The Transformational Power of Private Credit

When reading the financial press, it is impossible not to come across an article on private credit. Most of these articles are investor based, they are focused on why private credit is a good investment and why you should have some in your portfolio. We agree with this concept, it is the reason we started GCI nearly 10 years ago, however, our view is that many of these articles are missing the most important aspects of private credit – why is private credit booming, what are the types of private credit available and most importantly for GCI, how can private credit transform a business or opportunity?

This final point is what excites us most as it plays at the intersection of capital being productive and value added, great risk return investments and boosting the economy by providing risk capital to underserved businesses in Australia and New Zealand.

The rise of private credit as a percentage of the total credit market has been driven by numerous factors which will continue as Australia and New Zealand plays catch up to the US and Europe, where private credit represents as significant majority of the credit issued rather than a minority as is the case here.

The primary factor driving this private credit growth across the world correlates to the significant increase in banking regulation post the global financial crisis, coupled with financial institutions and wealthy investors wanting access to private credit for their significant investment portfolios.

Due to changes in policy, most large banks today require large scale and highly liquid investments (i.e. investment grade debt and residential mortgages). It has become increasingly difficult for your friendly bank manager to continue to provide the same level of credit to small, medium and new businesses to allow them to grow and transform. Even when or if the banks have given debt capital to these businesses, the decision factors considered are skewed to the value of the real estate that the business owner has pledged – factories, personal homes etc.

These property-based underwrites are significantly easier for institutions to value than digging into the operating performance of a business – cash flows, assets, risks and opportunities. Increasing shareholder and regulatory pressure suggests that the banks do not have the same historical freedom to lend to these business opportunities without the real estate backing.

Private credit as it is emerging throughout the world covers numerous sectors which are all different and idiosyncratic. While all the private credit sectors are fulfilling a role, they are not all transformational to the businesses taking this debt, in the way we think GCI credit can be to many of the businesses that we fund.

All debt provided to companies or projects not provided or arranged by a bank could be considered private credit. A large portion of the private credit market relates to LBO debt (leverage buy out). However, in our world a large global credit fund providing leverage buy out debt to another large global private equity fund is not what we would call transformational. Yes, it allows the deal to happen but does it really help the businesses transform and become more productive? Likely not. What it does do is potentially enhance the returns of the private equity fund if everything goes to plan. We are not denigrating this type of credit, it has provided a role in the economy and has allowed business to grow under value added ownership. We are pointing out that many if not all of these businesses would be able to get credit from a bank or the fixed income markets before that buy out.

In the property world we have seen the emergence of two types of private credit – construction debt and leverage against properties where borrowers cannot get bank debt (residential and commercial). Both are turning out to be essential in a world where banks are pulling back. This debt is allowing new projects to be built and giving property owners a second chance.

So this leaves the question of what GCI is doing and why we consider it transformational to the businesses we lend to? GCI focuses on the “middle market”, we would define this as transactions from $5m – $50m. We believe this is the sector of the lending market that is most ignored or is the most difficult for banks or large institutions.

Companies in this sector are often changing significantly and the credit they require by its nature cannot be “cookie cutter’’. They cannot be underwritten with a simple box ticking exercise which makes it very difficult for banks to lend to as there is often not enough company or director property to lend against. The loans require a deep understanding of the businesses, the changes that are coming, potentially looking beyond any negative history and a genuine belief in their future.

This is the place where we thrive and is the place where we truly believe private credit can be transformational. Providing credit to these businesses can mean everything to their future and their owners as it arms them with the power to drive change.

These investments require us to dig deep in the due diligence. They require us to be highly flexible, nimble and pragmatic through the life of investment (loan). In this part of the market, GCI’s work is operating in a spectrum which is somewhere between debt and private equity.  It requires out of the box thinking as we need to understand the business, the opportunities and the issues and then find a way to structure around risk but also provide capital to allow the business to achieve its goals.  We believe our creative capital solutions allow businesses to transform and thereby move into a more traditional bank financing in the next stage of their journey.

The transformational capital that GCI provides can come in many forms and we look at the risks with a commercial mindset and try to find a structure that works for our investors and the borrower.

Since inception, GCI has provided transformational capital in the order of $1B that has delivered enormous value for the shareholders of our borrowers. Our transformational capital typically falls into one of the following categories outlined below.

Most lenders are constrained by products designed with a “cookie cutter” mindset. At GCI we have the flexibility to be able to look at each asset and each business individually as we are not constrained by traditional bank or institutional restrictions. We work closely with our clients to develop strategies that will help them achieve their objectives and position them for future success. Everything we do has the power to transform a business or opportunity. Everything we do requires deep thought, deep understanding, and a requirement to structure around the issues and risks to allow our borrowers to transform.

Our ability to help businesses transform is what gets us excited and helps us deliver value to both our borrowers and our investors. Just as we thought when we started GCI, we hope that private credit continues to grow in Australia and New Zealand, because it will open up new capital to underserved but worthy businesses. Private credit has the power to transform these businesses and drive economies.

To read more about how we have helped a variety of businesses transform over the years, visit www.gcifunds.com/case-studies/

Authored by Steven Sher (Co-Founder & Managing Director) and Gavin Solsky (Co-Founder & Managing Director)