Private credit offering predictability in unpredictable times

Ryan Wood-Collier – Greenpoint Capital, CEO

Worries of persistent inflation, the effect the rate-hiking cycle will have on an already strained economy, compounded by domestic own goals of size and frequency most economies would not have the resilience to deal with, have left local investors rattled, leading them to carefully assess the risk environment for asset classes that are capable of providing decent returns with some degree of genuine downside protection.

Private credit, a relatively nascent asset class in South Africa but an established and now essential component of the alternative asset segment in developed markets, has historically performed well during rate-hiking cycles and the volatile economic environment that typically follows.

This is primarily because private credit assets typically exhibit the following key features:
• Priority in the capital structure with specific security,
• Short-duration, floating-rate, contracted returns with cash servicing,
• Bespoke structuring with contractual protections (financial covenants).

The short-duration, floating-rate feature, combined with capital structure seniority, significantly reduces the impact that rising interest rates and market volatility can have on the price of the asset as compared to more liquid fixed income alternatives.

The illiquidity of private credit allows for bespoke structuring, which in turn provides the contractual protections and specific security that underpin the product’s stability benefits.

The combination of these factors has enabled private credit assets to demonstrate resilience and deliver strong, stable returns during periods of market volatility.

Demand for private credit assets is strong and growing. Aside from the stability benefits, investors are attracted by both the yield potential and the low to negative correlations with more traditional asset classes.

In addition, as the underlying private credit assets are primarily loans held to maturity (and not traded) they are typically valued at ammortised cost (subject to IFRS9 expected credit loss assessments) rather than being subject to fair market valuations. They are also partially self-liquidating as they are typically structured with some amortisation, which mitigates the risk of needing to achieve an exit at high multiples to crystallise equity gains. They therefore tend to exhibit a more uniform return profile with little to no J-curve effect associated with other alternative asset classes.

While the asset class offers the structural features to allow for a strong risk-adjusted return, the illiquid nature and bespoke structuring requirements mean that manager selection is critical, even more so in the current risk environment.

There are a growing number of private credit managers in the local market. The managers that will be best positioned in this environment are those that:

• Have well established investment processes and a long and demonstrable track record of discipline and consistency in underwriting.
• Have an intimate understanding of their portfolio and experience in managing private credit assets over multiple market cycles and the expertise to manage situations when there is underperformance.
• Have deep local relationships, positioning themselves well to capture deal flow.
• Are not constrained by fund maturity horizons and have available capital to deploy.

Established in 2011, Greenpoint Capital is regarded as one of the pioneers of private credit in South Africa. It focuses exclusively on investing in and managing private credit assets and to date has invested over R4 billion in 70 investments, with 55 exits. It currently manages a portfolio of 15 assets across sectors including logistics, IT services, financial services, education and business services.

Greenpoint’s focus is on medium-sized privately owned businesses in SA with exceptional management teams and leadership positions in their market niches. Companies must demonstrate stable cashflow with earnings visibility and typically generate between R20 million and R200 million ebitda (earnings before interest, taxes, depreciation and amortisation). They are usually service-oriented and operate in defensive sectors where demand is less impacted by economic conditions, and typically exhibit a strong and reliable customer base. There are certain sectors they are excluded from investing in, including direct mining, property development and certain ESG exclusions.

“We believe the key to success in private credit is in asset selection and the effective management of those assets post investment. For us, this means being highly selective in our investment process, focusing primarily on downside risk mitigation and prioritising avoiding losers rather than picking the one-hit wonders. Being highly selective requires strong pipeline with access to deal flow, which in turn requires you to be deeply entrenched in the local market. We typically assess around five to 10 new investment opportunities a week with the average investment rate being in the low single-digit percentages.”

This requires deep experience in the investment team and extreme discipline in the investment process. “We are not looking to determine strategy or be operationally involved in investee companies. We focus on identifying strong management teams, ensure they are appropriately incentivised and aligned and back them to deliver on an agreed credit case.”

So what makes private credit an attractive form of capital for businesses? Why do they not follow the traditional route of going to the senior debt (banking) and private equity markets?

“In our experience, businesses have gravitated toward Greenpoint for three key reasons. Firstly, we offer greater speed, reliability and certainty of execution, particularly when banks are risk-off. Secondly, we can provide flexible, anti-dilutive financing solutions tailored to the bespoke requirements of the business. Finally, we are relationship driven, take a longer-term approach, work with companies through cycles and facilitate follow-on capital for future growth if the situation allows for it.”

Greenpoint are focused specialists, investing only in private credit and having done so in the South African context for more than 12 years. They have 10 investment professionals and operate from offices in both Johannesburg and Cape Town.

“With each of our senior management team spending on average 10+ years in the UK private credit market prior to establishing Greenpoint, we have built the business on international best practice and have consistently applied those principles here in South Africa.”

So while the economic environment is challenging and unpredictable, we believe that private credit has sufficient characteristics as an asset class to offer good returns and stability. However, given the bespoke and illiquid nature of the underlying investments, manager selection is critical. Copyright. HedgeNews Africa – October 2023.

Ryan Wood-Collier joined Greenpoint as CEO in 2013, prior to which he spent 14 years in London in investment banking and private credit, primarily at British merchant bank, Close Brothers and US investment bank, Lincoln International. Ryan started his career at PwC in London focusing on Infrastructure M&A and is a CFA charterholder. Greenpoint Capital was awarded Specialist Manager of the year in 2022 by HedgeNews Africa.