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Interview with: Private Debt Analyst

What is Private Debt?

Think Private Equity, but in debt instruments. Private Debt invests in privately placed bonds that are closely negotiated between the bond issuer and purchaser.

Debt structures are often highly tailored to the needs of the issuer. Due to this closed negotiation process, private debt investors often can “peek under the hood” and more thoroughly look at underlying credit issues. Accordingly, debt structures of private debt contracts are often stronger than that of public bonds.

Private debt can be both Investment Grade or non-Investment Grade.

What asset managers are looking for private debt and how does this fit into their asset mix?

Private Debt is a part of an asset manager‘s fixed-income strategy to provide yield enhancements to fixed-income investors. The current low yield environment incentivizes fixed-income investors to seek out higher yields without sacrificing credit quality. To this end, investing in Private Debt allows investors to gain exposure to often secured debt instruments with strong credit quality and closely negotiated debt terms, while receiving higher interest payments than the general public bond with the same credit rating.

What are the upsides to private debt over public debt?

As alluded to above, Private Debt’s main advantages vs. public bonds are:

  1. Higher yield compared to a public bond with the same credit rating, mostly due to ability to structure terms that are tailored to the needs of the borrower, as well as the need to compensate the illiquid nature of private investments. Private debt is often held until maturity because there is not an active secondary market to trade the bonds.
  2. Debt terms and structure are stronger than that of public bonds, particularly in the Investment Grade space. Often times the term structure of public investment grade bonds are quite loose. In Private Debt however, each transaction is highly structured and risks are often mitigated through very specific debt terms.
  3. Investment Grade Private Debt is often secured, whereas public IG bonds are often unsecured.

What returns do you expect from private debt and how does this compare to public debt?

Higher than public debt given the same credit rating due to an illiquidity premium and the ability to closely negotiate with the borrower/dealer.

When you look at major private debt strategies in direct lending, mezzanine debt and distressed debt, you often have a better risk-adjusted return than private equity.

However, like anything else, this is influenced by supply and demand. The attractive returns of private debt have resulted in a lot of capital being raised for private debt funds and the resulting erosion of pricing and structure (weaker covenants being negotiated).

What does an asset manager benchmark private debt to?

There is no specific private debt benchmark. The market uses a fixed-income index comprised of public corporate and government bonds that has a very specific duration. The Private Debt Funds are duration matched to its comparable benchmarks, but should outperform benchmark in terms of yield.

What companies issue private debt? What are some institutions that issue private debt?

A wide range of corporations can issue Private Debt, either through on-balance sheet financing (ie. issuing a private bond at the corporate level), or through off balance sheet financing (ie. project financing – issuing a private bond for a specific project through a single-purpose, bankruptcy remote SPV). In the case of project finance, the private debt is non-recourse to the Sponsor (ie. the corporation that owns the SPV / borrower) and the private bond is secured by the cash flow and asset of the project. Examples of projects include infrastructure, renewable energy projects, real estate, or equipment financing.

How does a private debt investor consider duration?

Duration is considered through an asset liability management context. Private debt is often offered as part of a LDI (Liability Driven Investment) strategy to manage future liability cash outflows of pension funds and insurance companies. Fund durations are matched closely with the benchmark. When an investment is dropped into a fund, duration may move significantly and therefore a portfolio manager has to barbell the duration to ensure fund duration closely matches that of the benchmark.

How much of the private debt issue is negotiated (buy side investor is the primary point of sale)? What are some terms and conditions that are need to have? What are nice to have?

Almost all deals are closely negotiated, either directly with the borrower or through a dealer. Each deal has specific terms and conditions to provide tailored solutions to the borrower. Terms and conditions depend on the credit profile of each transaction.

Can you walk me through covenants – maintenance, incurrence etc.

They are deal dependent. As mentioned above, structures have weakened lately as liquidity has flooded the market.

However, they can be non-standard as opposed to public bonds, which generally will have common features in place. Private debt can be negotiated to meet the needs of borrower and lender.

What are terms that a private debt investor should consider before making an investment?

As a buy side investor, you are mainly looking at the credit quality of the transaction and yield enhancement vs. public comparable bonds.

How is private debt marketed to the buy side?

Private debt can be marketed to the buy side either directly from the borrower/Sponsor, or through an investment dealer / investment banking shop.

As you do not require a trading desk or debt capital markets platform/balance sheet to help broker a private debt transaction, financial sponsors and private capital teams at boutique investment banks such as Guggenheim are always in touch with their buy side accounts to raise capital.

For more bond like instruments, banks will have private placement divisions as a subset of Debt Capital Markets or somewhere else. Investment banking fees on private debt can be 1-3% depending on the need for structuring and the difficulty of placement.

What experience do you need before going into private debt?

  • Strong financial modelling skills a must
  • Corporate or project finance credit analysis
  • Basic knowledge of fixed income is nice to have. Ie. understanding of the bond market, how interest rate and duration impact bond valuation, yield curve, etc.

What are some private debt technical interview questions?

Both behavioural and technical. Technical I would like to test the candidate’s ability to analyze the credit quality of companies and their modelling abilities. Behavioural I’m mostly looking for people who are problem solvers, who take initiative, are self-starters, and have an insatiable appetite for learning. Strong verbal and written communications are a must. The candidates should also have the ability to understand complex deal structures and identify risk mitigants.

Who are the leaders in private debt investing?

In Canada, TD Asset Management, Sun Life, Manulife, pension funds (Canada Pension Plan Investment Board, Ontario Teachers’ Pension Plan), Blackrock, credit funds in the US.

In the U.S. and abroad, plenty of private debt shops and divisions which may be called illiquid credit, private credit, direct lending etc.

Major players are everyone from Oaktree to Apollo to Magnetar and are all across the credit spectrum.

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