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9fin team

Stefano Questa is a managing director and portfolio manager for private credit at Hayfin. He spoke to 9fin about the company’s tactical solutions strategy, why private credit is set to grow and his predictions for the next year.

What is Hayfin’s role in private credit, and how does the firm expect to grow in this space?

When Hayfin was founded in 2008, in the wake of the financial crisis, we saw two key drivers in private credit: first, cyclical demand, created by the immediate need for liquidity, and, second, a structural shift towards non-bank debt providers.

If you look at the current environment today, we see both of these dynamics still at play.

Thinking about what differentiates us, we have always looked to build long-term franchise value. We've also created a stable local presence in all major target jurisdictions, still a differentiating factor.

The core of our business was and still is corporate lending, but over time, we have taken that same kind of investment approach, discipline and reputation to adjacent areas which also require flexible, patient capital.

So for many years we've been deploying in selected real estate opportunities, transportation assets, specialty lending and other principal finance-type opportunities. We think that the corporate market will continue to grow ahead of the wider private equity market and that these other adjacent areas will remain underserved by banks.

In terms of pricing, what do you expect from 2023?

I think we're all playing it by ear. So far this year, we've seen vanilla direct lending pricing stabilise after a quite a significant move up in 2022. That move up was obviously driven by rates, but also by credit spreads and perception of risk. But market conditions also changed other metrics as well as pricing. We’ve seen a decrease in leverage multiples and fewer accepted EBITDA adjustments, for example, and lenders have become a more rigorous.

Overall, the product has become much more attractive for lenders on a risk-return basis, even though spreads have stabilised in the last couple of months.

The syndicated markets have shown a little bit of positive momentum this year, but the underwriting appetite on the syndicated loan side is still pretty limited relative to  appetite before the invasion of Ukraine and the rate hikes. Most issuance has still been "best efforts" refinancing for high-quality borrowers, as there has been a real divergence between higher and lower quality businesses.

Despite slower activity on the PE side, there’s still a good amount of dry powder out there. This, alongside a weaker syndicated market, means that the supply-demand dynamics appear favourable for private credit. 

If we focus away from the big, traditional corporate market, and look at those niches that are not well served by banks or traditional private credit strategies, we see that dynamic even more at play. These niches include stretched refinancings, subordinated debt or stressed corporate debt trading. 

Can you tell us about Hayfin’s tactical solutions strategy?

The strategy started investing at the beginning of the Covid 19 pandemic in April 2020, with the support of some of our largest and more sophisticated investors.

It seeks to target gaps in the supply of capital that exists between those private credit strategies that are pretty well-defined traditionally, such as direct lending or special situations. 

Some examples could be providing junior capital to bridge the gap to lower senior leverage, or providing super senior loans to companies facing financial stress, both of which are topical today. We also fund specialty lending strategies or fund areas that banks retrench out of in times of crisis.

The focus, which is very typical of Hayfin is also to provide downside protection and generate a high cash yield, which gives our clients liquidity and ongoing de-risking. It's very much a “through the cycle” strategy, which will still benefit from the current market uncertainty and volatility.

Do you expect to help businesses struggling to refinance in the syndicated markets?

In part. Only 8% of European leveraged loans mature in 2024 or earlier, so it's not a big number. I don’t expect that to be the primary source of deal flow. 

However, many balance sheets are over levered. The debt pricing implied in the public markets and the reduced appetite of bank lenders makes refinancing much less straightforward. 

We also have rising rates, with hedges rolling off, and there's pressure on earnings. This is a little bit more subtle, and potentially more powerful. It could actually be more interesting from our perspective.

Some of these 2019-2021-era capital structures are going to become unsustainable, and that might necessitate action before the scheduled maturity. So we don't have a maturity wall, but we have pressure building up that might lead some companies to need some kind of creative capital solution.

I think these companies are well-suited to flexible mandates like tactical solutions, or even special situations, depending on the level of stress that the balance sheet has created. 

We’re also pretty flexible in those two funds across the capital structure. So we can offer a senior facility, a subordinated loan or an equity-like instrument, whatever provides the best solution for us from a risk-return perspective.

Do you think the maturity wall is effectively being dealt with then?

