As private credit becomes more competitive, managers may diversify their platforms, whether it’s via sector speciality or through multiple credit strategies. Doing so through both methods can be a boon to credit managers and allow them to better serve their investors, Howard Levkowitz and Rajneesh Vig, CEO and President respectively at TCP Capital Corp, say.
What are the benefits a broader platform can bring a private debt manager?
Howard Levkowitz: A broad platform can be thought of as one that invests across a variety of asset classes and also across a variety of different industry sectors. We see managers that specialise in certain industries, managers that are generalists, and managers that focus on only one asset class.
Having a single platform that specialises in different industries, different assets and different parts of the capital structure – provides a much better opportunity for deal flow and for understanding investments. A manager that sees investments opportunities across different sectors and also in different parts of the capital structure is going to be able to leverage that deal flow and knowledge along with contacts within industries to create better sourcing opportunities and more effective deal structures. Ultimately this creates better deal flow and investments.
Can you talk a little about how direct lending and special situations operate differently, and can/should they complement each other?
Raj Vig: With regard to special situations and direct lending, TCP Capital Corp. handles both strategies. These strategies complement one another because the ability to assess risk at both the industry and company level helps a manager understand risk broadly and mitigate it through appropriate deal structures.
Working across these two strategies also allows a manager to avoid certain identified risks outright. When making investments, it is important for the manager to effectively underwrite investments from the outset, crafting the right protections or mitigating or eliminating identified risks where appropriate.
When it comes to challenged investments, these complementary skills allow a manager to react quickly and address problems effectively with a team armed with special situations skills that are experienced in managing such situations. This allows the manager to come to a better resolution more quickly, and ultimately to deliver a better return – in terms of the risk taken and the reward received for that investment.
Can corporate cash flow direct lending and asset-based lending fit together, and if so, how?
RV: Yes, in our case, when you think about asset-based lending and speciality finance, it is similar in many respects to cash flow lending, and we provide both. Ultimately, when you’re underwriting a loan or making an investment, it’s important to understand the value of the operating company and its assets, and the level and stability of the cash flows being generated by that business or those assets.
In the case of asset-based lending relative to traditional cash flow lending to an operating company, the assets that secure the loans and generate that cash will likely be different. For example, the assets may consist of a portfolio of loans rather than the cash flow generated by an operating plant. Alternatively, instead of cash flow from a software business, it may be cash flow from mortgages or other types of financial servicing rights. But at the end of the day, understanding the assets and the company’s ability to generate cash flow that will service the debt is the most important thing, whether it is from a portfolio of unique cash generating or operating assets.
So, asset-based specialty finance fits in a broader platform, but being able to do it effectively requires looking at the niche set of assets in isolation, the same way you would a specific company within any other industry.
How does a manager source quality deals?
RV: The key to sourcing quality deals is to source them from a very broad, very diverse set of places – whether that’s different types of counterparties such as management teams or board members, a broad range of intermediaries and advisors, or sometimes, but not always, private equity firms. Having a breadth of well-established relationships allows a manager to source from many different places simultaneously rather than being tied to or beholden to any one group, and therefore having fewer deals to choose from as the market changes.
In addition to having a breadth of relationships, it’s important to have a lot of history with deal sources so people aren’t just coming to you for the lowest price or the easiest structure. Instead, they are coming to you because they believe you can move more quickly, are more constructive, or will take the time to understand their business, and ultimately craft a better financing solution.
What specifics should investors look for when they choose a private credit manager?
RV: Return is always going to be a very important factor, whether it’s internal rate of return or some other measure such as a multiple of money. What’s also important for investors to assess is how a manager got to their returns, meaning how much risk was taken for that return? Whether it’s a lot of volatility in the returns over time, or a lot of risk in underwriting in the case of a private credit manager. How much principal impairment has the manager faced? How much principal loss have they suffered to get to the net return?
Ultimately, while return is an important measure of risk – and we think principal impairment and principal loss as good measures of that over time, for private credit – measuring risk taken is equally important in assessing a manager.
HL: Experience is critical. It’s important to look at how long people have been in business and where they’ve been doing it. There are many new entrants to the direct lending industry and having experience over multiple credit cycles is very important.
How should industry evaluation play into credit selection?
HL: Industry selection is critical. While the economy overall is growing, certain companies and industries are going through challenging times or facing disruptive change. In many industries, the changes are as significant as what transpired in the Industrial Revolution, but change today is happening much faster. In our view, having a deep understanding of industry dynamics, and what they say about the future versus looking in the rearview mirror, is absolutely critical to analysing, underwriting and structuring transactions.
This article is sponsored by TCP Capital