Episode Transcript
CJ Doherty: Welcome to the Lending Lowdown. I'm CJ Doherty, director of analysis at LSEG LPC. And today, we're gonna pivot from some of our recent topics and focus on capital solutions and specifically in the European market, there have been challenges for borrowers in the last few years, including higher inflation, which has resulted in tighter Central bank monetary policy and higher borrowing costs. And we've also had geopolitical tensions and supply chain problems. And so to discuss how capital solutions fits into the current environment, I'm delighted to be joined by David Brooks and Alice Cavalier. Partners and Co heads of Capital solutions at Arcmont Asset Management, Alice and David, I'm looking forward to our discussion. Thanks for joining me.
Alice Cavalier: Hello.
David Brooks: Hello. Thank you very much, CJ. Nice to join you.
CJ Doherty: Great. And and and before we delve into the nuts and bolts of the market, can you share a little bit about both yourselves and your firm?
Alice Cavalier: Yeah, with pleasure. So I'm Alice Cavalier and obviously I'm Co head of the Capital solution fund within Arcmont. So Arcmont is a is a large private debt fund in Europe and which is a mainly focusing on on private debt for mid cap companies. And with regard to my background, I've always working credit opportunistic fronts. You know, obviously before Arcmont, I was working in other competitors and I started my career at Morgan Stanley Investment Banking.
David Brooks:
And I started at Arcmont at the same time as Alice. So in January 2020, my background prior to that was also in opportunistic credit in Europe. So I had spent the previous 12 years at Bain Capital credit that whole time focused on European opportunistic investments and originally I'm a recovering strategy consultant. So I think what very much attracted us to Arcmont, if that's interesting to hear because I I think it's relevant to the capital solutions story is the fact that Arcmont is, as Alice said, one of the largest private debt players in Europe as part of that, we have extremely long term deep relationships with the private equity community with the advisors around them where we've actually done over 350 transactions with more than 100 private equity firms. And so those are established relationships really give us a very interesting in when it comes to also looking at the more complex credits with those same counterparties. And so looking at this, we thought that that was really a a tremendous opportunity for for us to be able to leverage all of that history, all of that network to be able to do those more complex transactions in a separate fund at Arcmont.
CJ Doherty: OK, great. Thank you both for that intro, and let's start with a basic question for any of our listeners who might not be familiar with it. What is capital solutions? What does it encompass?
David Brooks: Yeah, absolutely. So capital solutions in in essence it's it's really all about more complicated credit. It's a branch of Special Situations or or credit opportunities investing. There's no precise definition really, but to us it means a few things. Firstly, it means private lending, so we're we're definitely negotiating transactions for the most part directly with borrowers and it's those more complex ones where traditional lenders are not necessarily equipped for those situations. It could be about the sector at a less loved industrial sector. There can be subordinated debt opportunities where inherently they they come with more yield and there can be situations of company underperformance, but it's different from distress. So this is not loan to own. This is providing flexible, constructive capital. On on the flexibility we we are stepping in and and really being thoughtful in each case about what the the borrower actually needs. So for example, does everything have to be paid in cash or can we find other ways to make some of our return be that through a pick component to the interest for example, or often we structure things with equity upside also, but these are by their nature for that flexibility we're also earning a premium relative to to traditional direct lending and it's typically a few 100 basis points of premium. And as I've said, this is about constructive capital. So we explicitly avoid distressed opportunities loan to own or anything that could quickly move in that direction. I think it's worth saying that some other players in the market have adopted this term of capital solutions euphemistically in order to distance themselves from what they might have as a more aggressive, distressed investing track record. Historically, the nice thing about Arcmont is we don't have any of that taint because shareholders supportive lending is everything we've ever done.
CJ Doherty: Great. And and what cases is capital solutions, you know better suited than other forms of credit at addressing complex borrowing needs?
Alice Cavalier: Interesting question. So look on complex borrowing needs, you know, the the type of, you know, I guess option of financing option for borrow would be the following I think the first one would be potentially direct lending, but direct lending is less suitable because the asset class in general has become increasingly well defined and risk adverse in terms of the situation and sectors they will back. So, for instance, direct lenders, you know, now very focused on only certain number of sectors such as software, services, healthcare and also they're very focused on low leverage and strong equity cushions. So there's a lot of situations that unfortunately are not, you know, within the remit of the direct lending. As you can imagine, because you're on the European economy is much more than just three sectors, for instance. So these are the first alternative, which obviously is not really addressing complex borrowing needs. Then you have obviously syndicated markets, loans and bonds. So but again, you know syndicated market, I'm more focused on well performing credits and therefore you know again you know cannot really be tapped in in a certain complex borrowing needs. So a good example for instance is, you know, you know, triple C paper. So companies are a bit more complex and often you know rated as triple C's. And interestingly enough, we haven't really seen much triple C new issues since pre since the beginning of Ukraine war. Uh, so really that shows you that you know the syndicated loans and bonds are not interested in more complex situations and and then you know in the last rational market you have the special situation and distressed funds. But here, obviously these they're interested in inborne needs, but obviously they are seen As for the distressed, funnels are more aggressive lenders and therefore are less accepted by the companies and their shareholders for obvious reasons because they don't want to have an aggressive or vulture funds in their syndicates. So really, you know, if we conclude, you know, there's really only the capital solutions that are really ideally suited for this type of complex situation in in Europe at at the at this at this stage.
