolio has a significant equity cushion, but that is fallout from the credit work they do, not a result of the firm seeking positive metrics reliant on equity, explains Lloyd.
Shortly after he joined Babson, he sat down with the senior team and asked them to share the most important risk lessons they had learned. A key issue, especially with highly leveraged deals, is performance over the first 12 to 18 months of the life of the loan, so Babson has an intensive portfolio management regime for that period.
Deals are monitored for any signs of weakness in the opening stages because poor performance can ratchet up leverage into dangerous – read ‘enterprise value’ – territory. So far though, Babson has not had to work out any troubled assets.
To mitigate the inevitable risks, Babson focuses on diversification, says Ben Silver, managing director within the private finance group. Looking at competitors’ portfolios, they’re often lumpy – concentrated on sectors – which makes sense in a private equity portfolio where the equity upside can offset bad deals.
“In a credit portfolio, you generally don’t have any or very little equity upside so therefore that diversification mind set is critical and that’s ingrained in everyone at Babson,” says Silver.
BETTER DEFINITIONS NEEDED
Babson are happy telling their own story but they are less happy with the way the wider private debt narrative is developing.
Neil Godfrey, on the front line of telling that story, is blunt: “Given its infancy for new investors, if the industry doesn’t get its act together and display what the asset class opportunity really is, we shouldn’t be leading with rather glossy numbers that two, three years down the tracks investors are disappointed in. The private credit industry will look at itself and say we did a bad job in marketing the opportunity.”
Lloyd is equally scathing of managers telling investors that their senior debt fund will produce returns in the mid-teens. “If it’s the last-out part of a first-out cut up thing, the reality is that you have the sub debt,” he explains. “You just put it in a costume and called it senior debt.”
Investors have been educated on credit markets and the more illiquid nature of the opportunities over the past five years, so direct lenders are not starting from scratch, but there is confusion over what direct lending is, and more importantly, what it will return to investors, says Godfrey.
The waters have been muddied by some consultants marketing credit funds investing in the broadly syndicated loan market as direct lending, he continues.
Babson’s view is that returns will range from the high single digits to the low double digits for its senior debt strategy. Realised returns are over 11 percent on a global basis, with Asia-Pacific returning about the same and the US returning over 8 percent. With fewer realised assets in Europe, the team are keen to downplay the over 25 percent figure returned by the region, because it is not what they expect in the longer-run.
The key issue for investors assessing private credit opportunities is the illiquidity premium, says Godfrey, and that cannot simply be a function of the retrenchment of the bank market.The risks must justify the return and that should be a measurable number of basis points slapped on the price of the debt, not earned through financial engineering, adds Godfrey.
ON THE HORIZON
Lloyd agrees that leveraged finance markets got a bit frothy in 2014 and will have questions to answer when the music stops.
“You add it altogether; liquidity, frothiness, cov-lite, dividend recaps, PIK toggles, geopolitical risk… Something may go boom in the night in 2015. What it is, I don’t have any idea. We challenge ourselves all the time to ask ‘what if?’,” says Lloyd.
But equally, the firm can’t shy away from doing deals and will have to prove itself to investors in the year ahead, he adds.
The first test the firm faces is finding investors for the planned new lending fund. Beyond that, the market awaits to continue to challenge Lloyd and his team in finding the balance between aggressive origination with market discipline.
Lloyd doesn’t shy away from the challenge: “If we don’t really pull it off on a global basis with the best private credit businesses in the world, it’s our own fault because we have all the pieces in place here at Babson,” he concludes.
Babson believes that its global direct lending fund will be different from others who claim to have global offerings because AsiaPacific is not just an afterthought for them.
Around 40 percent of their deals are done in the US, with the balance roughly evenly split 30/30 between European and Asia-Pacific deals, a weighting distribution that others would struggle to match, says Neil Godfrey.
“I don’t believe that there’s anyone with the depth. They may have the experience, but not the depth to do that. We’re truly global,” adds Godfrey.
Other firms might disagree with his assessment. KKR and Partners Group both operate within the Asia-Pacific private debt market as well as having presence and strong brands in the US and Europe. Other alternative credit providers with a global outlook include UK-based ICG and Sankaty Advisors.
One of the Asia-Pacific deals that Babson is most proud of is a $75m term loan to refinance Accolade Wines, owned by Australian sponsor Champ Private Equity. Accolade is one of the largest distributors of wines in the UK and Australia with a large network stretching from Asia Pacific to Europe and including South Africa.
The deal paid a margin of Libor plus 775 basis points with a 300 basis point fee. Senior and total leverage was 2.25 times with an equity cushion of over 70 percent.
The complication was the firm’s capital structure with a number of asset-based lenders with first lien rights at various subsidiary levels, so Babson had to work through and see where they would have second lien on assets and first on cash flows.
The deal closed in February 2014.
*This article was updated on 2 February to reflect the fact that MassMutual does not own the investment bank Jefferies.