Private credit investors turn to asset-backed lending

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Andre A. Hakkak, co-portfolio manager of credit manager White Oak Global Advisors LLC with $8 billion in assets under management, said the company was “very keen” to increase its investments in mortgage-backed loans. assets because of their inflation hedging qualities.

Some of the assets backing the loans are integral to business operations and the loans are usually offered at a discount to the value of the asset, so the lender will make a profit if they have to seize the asset and the sale. , said Mr. Hakkak.

Those assets can include the trucks a company uses to deliver its goods or the servers for robotics, he said.

Also, not all direct business loans have the same risk profile, he said.

Loans to private equity-backed companies make up only about 5% of the direct loan universe, Hakkak said. Many privately-funded companies to which private credit managers had lent were heavily leveraged, he said. So these businesses will be in a situation where cash flow is tight due to the economy, while at the same time their interest payments on their loans will continue to rise as interest rates rise. , said Mr. Hakkak.

“There will be many, many instances over the next few quarters” in which some of these highly indebted companies will not be able to pay interest, he said.

Richard Miller, Boston-based chief investment officer and group managing director of private credit at TCW Group, agrees that lenders to private equity-backed companies may need to start trimming their portfolios in the current market environment.

Loan contracts with very few clauses to protect the lender, called covenant lite, have infiltrated the middle market, Millier said.

“I think lenders with covenant-lite contracts have ceded a very important tool” in their lending arsenal that protects the investor principal and gives the lender a seat at the table to help the company solve its problems, said he declared. Without covenants, the lender cannot affect the company’s operations, but “looks on the outside” while the company loses value and runs out of cash, Miller said.

Most of TCW’s loans are not private equity-backed loans and do not enter into light loan agreements, he said.

Asset-backed lending has been around forever, Miller said. They tend to gain popularity when the economy slows because “people want to lend long-lasting assets,” he said.

Some of TCW’s loans have a durable asset loan component.

Its portfolio is a mix of service-oriented companies, companies with few assets such as software and companies with more guarantees, such as industrial companies.

“I don’t know if the lending approach is materially different,” Miller said. Lenders are looking at the resilience of the value of that collateral, he said.

If there is real estate, for example, it can be reallocated and sold, mitigating lender risk, Miller said.

“As a lender, we’re not paid to be optimistic. If we’re right, we get our money back,” Miller said. Unlike private equity, “your gains don’t offset your losses,” he said.

“There seems to have been a big increase in optimism in our (private credit) market” with the proliferation of loans with fewer covenants and higher debt to earnings before interest, taxes, depreciation and amortization, Mr. Miller said.

“I would be worried if I went down a more optimistic path,” he said.

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