CJ Doherty: And how big of a market is capital solutions financing in Europe you know, is it growing in the current environment?
David Brooks: Yeah, it's definitely growing. I guess we'll come on to that in a minute. And your question on size is, is a great one. I guess the flippant answer that we tend to get away with is that it's big enough. And what I mean by that is that we manage a little over a billion EUR of capital in this strategy today and we've quite a differentiated position in the market where we feel we don't struggle to either source or win deals, whereas I think very quickly by some conservative estimates, you you very quickly conclude that this is a market that is worth, you know, dozens of of billions of euros in in Europe alone. I mean, if you think about prequin data sizing, the distressed and the special sits market, you know there's something like $100 billion plus of AUM across those two areas. And so we are a subset of that $100 billion industry and and as Alice said, we are I think at the moment that, that subset that is particularly well suited to to the the challenges in, in the market and those challenges are are very much what's driving the strong growth currently. Number one is is I would say maturities. So as you think about not just a public debt but but if we think about leverage loans, high yield bonds in, in the the public debt space that they're truly is a growing maturity wall of debt that needs to be refinanced in the coming years. And actually from a private debt perspective, even though there's less good data, you can very much understand that if you look back 5 6 7 years ago at the amount of unitranches and other forms of private debt that were being concluded in transactions back then all of these things are now coming back home, home to roost and and a certain proportion of those are now more difficult refinancing cases, that is propelling the the capital solutions piece of the market. And then what? Accentuates that. Further, is the quite challenging economic history that Europe has been through in the last few years and CJ, I think you very eloquently picked on some of the highlights when you introduced the topic, but it is clearly not been a particularly easy time for companies and their CFOs and therefore there are many businesses that even if they're very viable, good quality businesses, they haven't hit the business plan that they would have already had. And as a consequence, leverages is higher, refinancing options are more difficult and and that is growth.
CJ Doherty: And how is this type of strategy performed in recent times? You know what? And will it continue to generate these returns across market cycles?
Alice Cavalier: Yes, look, we think this type of strategy is compelling in all cycles. We, we, we, we we think it's all weather strategy. So I can make compelling returns in in strong economies and in more volatile environment. And the reason why we we think so is because we construct our strategy that that invest in both primary and secondary. So on the primary side, we we can, you know, invest in, in, in new LBO where there they're looking for either unitranche on the on the complex industry for instance unlocked industry by the traditional lenders such as the direct lender or you know the banks and or you know we could also look at new LBOs where we are providing a subordinated investment like a mezzanine or a Peck into again a highly performing business and even a very strong sector. And obviously in these cases, you know these new LBO and performing businesses, so this would be no stronger and more booming economy. You would see more of this type of transactions, so that would be in a strong economy, would see more of that. And then in a more volatile environment, we we also invest in into what we call your really capital solution transaction, which is really investing in businesses that have balance sheet issue such as covenant breach or also a refinancing coming up and the traditional lenders are not there for this type of refinancing. And obviously we see more of these transactions where there's a balance sheet issue in weaker and more volatile environment. So obviously in a recession or in the current environment where we have lots of volatility and businesses are under pressure for all the reasons we you you highlighted that in your introduction, CJ and then the last leg of our of our strategy is really the secondary investment which is investing in loans and bonds. When there's a market dislocation, where there's a credit dislocation and again these secondary section is also I guess emphasize in a more volatile environment. So when we see, you know for instance pass Ukraine war or you know when we had all these news about the the bank scandals and the we were seeing much more volatility in the market and therefore we were able to invest much more in the secondary opportunities. But as I said, you know it's pretty balanced in our strategy because we have both, you know this primary Lending where we are definitely doing more of that in a stronger economy, but we can balance that with with the secondary and with the capital solution where we help businesses that have balance sheet issue, which is you know we see busier in more volatile time. So that's why we feel that it's it's on on by design, A structured uh, you know, uh strategy where we can be investing in a in a high returns opportunities in all cycles.
CJ Doherty: OK, great. And let's talk about sectors. Now, what sectors are you expecting to have the greatest need for sponsor friendly capital in the new Year? Or sorry, in the next year, I should say.
