Roles in Credit and the rise of Double-Dip Financings

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Welcome back! It’s time for another edition of the newsletter. This is a three-part newsletter:

In Part I, we’ll discuss some of the initial murmurs on hiring trends within the credit markets.

In Part II, we’re going to have some commentary on some popular credit tweets and explain how it relates to some of the careers you can pursue in credit.

While I’m looking to shift a bit during the rest of the year towards what I’m up to in Private Credit, Lender-on-Lender has been highly topical. So in Part III, (the Premium portion of the newsletter) we’re going to talk about Double-dips. In a prior paid piece, I talked through uptiering and drop-downs from the lens of a liability management exercises. Double-dip financings have grown to be an increasingly important type of liability management, so I’m overdue to talk through the mechanics on those a bit and to cite some notable examples.

Part I

On my Insta story the other week, I anonymously requested feedback on how hiring trends in credit were shaping up in early 2024. The good news? Hiring in Credit is looking good so far.

Private Credit: Respondents overwhelmingly seem to be hiring. This includes LMM firms, but also some big shops like KKR, BlueOwl, TwinBrook, and JP Morgan Credit. For Example, Adams Street is hiring a Private Credit Associate for a Summer 2024 Start. Additionally, Blue Owl is adding a Workouts Associate.

Public Credit: For the most part, it sounded like public credit employment is holding steady. So no job cuts plus stability is great. But even better, some liquid credit shops are looking around for professionals. “Steady” seems like the main takeaway at the moment though, with some hiring around the edges.

Private Equity: Had fewer responses here but half of the respondents noted that hiring is picking up, while the other half of replies weren’t so hot. Hiring smaller Associate classes, or cutting in mid-career levels made up a few of the responses. Some MM and LMM firms were looking to add 2+ Juniors. What’s interesting about PE though, is a few respondents said that the Cap Markets teams or IR are hiring, but deal teams are not. One PE professional noted that the juniors they hired in ‘21/’22 are going to be used more often now that activity seems to be picking up.

Separately from Credit and PE – Some RIA guys let me know they’re hiring like crazy rn.

A key trend though for ~10% of “yes we’re hiring” respondents was that they’re just backfilling roles, not hiring for growth.

One response noted that “it’s too early to figure out hiring, we need to see what happens in February/March post bonuses” and I definitely agree with that sentiment. If people start moving around suddenly, then firms looking to backfill that role will drive a second wave of hiring. Another interesting quote was: “Some recruiters are saying supply outstripping demand is driving comp lower”.

Ultimately though, there is a decent amount of hiring going on to start the year - especially in private credit. I always tell people you can’t just rely on the obvious channels (LinkedIn). When you’re looking around you need to ping people on the street you can trust and get a sense of who is looking to fill seats.

Part II

I did a “Day in the Life” tweet that got a lot of attention (naturally, this is the Golden Age). So let’s dig a bit more into the dynamics of sponsor direct lending:

Sponsor Direct Lending:

A big point I try to stress in this market is that deal flow is relationship-driven. It’s important to have good relationships with Sponsors who regularly give you looks on deals they’re working on. There’s plenty of memes of direct lenders bootlicking and simping for private equity, but despite the power dynamics, it’s a win/win situation for both parties if a Sponsor can find a Lender they enjoy regularly working with. You may not want the same lender in every deal, but it’s crazy how much business comes down to the same 10, hey, maybe even 5, sponsors regularly showing you deals.

Direct lenders provide unitranche variable interest rate loans to Sponsors. Think of unitranche as a blend of senior secured and junior rates, but bundled into a one-stop solution to provide Sponsors with speed and certainty. Part of the joke in that tweet is Sponsors like lenders who “move fast” with them, and when you’re pitted against other lenders to move quickly early on as well, then you need to get terms out asap.

When the base interest rates rise, bank lenders pull back or when things get tougher and dicier, the rate a lender can charge goes up - hence, the golden age of private credit. The farther down the market you go, the more you might use PIK (Payment in-kind) solutions, where interest accrues to the debt balance, as opposed to being paid out as cash interest. The PIK feature of debt is recognized when the Sponsor pays down the debt. For example, if you lent $50mm but had a PIK interest, you might end up with a closing debt balance of $55mm when you get refinanced, helping juice your exit IRR as a lender.

