Garrett Black April 08, 2015
Chris Flynn, co-CEO and co-CIO of THL Credit, was kind enough to share some thoughts regarding credit markets, debt usage and fundraising, leverage levels and more. The transcript of our Q&A is available below:
What’s your take on the current state of credit markets, and how do you foresee it affecting your business looking ahead to the rest of the year?
The credit markets are competitive, but value can still be found with a solid direct lending origination platform and an ability to structure creative credit solutions. We expect the market to remain competitive through 2015, and expect to continue to work with our private equity sponsor partners to provide financing solutions that meet their needs while providing an attractive risk‐adjusted return for our stakeholders.
An additional theme that we are watching is a pullback from commercial banks due to tighter regulations. For alternative lenders like THL Credit that provide greater structuring flexibility, this has created an opening to take a greater share of the direct lending financing market.
In a recent PitchBook survey, respondents indicated that in 4Q 2014, senior debt usage increased sharply after mostly rising through 2014, while non‐senior debt usage—although proportionally much smaller—rose as well. Is this merely due to how unattractive middle‐market junior debt is right now?
We have not been active in the traditional mezzanine market recently and have reduced the percentage of subordinated debt in our portfolio. THL Credit, Inc.’s holdings in subordinated debt have shifted from 24% of its portfolio in December 2013 to 13% in December 2014, while its holdings in senior secured debt (1st and 2nd lien) have increased from 65% to 72% during that period. By moving up the capital structure, we have been able to win mandates by providing more flexible capital solutions. In this market, private equity sponsors are looking for creativity and flexibility when selecting their financing partners. To be a meaningful partner in this market you need to bring multiple financing solutions to the table.
One solution that is becoming increasingly prevalent for us and other lenders is a first‐out/last‐out or bifurcated unitranche structure. This mimics a more traditional first‐lien/second‐lien or senior/mezzanine structure, but provides a single credit document to the borrower and increases ease of execution, while maintaining an attractive blended cost of capital.
For a comprehensive look at the U.S. PE scene, download our latest Breakdown by clicking here.
It would appear leverage levels are still fairly low, with sponsors putting in more equity, yet price multiples— although they may have inched downward slightly—are still fairly high. What is your read on this?
We believe the middle market is bifurcated to a degree. Strong sponsors that buy clean businesses are going to pay full purchase multiples and be able to demand high leverage multiples. On more storied opportunities, leverage levels are lower and the sponsors are putting in more equity capital to close the transactions. In these situations, the market is less competitive for the debt financing and lenders are able to garner more attractive rates and terms, though there is more wood to chop during the underwriting process.
Do you foresee another active year for private debt fundraising? Current monetary policies currently seem set to encourage that.
Yes. Investors are still searching for yield in a very low yield environment. True direct lending platforms are a great way to access these yields as long as the investor recognizes not all direct lending platforms are the same. Additionally, publicly‐traded BDCs are a very efficient way for retail investors to access the higher yields available in the private debt market while retaining liquidity in their investment exposure.
How do you think the current push to make distressed energy plays will turn out?
As with all distress or point‐in‐time trades, timing is critical. We feel that there will be a great opportunity for lenders to make money in the lower middle market energy space, but feel as we sit here today we are still in the early stages. The upper middle market or large cap market may move a bit more quickly.
Obviously no one knows the direction or magnitude of change in oil prices going forward, but prices appear to have settled in around $50/bbl for the last three months. The initial lending opportunities will likely be with companies that cannot adjust their cost structures to handle the lower price environment, or those that were already highly levered before the fall in prices.
A recent report from White Oak seems to indicate that debt financings for PE‐sponsored transactions underprice illiquidity risk. Do you agree?
The article brought up interesting points, though we found it hard to agree or disagree because the illiquidity gap quoted in the article was a pretty wide range: 100 to 400 bps. Right now liquidity in the syndicated loan market is generally weaker, with fewer deals coming to market, lower dealer inventory, and re‐pricings drying up in part due to implementation of new Dodd‐Frank rules. There is less liquidity in the syndicated loan market now than in 2008 or 2011 and because of that, liquidity risk becomes an even greater consideration in the underwriting process. In short, we think investors should expect some premium return for having their capital tied up for an extended period of time. With that said, investors should remember that just by having the right to sell or liquidate does not necessarily mean that there will be a reasonable price to execute when they are looking for a bid.
Mr. Flynn is Co-Chief Executive Officer and Co-Chief Investment Officer of THL Credit, Inc. and THL Credit’s Direct Lending platform, Co-Chief Executive Officer of THL Credit’s Tradable Credit platform, and a member of the Board of Directors of THL Credit, Inc. and THL Credit Logan JV LLC. He also serves on the Investment Committee of THL Credit, Inc. and THL Credit Logan JV LLC. Previously, Mr. Flynn served as Co-President and, prior to that, Managing Director, of THL Credit, Inc. and THL Credit’s Direct Lending platform. Since joining THL Credit, Mr. Flynn has been involved in origination and closing investments, portfolio management, capital raising and management of THL Credit’s direct lending private funds and accounts, and the establishment of the Chicago and New York offices of THL Credit’s Direct Lending platform.
Featured image courtesy of Wikimedia user Revisorweb.