Private Debt Market Commentary Q4 2019
2 December 2019
"Good opportunities exist for those prepared to go the extra mile." - Stephen Catling, Head of Private Debt at Connection Capital.
- Selectiveness required to identify high-quality deals in current climate
- Favourable pricing and/or asset coverage are key areas of strategic focus
- Striking the right balance between yield generation and market risk is critical
It’s fair to say that in the private debt market, there is currently very little low hanging fruit in terms of lending opportunities. That does not mean that demand for credit from non-traditional sources from UK businesses has disappeared. Far from it: on average, we are looking at around 100 opportunities a year. We’ve always been highly selective in our processes, choosing only around three to four of those to put to Connection Capital clients annually. However, in today’s climate this approach is well and truly coming to the fore.
Careful selection more important than ever
There are always sound businesses seeking capital. But given economic and political uncertainty, and as we approach the end of the natural credit cycle, in-depth expertise and thoroughness are more important than ever to sift the wheat from the chaff. Rigorous screening and due diligence are essential to ensure business models are resilient, management is strong and governance is robust.
As a result, deals may take longer to complete, sometimes even requiring companies to be restructured to get them into the best possible shape – hard work that not many market participants are willing or able to do.
Our model means we are in a strong position to spot and capitalise on the best opportunities, even when times are tough. For those players at the volume end of the market, it’s a very different proposition. Clearly, finding 50 good deals is far harder than identifying a handful. Resources are often more thinly spread, allowing less scope to analyse the opportunity set in minute detail. Few, if any, other players have Connection Capital’s flexibility to structure deals in whatever way best suits a specific business, while serving our clients’ interests.
Balancing security with the search for yield
In order to generate risk-adjusted returns that are targeted to beat the market, right now our strategy is primarily focused on pushing for better pricing and/or ensuring a solid security position. Assessing everything on a deal-by-deal (rather than wholesale) basis is an advantage here, in order to pick the right type of credit structure for the circumstances.
Balancing yield generation against market risk is currently the name of the game. While interest rates remain low, yield is front of mind for many investors, making income-generating private debt highly attractive.
However, clients are pragmatic. In the current climate, they are responding particularly well to private debt opportunities where there is real asset coverage over which we can take a senior charge, but which may have more modest (yet still very appealing) return profiles in the high single (rather than double) digits.
Portfolio performance and outlook ahead
Overall, despite macro turbulence, the existing Connection Capital Private Debt portfolio is performing well, reinforcing the importance of careful selection processes to create a well-structured, resilient portfolio. Over-exposure is not to be recommended at the best of times, and certainly not now, which is why keeping the portfolio relatively small and highly focused is a sensible strategy.
Going forward, we are increasingly being approached by senior lenders and institutional funds to act as co-investment partners. Done right, this kind of co-operative arrangement can be win-win, as we can access their deal flow, while benefiting them by opening up new parts of the debt curve, and we are developing those relationships to benefit our clients.
Whether 2020 brings more or less certainty, we expect to be able to continue to offer clients exposure to good deals irrespective of macro political developments, especially since bank lending to SMEs remains subdued. By being smart about where to invest, focusing on quality not quantity, taking our time, working deals hard and by being flexible, we’re confident about the prospects for the year ahead, with a clutch of exciting opportunities already in the pipeline.
Stephen Catling, Head of Private Debt - October 2019.