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APRIL 26, 2023
Chris Wright, Managing Director at Crescent Capital, discusses navigating a challenging interest rate environment, working with management teams, and how changes in the banking sector have impacted the private credit market.
Steve Peacher: Hi everyone. Thanks for dialing into this episode of “Three in Five.” Steve Peacher, head of SLC Management. Today I’m with Chris Wright who is the managing director at Crescent Capital, who oversees the in investment of many of the Crescent's big private credit funds. Chris, thanks for taking a few minutes.
Chris Wright: Great. Well, thanks for having me, Steve.
Steve Peacher: So the topic is private credit. It gets a lot of press these days because it's grown so much from an investor standpoint. And now rates are up, and there's talk about potential recession. So you know, the future of private credit is just a hot topic, and so that we want to talk about that today. The other big topic, of course, has been turmoil in the banking sector and the impact on regional lenders. And so I guess my first question is given the turmoil that we've seen in the regional banking industry and given that to some extent private credit providers like Crescent Capital have stepped in where the banks years ago used to be. How have we seen? What's been the impact today and what are the opportunities you see? And how is that benefiting your clients and limited partners that are invested in your funds?
Chris Wright: Yeah, sure. Yeah, certainly that is a hot topic that a lot of lots of our investors are focused on today. And look, you know, the way that we look at it is really this turmoil is only accelerated a long-established secular trend of banks, and specifically regional banks, getting out of the business of holding loans and bonds for companies. You know, if you actually look back in 1980 there were over 14,000 commercial banks that had FDI insurance. And today that's down closer to 4,000. So, there's been a 70% reduction in commercial banks over the last 4 years, and at the same time credit has been more available to companies during, it has been made more available to companies over those four years. Specifically, as it relates to the recent turmoil we do expect to have and see more owners’ regulations across the banking industry, not just with big banks, but certainly you know more onerous regulations within the regional banking sector. And it creates more volatility and volatility is what is good for private credit. PitchBook just recently did a survey of some of the sponsors, and they asked them what was the most important driver in them choosing between using a private lender or private credit provider versus going to the banks and the syndicated markets. And the number one reason that was cited was certainty of execution, and so periods of volatility, private lenders provide that certainty of execution. And so that is going to be a big benefit for our business. And with increased regulation we think the secular trend will continue LPs, I would say our investors, they really benefit in a multitude of ways. We provide them with enhanced pricing and structures over public alternatives. We also have greater access to due diligence. We have relationships with the owners of the businesses which are the sponsors. We develop relationships with the management teams. And so it allows us to be much more proactive on our monitoring of our investments, and that really translates into lower default rates and higher recovery rates, which ultimately results in better returns. And so it's really access to true partners that we are able to give to our investors. And then what I would say finally is there's a lot been written about stability of returns. And so private credit does provide more stable returns over other public alternatives. You don't see the volatility. Public markets really are driven by a lot of technical factors, and we don't have those technical factors because we do have good matching of timeframes with our investments as well as the investors timeframes and when their expectations for receiving returns are.
Steve Peacher: You know, obviously the overriding factor over the last year in the markets has been that the Fed has been so aggressive in raising interest rates, and the good news for the private credit markets is most of your loans are floating rate. So, you know it means the interest rates have gone up or return to investors have gone up, but the flip side of that is that that increases the interest burden on the underlying company because the cost of it gets going up the short rate to go up. So, how have you seen management teams and the private equity sponsors that back them handle these heavier debt services while continuing to try to fund and grow their businesses?
Chris Wright: No, I mean it's certainly, that is a I think, one of the biggest challenges that both the sponsors and the management teams are facing today. I think from a management team standpoint they are focused on costs and cost reduction and expense reduction. And so, you know, we're sitting in board meetings and working with management teams to really come up with contingency plans and how we reduce labor costs, how we reduce production costs, really to kind of offset that increased burden. So, first and foremost, it's really we're seeing a lot of cost reduction plans being put in place on the sponsor side, they have a number of tools. A number of sponsors have actually hedged their interest rate, and so they fixed it a year or two ago, and so that has served them very well. Now, not all sponsors have done that. And so those that haven't have certainly seen the burden, the debt service burden increase over time. That's where it really benefits the sponsors to have true partners in their capital structure. And so, while our yields have gone up and we're benefiting from that, we are also cognizant that we need to get our principal back at some point in time, and so we want to work with sponsors when it's a situation where there's a good company, where we can support that growth or give them that runway so that those management plans and cutting costs can get executed, and offset the increased expense burden. And so we are seeing situations where we may pick, where we may put in an incremental piece of debt to pay down cash pay debt, and in either of those cases our expectation is, is, the sponsor will put in equity. I would say at this point in where we are in the cycle, sponsors have been very receptive to supporting their companies and putting in equity. And so it's really a true partnership as we look to help offset some of the increased costs and work together for a successful you know investment.