Fears with this market: Relationships aside - you are a commodity – you need to provide the cheapest financing with the least amount of friction possible. Maybe that’s a stark way to look at it, but 9/10 times am I wrong? If you’re a more senior, relationship-driven person it’s up to you to appease the private equity Chads. You have to eat it sometimes. But there are areas you can push back on, and you also get paid pretty well, just not as well as private equity. Another fear in the market is that “the golden age” was 2022/2023 and now private credit will rationalize as CLO issuance picks up and middle market sponsors/portfolio companies look to refinance in the broadly syndicated loan market. When rates are at 5%, there’s a pullback from traditional lenders to provide capital, driving the need for private, direct capital. But if rates swing back down, you might start seeing borrowers move towards financing that’s cheaper than private credit, as well as covenants that are looser than public credit. I don’t think this is a 1H24 story though; at least based off of the past month or so.

We’ve discussed some of the other key risks in the past too: when Sponsors can get aggressive in initial terms and shop around to find the most accommodating lenders, you can find yourself in a situation with looser docs, a dicey EBITDA bridge, and/or lower than ideal pricing. Direct deals have less liquidity – you underwrite harder because you can’t really trade out of it. Even though credit docs are tighter for the most part and you can potentially syndicate some of your debt away, depending on the shop, but in most instances once you’re in it, you’re in it. The ironic, unintended version of “Loan to Own.”

Addressing the other points from my tweet: Things move very quickly in Private Credit - that’s why my note on quickly moving on a deal on short notice and even over the weekend isn’t completely a joke - it’s the reality. Some of the deals move with hilarious speed, always with a 5:15pm-5:45pm call to action by an MD imploring his junior staff to “sharpen their pencils” and give a timeline on how quickly “we” (this means you anon) get something in front of IC.

It’s sometimes hard to 100% immediately understand what exactly a new Company you’re looking at for the first time does. Especially if the materials you’re provided are quite obfuscating. So you may be cranking away on a Saturday afternoon, writing about the pros and cons of a Company, building out a model, and still not really understanding what exactly the Company you’re analyzing does quite yet. When you get thrown into a quick deal, you’re really “learning as you go.” It will come together by Sunday night, you’ll be able to figure it out by then, but man you’re really low-key learning along the way. This isn’t even a Junior thing tbh - the MD may not even truly get the Company at the initial look. They’ll obviously be ready to make their sales pitch prior to the IC meeting, but it may not just be you who is learning on the fly.

The end result to this 3-5 day stretch to quickly put together an IC Memo? Usually a rejection from the Bulldog. What’s a Bulldog, you ask? → this UnstructuredCapital Meme nails it. It’s the guy who kills every deal over a small EBITDA adjustment. He’s the type of guy who doesn’t want to do 95% of deals. And if he’s on your Investment Committee, all the work you did this weekend is going to be for naught.

Sure this doesn’t happen every time, there’s plenty of deals to get done that Sponsors send your way, but man it certainly stings after blowing up your weekend for this. But hey - could be worse, could be even worse hours in banking.

So who can get into Private Credit? Investment bankers have a clearer path into direct lending given the deal team-oriented nature of the work and the modeling, negotiating, and structuring associated with the job. Plus they may be used to those weekends of work disappointments. There are out of school hirings for direct lending though, with firms like Antares and MGG Investment Group for example.

Part II of Part II - there was an amusing tweet the other week on Twitter that poked fun at the different types of careers in Credit.

These are all in good fun, but let’s talk through the background of these types of Credit roles. I talked through Sponsor Direct Lending so let’s go through 1) Non-Sponsor Direct Lending and 2) CLOs. I will find a time to talk about the more “middle-office” oriented seats at a later time, plus IG, but encourage anyone in that type of seat (let’s say Credit Risk or Portfolio Management) that you can absolutely 100% pivot into Public or Private Credit one day.