In every other crisis that I've been in, maturity walls just get pushed out. Anyone with a problem this past year has been able to deal with it. It seems a borrower can always do an A&E, except in the greatest positions of stress. 

I remember the crash in 2009, the maturity wall in 2016, and investors focusing on it during the pandemic. Now there is no real maturity wall, but a better question is: can you pay interest? Are you over levered? These things are going to come into the fore and will create opportunities.

What do you see as the benefits of private credit to borrowers?

There are a few well-publicised benefits of private credit. It offers flexibility, because we can use tailor-made solutions amid less regulation. There’s speed of execution, and a smaller number of lenders (which is also beneficial for the borrower).

But the experience of the last year illustrates another good point that private credit offers, which is reliability and depth of capital. Only the highest quality issuers were able to tap the leveraged finance markets. 

In US high yield and leveraged loans, volumes were down around 70-80%, with similar numbers in Europe.

In that time, many sponsors established relationships with the private lending community. These relationships are sticky, and private debt providers offered effective solutions to sponsors when the public markets faltered. 

When things get tough, the sector is a lot more reliable as opposed to the public markets. I think we showed that to both banks and sponsors, and we think it's likely to continue. And to some extent, it's building on itself. A lot of these relationships are now established between sponsors and private lenders, and the private market is now sufficiently deep.

There are several European-focused direct lenders, of which Hayfin is just one, with individual fund sizes in the multiple billions. Very large deals can now be effectively executed away from the traditional syndicated loan market. It's kind of like private syndications and effective direct lending club deals. The proof of concept has worked through the sponsor community now and their capital markets teams.

Deals above a billion dollars were quite rare before 2019 and they are now relatively commonplace. And there is still a lot of room to grow: direct lending is only about 13% of the global leveraged finance markets, (relative to 50% for high yield, and 37% for bank loans), but up from circa 2% in 2010.

That’s been tremendous growth, but there's a lot of room still, it's still a small percentage.

Has the recessionary environment impacted Hayfin’s strategy?

It hasn't impacted much. We were created, as I mentioned, in the wake of the GFC, and our strategy has remained consistent since inception. We remain focused on high quality sponsors with defensive businesses.

Obviously now we are in a high inflation environment and everyone's suddenly focused on that. But if you go back to our earliest investments, good pricing power and high and stable gross margins have always been considered the most crucial credit factors when we looked at new investments.

Back in 2009, the industry was talking about stagflation, so I think we're a product of when we were created, and we're made for the environment we’re in.

If you think about our portfolio construction, we are senior secured in 100% of our direct lending strategy. It’s effectively all floating rate, so we're not taking that rate hit. This gives us a lot of comfort heading into a downturn and a high inflation environment.

If you think about our track record also, we had great credit performance in the wake of the GFC. We also had great credit performance during the Covid downturn, though, that was obviously much shorter lived than the GFC.

At the end of the day, I think we have the investment approach, the discipline, the depth and breadth of team experience to get through this type of market, and we don't think we need to adjust our  philosophy.

What are your predictions for the next year?

I wouldn’t say my predictions are predictions, but more pattern recognition. Liquidity seizes up, people can't refinance capital structures, or they otherwise become unsustainable. Maybe sponsors need capital because they see good pricing. Vendors might start selling assets and funds can pick them up. 

These times can be a good to buy anything from non-performing loans to perfectly performing assets. Companies need liquidity, so they might effect sale and leasebacks, carve-outs etc.

Across Hayfin, this is going to create opportunities to both invest on the credit side to help refinance balance sheets, and also to fund the acquisition of, or directly acquire interesting assets at an attractive entry points.

I would say that we're pretty constructive right now. We see opportunities for all of our major strategies. The market reset has created attractive opportunities for our private equity clients to buy new businesses and undertake strategic M&A at the portfolio company level in a better pricing environment. 

At the same time, syndicated markets will become less receptive, which creates increased demand for the direct lending product, in addition to all those market dynamics that I talked about earlier.

Senior terms are becoming less attractive to borrowers than what they used to be. So there's also an opportunity to provide junior debt to bridge that gap between what sponsors need to achieve their return targets. And I think tactical solutions is the more natural pocket of capital for that.

9Questions—Stefano Questa, Hayfin

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