Steve Peacher: There are a lot of cross currents in the current environment, you know, like we were just talking about interest rates are going up. The companies have to react to that, as you just described, there's increased concern that those that the increase in rates could lead to recession, which where, as a lender, you wanna make sure we protect our investments. You say we want to get our money back. What has all that meant for market for deal structure. What do you see happening in terms of pricing, terms on deals, the structure of deals? How has that changed as the environments’ changed over the last year or so.
Chris Wright: Yeah, I mean, look, it has become the leverage in that negotiation has certainly shifted from borrower to lender. So, when you think about that I kind of think about it along three dimensions, you know. First is pricing. We're seeing higher spreads. We're seeing more OID, and obviously base rate has increased tremendously. So the all-in spread has increased tremendously. We are today seeing unit trance structures, senior debt structures, in excess of 12% gross unlevered yields, and so that has that has gone up meaningfully. The second component of that is really structures. Simple, certainly a company is not able to take on as much debt with base rates at five percent as they were when base rates were at 15 basis points, and so that's translated into lower leverage. And so we've seen meaningfully lower leverage on new investments. Purchase prices have generally stayed consistent with where they were about a year ago, and so it means we're lending at a lower LTV, or loan to value, than we were a year ago. So, lower leverage with a lower loan to value. And then, finally on the documentation side, documentation has gotten much better. We're able to limit the capacity incurrence of additional indebtedness. There's tighter provisions or smaller baskets. There's fewer EBITA addbacks. There's more covenants, and there's more control, and so that all accrues to the benefit of the lender as well. And so it's really pricing structure and documentation that have all gotten better over the past 12 to 18 months.
Steve Peacher: So, I guess it's like in any market there are pros and cons, and there are certainly pros to private credit right now because you're able to dictate better terms in this environment. You kind of, no pun intended, have more leverage than you have in the past, and, in fact the deals have less leverage have higher interest rates. But you have to worry about the economy and the impact on companies in a higher interest rate environment. So it always cuts a couple of different ways. So, let me end with a personal question that has nothing to do with private credit. You hail from the great State of Michigan. So what I want to know is what's going on with teams in in Detroit. But in particular, what do you think is gonna be that? What's the outlook for the Lion. It's this gonna be the year?
Chris Wright: Well, you know, specifically for the Lions, you're asking me at a good point in time of the year. The emotions of a Lions fan follows the seasons. Unfortunately, we usually have a very good draft pick, and so we've got a good slot in the draft, and with the upcoming draft next weekend, you know, we've got 2 first round drafts, and we obviously ended this season well, which is typical for the Lions. They typically start off at one and five and one and six, and then they have a pretty good run at the end of the year, and we won I think we won eight of the last 10 last year, and I don't think there was a team in the NFL that wanted to play the Lions in the playoffs, but we fell a little short. But I’m certainly feeling optimistic. Two picks in the first round, decent one in the second round, good core nucleus of the team that's coming back that finished the season well last year, so I’ll continue to be optimistic, at least until the second week of the season, and then we'll see. We'll see where we go from there, but
Steve Peacher: Well, it is going to be interesting to see what they do with those picks, because they do have a, they do have a, they've got some good slots and you know football we need the Lions to win the Super Bowl.
Chris Wright: I would second that. I think I think a lot of the country would that would appreciate that.
Steve Peacher: Oh, yeah, everybody's used to watch the Lions on Thanksgiving Day, and we need the same to come through this year.
Chris Wright: I used to go to every Thanksgiving game that was, that was our family Thanksgiving tradition back in the day. At the Silverdome.
Steve Peacher: At the Silverdome. All right, Chris. Well, thank you for taking some time interesting comments on a market that's you know that's at a very interesting time, and definitely growing.
Chris Wright: Sounds good, thanks Steve.
Steve Peacher: And thanks to everybody for listening to this episode.
 Federal Reserve of St. Louis, 2021.
 Moody’s Investors Service, as of 9/30/22
 ICE BofA US High Yield Constrained Index
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