David Brooks: Umm, in the next year? Well, I think firstly, it's, it's not actually just about sectors and companies that need the money, it's also about. Transactions where there are highly performing businesses, but nonetheless you're more traditional lender base be that banks or direct lending funds just aren't showing appetite for that sector. So we, among other things, we have examples from recent transactions that we've done in the automotive industry or in the aerospace industry where these are highly performing businesses. There's truly nothing wrong the business, but just because of sector reasons, people are are not on the traditional side, interested in in pursuing those transactions. So it doesn't just have to be challenging industries. With that said, clearly there are quite a number of industries that have had some challenges to work through in recent times. So I guess less is a comment on industries that we may love at Arcmont more about the sectors that need it. There's quite a range, I guess you know anything that's that's cyclically exposed or has energy or commodity price risk will have had some effects. So whether that's on one side, industrial companies or chemical or in some cases, packaging businesses, there's the the real estate market that has been dependent on on rates and and relatedly building materials, construction products, consumer and retail, some travel that's definitely an area where we have seen opportunities. And interestingly enough, some affected businesses there are dealing with post COVID dislocation. Still, I think 1 interesting example is the cycling market, which actually had a great COVID for various reasons. And then people saw that as a as a sustainable trend and and in some cases volumes have not been as sustainable as people thought, even if they have still performed well relative to pre COVID the food industry, that's something that again has been touched by commodity prices and inflation. And then lastly, parts of the healthcare market. So, for example, where you're using labor, for example in care or where you might have been affected by long term consequences of of COVID, again, we've we've definitely seen examples and and opportunities and then of course outside of the macroeconomic cycle, there's always sectors and companies where idiosyncratic challenges will arise. I think one example at the moment is fiber alternative networks. So people laying fiber to the home, that is a business model that is currently undergoing really some delays rather than I think a fundamental existential question. But, but there's definitely opportunities across Europe from those types of businesses.
CJ Doherty: And last question now, can you provide your broader market outlook on credit? You know, how do you see things playing out in the remainder of 2024 and beyond?
Alice Cavalier: Yeah, sure. Look, I think there's a there's a. There's a few few interesting facts, and I think we can give you our our crystal ball, I guess answer on the outlook, but I think on first of all on the loan market, we've seen obviously strong technically you know the yield increase significantly on the loan and bond market, but mostly on the loan side. So loans have been up here about 250% year to date and accounting for about 60% of the market as of last week and bond issuance server increase as well significantly. But it was not as much. I think they've been up 55%, definitely people are busy, more bullish on M&A. Volumes are really related to obviously, inflation moderating and rates on being absolutely reducing. So I think there's definitely a, I guess, optimism about M&A for sure. And actually, we've seen it ourselves. You know, there's much more Manning, especially on the corporate side, and we see actually quite an interesting trend on carve out. You know the separate, you know, division that are being sold of large corporate businesses that is quite a increasing significantly, at least according to us, though I guess you know this booming I guess loans and bonds feels it doesn't feel that he's going to stay to us. You know, I think for a few things for a few few reasons. And I think I think first of all, if there were much more volume, I think we would expect you know, a bit of a change in, in, in the documentation and having less, maybe more friendly, you know documentation if there were some pickup of volume, but also in general I think we are seeing some I guess deterioration or we would expect some deterioration on this yellow market. And I think a very topical name is altissia that is in the news currently and at Altisource is a very large issue in Europe and has about 24 billion of that. And obviously the risk of being downgraded is high from what we can hear from public sources. The Triple C and CLO in Europe are higher video exposed to to altissia. We understand that 85% of the European CLO have exposure of at least you know 1%. And according to Barclays, 20 slows could exceed their 7.5% triple C buckets, which obviously could be a significant issue for them. So look, I think all of that to say that, you know some, some, some like one deal, you know specifically this is good, good create some significant noise and some volatility on the secondary market which obviously has been technically very strong in the last few months. I think private credit our views that this market share will continue to increase. I think definitely sponsors and management have seen the benefits of certainties, speed of execution, simplicity, committed capital for your of direct lending versus the the the liquid market for sure. And therefore we will continue to use it even if you know the broader syndicated market is obviously. Continue if is is quite supportive. So and look, I think with yeah, I think in general the capital solution as we highlighted at the beginning, we feel is going to continue to grow because as as we said you know, traditional lenders are definitely not interested in in the complex situations and and complex situation is obviously growing in the current economy. So we think you know our strategy, the Capital solutions strategy and will definitely grow in the next few years and an offer as well, uh, you know attractive feature to to boars because of our friendliness and our yeah. And a I guess execution capacity of execution etcetera.
CJ Doherty: OK, great. And so much for us to keep an eye on over the next 12 months and beyond. Uh, David and Alice. That's all we have time for today. Thank you very much for your informative and interesting overview of capital solutions.
David Brooks: Thank you, CJ. Great to speak.
Alice Cavalier :Thank you very much.
CJ Doherty: And thank you all for tuning in. I invite you to check out our loan market news and analysis at loanconnector.com. Follow us on X at LPC loans. I'm CJ Doherty, subscribed to the lending lowdown on your favorite podcast platforms.