1) Non-Sponsor Direct Lending: (Fundless Sponsors)

Fundless sponsors, as the name suggests, are sponsors but without the money. They have to raise $ on a deal-by-deal basis and often put in very little of their own cash equity (they might roll a transaction fee and count it as equity) to finance a deal. Some of these fundless sponsor groups are relatively more junior investors or don’t have a significant private equity or operating background and are not people you’d want to have to call all the shots. Naturally, this group is having a harder time raising capital and executing on deals given the rise in interest rates and fall in M&A activity.

Given that non-sponsors have a harder time raising money, this is a great opportunity for non-sponsor lenders to extract attractive returns and terms that traditional sponsors may not allow. Having a less competitive and less “chiseled down” negotiation process compared to working with a traditional sponsor can drive higher returns, but more work. Some of the headwinds in doing deals in this space are as follows:

1. Deals take longer to close and have more execution risk – working with a non-sponsor creates a longer timeline and more inefficiencies in their processes.

2. You’re working with a Sponsor who can’t write a check - what if the purchase price increases or if someone needs to put more capital into the business in a couple of years?

3. Deal quality may be pretty poor unless they somehow stumbled on a gold mine - hence your Pokémon card collateral.

I spoke a little bit about SMB business analysis in a prior piece, and you can probably tie a lot of that same thinking in here in terms of fundless or independent sponsor lending. You can learn in greater detail about the typical economics of an independent sponsor here, via the law firm McGuireWoods. The report details typical transaction size, multiple, fees, and carried interest hurdle information for independent sponsors.

 2) CLOs/Loan Shops/High Yield:

Credit Analysts are segmented by their industry/industries and spend time focusing on their coverage and evaluating new issue. Managing your coverage includes keeping your ear on the pulse of any news updates, changes in trading levels or runs, getting the information you need from earnings calls/management updates, and refreshing your thesis and model every quarter. Firms that hire right out of school include Octagon, Blackstone, and CVC. Note that compensation levels can vary by a decent clip depending on the strategy and the intensity of the fund. L/S and distressed can find higher compensation levels than a more sleepy type of shop.

Credit certainly gets busy though – I just view it in ebbs and flows. You’re busier when there’s earnings and a pick up in new issue, but if you find yourself in a bit of a lull post earnings then that’s an opportunity to revisit the secondary market, catch up on updating models, or deal with other credit-specific issues.

In good times, like the tweet above suggested, good loans can hang out at Par. However as rates have widened out in ‘22, plenty of loans widened significantly as risk levels repriced. There’s a lot of “sleep at night” credits out there, but there’s also 6x-7x levered names that give you a small packet of information every quarter, host no calls/don’t answer questions on earning calls, and then you don’t really hear from them for another 3.5 months and have zero clue if things are going south or not. So maybe there’s a lot of situations where you could “get sleepy” in the wrong type of way.

Fears in the Market: First, credit documentation has gotten really poor. I’ve gone on about this extensively, but loose, cov-lite docs allow borrowers to engage in all types of liability management transactions. This is why resources like Covenant Review from CreditSights are crucial in helping lenders push back against and understand weakness in credit docs. Secondly, a lot of the high-yield companies out there are melting ice cubes or may be in structural decline. Meaning, their industry is in steady -2% decline and the company is continuing to fight against the current. Their EV/EBITDA multiples are in continuous decline, leverage may be on the rise, and there’s not much the Company can do to fight the tide. The challenge this creates is that for 5-10 years, a lot of these serial high-yield issuers may be fine, but then one day it might fall apart. That’s what happens when you’re over-levered - one little slip and not enough FCF, and then boom - you might be heading to distress and a restructuring.

For more details on the traditional careers in credit, I would refer you to the High Yield Harry Guide to High Yield. I’ve written much more extensively on it there and have included dozens & dozens of private credit and public firms in that piece.

Double-dips:

It’s time to get into the Premium section of this piece! This has been a more complex part of “lender-on-lender”, so let’s get into it.

A double-dip transaction occurs through the following process:

Subscribe to Premium to read the rest.