As the world faces an unprecedented global health crisis, the escalating global economic crisis is in itself novel and completely unprecedented. While it may be tempting to draw comparisons to the economic shock experienced by global markets during the 2007 GFC, the current crisis is in many ways vastly different. Importantly, unlike the lack of lender liquidity experienced throughout the GFC, credit funds and other alternative lenders have raised vast amounts of capital over the past few years and remain a viable source of funds for businesses seeking flexible liquidity to see them through the uncertainty ahead.
While domestic and overseas banks focus on mitigating the fall out for current customers from the economic downturn, we are hearing from many private debt providers that have committed capital available to be deployed and are actively looking for good opportunities.
This article will discuss private debt capital as an alternative to traditional bank debt and equity raisings (for equity raising in the current markets see our earlier article, Raising Capital in uncertain times)
What is private debt capital and why consider it?
There are currently over 100 non-bank lenders operating in the Australian market, who have outlayed loans in aggregate of approximately $150 billion. Providers of private debt capital can come in varying shapes and sizes but increasingly private credit funds and other non-bank lenders are cementing their place in the market as alternative sources of more flexible debt. A debt capital provider will have an investment mandate and a preferred asset class (or choice of asset classes) in which they invest, often driven by a particular in-depth knowledge, experience or understanding of the industry to which the preferred underlying assets relate. Because of this specialised and in depth knowledge, we often find private debt capital providers are able to effectively and efficiently understand and cater for the unique lending needs of a business in rapidly changing market conditions.
The advantages of private debt capital
There are a number of advantages to pursuing private debt capital over traditional bank loans or other financing options. These include:
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greater availability and often risk appetite, particularly when markets are volatile;
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less reliance on non-negotiable “standard terms”;
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greater covenant flexibility, often driven by a more in-depth understanding of the borrower’s business;
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willingness to consider, and flexibility to provide, more variety in lending structure, including whether the funds are provided as senior, mezzanine or junior debt or as a hybrid structure;
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frequent willingness to structure financing options that include capitalised interest, deferral of amortisation or balloon repayments, thereby deferring the need to pay interest and make repayments during the current crisis period;
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ability to take equity upside if necessary for risk sharing in the current environment;
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more involvement at borrower level with some private capital providers taking board or board observer roles in order to guide businesses; and
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less regulatory constraints, such as those that typically apply to bank lenders (e.g. prudential capital limits imposed by APRA).
In general, many private debt capital providers are able to assess the borrower’s business from more than one angle and can often take a commercial view on short to mid-term risks if they have a clear turnaround or growth strategy.
Limitations of private debt capital
Despite the many advantages of private debt capital, there are elements of private debt capital which may limit how attractive such debt may be to borrowers:
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costs;
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covenants; and sometimes
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control.
Cost
Private debt is often more expensive to obtain than traditional bank debt. This is not just because interest rates and other lending fees can be higher, but costs will also increase when bespoke finance documents are required, or complicated lending structures require specialised advice.
Private lenders may also require returns in excess of interest and fees, such as options, warrants or other profit sharing style arrangements. However, when weighed against the risks to the company of not obtaining cashflow reprieve in an already stressed economy, any such disadvantages tend to pale in comparison to the consequences of not obtaining sufficient funding to survive the crisis period.
Onerous covenants
At the same time, private debt documentation generally includes covenants which provide an early warning sign in the event of any deterioration in creditworthiness of the borrower. The covenants empower the debt provider to engage with the company to remedy issues where necessary. Debt providers in the Australian market, particularly during uncertain times such as the present, tend to also require a more intensive range of covenants than alternate lenders or bond investors in overseas markets.
Control and oversight
A final consideration for a borrower in relation to the private debt market is around control and the level of oversight. Private lenders typically take a more hands-on approach to their debt portfolio investments then traditional banks. In addition to bespoke reporting, forecasting and business plan oversight, some lenders may also require board observer rights, director appointments or even veto decision making rights in respect of certain matters to be decided by the business. The implementation of these measures is going to be particularly likely in the current crisis environment. However, these additional layers of oversight and control should not necessarily be seen as a negative by a board of a company. Private lenders will often bring with them a wealth of business transformation, growth and turnaround experience which can provide useful guidance for the board and business during the volatile months to come.
The Hamilton Locke finance, restructuring and insolvency team have deep experience acting for a variety of stakeholders in both debt and other lending structures, and across a wide range of industries. For more information on banking and finance, debt structuring and restructuring or advice on insolvency and distressed debt, please contact Zina Edwards (Zina.Edwards@hamiltonlocke.com.au) or Nick Edwards (Nicholas.Edwards@hamiltonlocke.com.au).
