1) With so much market volatility, investors across the markets are becoming more selective (or, at least, they say they are). How has First Eagle changed its behavior around underwriting over the past year or so?

Based upon First Eagle Alternative Credit’s decades of experience providing capital in the middle market space over different economic and business cycles including disparate credit environments, we apply what we believe to be rigorous due diligence and careful structuring in pursuit of strong returns while also seeking to mitigate downside risk.

Today, it’s hard to see a specific catalyst to get us back to “normal.” The market at some point will find the level at which the deal economics work for borrowers, lenders, and sponsors, and then it will be off to the races again. This might even happen sometime in 2023, but this is why we seek to maintain stringent underwriting standards in good markets and bad. We’re not going to lend money just for the sake of it.

2) Are there any areas that you’re particularly wary of investing in right now, and why?

A weakening macroeconomic backdrop is always unsettling for lenders, but, in our view, those who should be most nervous are 1) lenders who have never experienced difficult market conditions, and 2) lenders that were positioned too aggressively into the downturn.

3) On the flip side, are there any particular areas of the market where First Eagle sees opportunity right now, and why?

We focus our origination efforts on a handful of industry verticals — business services, consumer, financial services, healthcare and technology — and further sharpen our attention within those verticals to a subset of industries that tend to be less cyclically exposed. For example, insurance brokers, software, and management service organizations (MSOs).

While not an industry per se, asset-based lending (ABL) may represent an opportunity to put capital to work for an attractive risk-adjusted return right now, in our view. Traditional middle market financing solutions like direct lending and broadly syndicated loans (BSL) are underwritten based on an assessment of the borrower’s cash flows. 

ABL facilities, in contrast, are secured by specific assets of the borrower — such as inventory, accounts receivable, real estate, machinery and equipment, and intellectual property — and thus provide a specific source of collateral the lender may tap should the need arise. 

These loans often appeal to companies that have high working capital needs and substantial assets but also inconsistent cash flows that limit access to other types of financing; think retailers that maintain large inventories or industrials renting high-capex equipment.

4) We’re hearing that super-priority revolvers are becoming a contentious point in some capital structures, given the risk of first lien term lenders being subordinated. Is this something First Eagle is concerned about?

We’ve always been concerned about allowing super-priority revolvers into our capital structures and as a result we’ve limited these structures in our portfolio. Our experience is that when a loan experiences distress, the lender that sits at the top of the capital structure and has the company’s cash as collateral, controls the restructuring. 

As a primarily first lien lender, we prefer to be the one driving those negotiations vs a super-priority revolver as it typically results in a better outcome/recovery for us.

5) Last year, many private credit lenders reduced their hold sizes, making it harder for borrowers to club up the amount of cash they were looking to raise. Is this still happening, and what are the challenges (or benefits) it brings?

It’s hard to tell currently where hold sizes are right now. Q1 is always a seasonal low period for M&A activity which drives private credit loan volume. Only increased M&A activity will really tell us what lenders are willing to do. My sense is that coming out of 2022, private credit lenders now have a better sense of how their portfolios are being impacted by the economic environment and interest rate increases. As a result, they will likely be willing to stretch into larger hold sizes for quality credits with appropriate structure and price.

6) The broadly syndicated loan market has come back to life somewhat in recent weeks. How do you think the competitive landscape is changing between private credit and the primary market, and what trends do you expect to see there for the remainder of 2023?

What we’ve seen happen in the BSL market is it became more volatile and the lower end (on a deal size basis) of the BSL market went to the higher end of the private credit market. This potentially gave borrowers certainty of price/structure vs taking syndication risk in the BSL market. I do believe some of this market has been lost to direct lending but hard to say how much and if real stability returns how short the memory of borrowers will be chasing back to the BSL market for better price.

7) Default rates are expected to climb this year. How concerned are you about this, especially for borrowers at the smaller end of the spectrum? Do you think there are pockets of loose underwriting in private credit that will be exposed this year?

In 2023, we expect to see a modest increase in default rates in the market generally as borrowers manage through a sustained longer period of higher interest rates. Based on our experience, borrower defaults are not correlated to the size of the borrower but are instead tied to the quality of the credit and capital structure in place. It really goes back to the lender’s maintenance of rigorous underwriting standards during all economic cycles.

8) You’ve been working in finance for over 20 years. Are you seeing more women enter the field these days, and how do you feel the industry has changed for women over the course of your career?

Within the investment side of private credit and the lending market broadly, I have seen an increase in the number of women entering the industry. Firms like FEAC see value in and make gender diversify a priority. Women have always been qualified for these roles, so it has been great to see them not only given opportunities but excel. Additionally, when I started in industry there were very few female leaders that I could look to for career path or as a mentor. Today there are more women in senior roles which hopefully encourages women to stay in the industry.

9) What about the eagle as an animal inspires you?

Eagles have strong and clear vision focused on achieving a target or goal.