By: Daniel Mafrice, Chief Executive Officer & Managing Partner, Remora Capital Partners
Increased access for individual investors appears to have opened a “Golden Age” for private credit. But how do investors in a new and unfamiliar private investment market differentiate opportunities and exert caution? Investors might be hesitant about participating in the newest or hottest investment trends. Some may question how long a “Golden Age” may last should the Federal Reserve lower interest rates. Others may be concerned that the Private Credit market might overheat.
Remora Capital Partners, through its unique loan selectivity, has been providing a truly bespoke and prudent approach to middle market Private Credit since 2021, before the Fed began raising rates and before the risk premium expanded in this attractive asset class.
Investing in privately held, floating rate corporate loans is a logical way to outpace inflation while gaining access to quarterly, recurring fixed income streams. U.S. middle market corporate lending, known as Private Credit, represents one of the most attractive areas for fixed income investors today. At the end of 2022, credit markets tightened substantially causing new loans in this market to be issued at an additional 1% - 2% higher premium. This occurred despite lenders demanding 15% - 30% less debt to be issued to new borrowers.
This credit tightening trend continued with the regional banking crisis in March 2023 and into the beginning of 2024. This expanded risk premium, coupled with historically high interest rates, has created what has been dubbed the “Golden Age” for Private Credit. Funds with vintages during this period have benefited greatly from this unique environment. Fortunately, neither high interest rates nor an expanded risk premium are necessary for Private Credit to remain an attractive investment class for individual investors.
Middle market borrowers, which constitute 100% of Remora’s credits, are tenured businesses with extensive operating history and enterprise values between $100 million and $750 million. Loans in the core middle market typically demonstrate many important characteristics that reduce risk for investors vs. publicly traded large corporate loans and high yield bonds. For example, they typically demand higher yields. The loans are floating rate vs. fixed rate treasuries or high yield bonds. This means as interest rates rise, the yield to investors increases in tandem. Importantly, floating rate loans have no duration risk. This can be an important tool for combating inflation pressure on an investment portfolio.
Since 2007, middle market loans have historically been issued at an average of 1.35% higher yield for investors vs. the large, publicly traded corporate loan market. Additionally, middle market loans typically retain important lender tools like first priority security and financial maintenance covenants. This is different from larger corporate loans, which are typically “covenant lite” in today’s market.
Within this market, Remora Capital Partners primarily targets first lien senior secured loans issued to private equity (“PE”) firms for leveraged buyouts (“LBOs”). On average, 50-60% or more of the purchase price paid for a business is subordinated to the lender. Loans that were underwritten to companies with the backstop of seasoned, “smart money” PE firms as the owners of the business stand out as more stable opportunities for investors. PE firms that have long-standing track records and multiple funds under management are more capable of infusing additional equity as needed to avoid defaulting on the debt borrowed by their portfolio companies. After selling to, and partnering with, their new owners, portfolio companies often benefit from the resources and best practices that PE firms can bring to the table.
Private Credit loans are typically floating rate, priced at the Secured Overnight Financing Rate (“SOFR”) plus a risk premium. In general terms, the SOFR rate represents the “risk-free” interest rate largely equivalent to the same duration U.S. treasury rate. The risk premium represents the additional interest rate premium charged by lenders for the borrower’s additional risk profile. While the SOFR rate component of these loans would decline should the Federal Reserve lower interest rates, U.S. treasury rates, money market rates and bank savings rates also typically decline with lower Fed target rates. While Private Credit loans might earn a nominally lower rate, the risk premium component of these loans remains, whether the floating rate component increases or decreases. This keeps an investor’s premium to the risk-free rate intact. Importantly, most middle market private credit loans have a 1% floor rate that prevents the floating rate SOFR component from going below 1% should those rates fall below that threshold.
Uniquely, Remora enables investors to gain access to a diversified private loan portfolio deploying 100% of investor capital commitments immediately. This is a differentiator because most private debt funds invest over 2 to 3 years in a typical capital commitment and drawdown process. They may never call all of an investor’s capital commitment.
By purchasing portions of loans from multiple direct lenders instead of acting as a direct lender itself, Remora is able to create a level of selectivity that is typically not available in a direct lender’s own portfolio. Remora narrows its loan portfolio into 100% first priority secured loans that are owned by PE firms and have maintenance covenants. In addition, Remora excludes the highest leveraged loans that its lending partners originate and does not participate in loans in highly cyclical industries like retailers, restaurants, and energy. This selectivity is precisely what is needed to remain prudent should markets overheat, whether lenders loosen or remove covenants, subordinate their lien priority or over leverage borrowers’ balance sheets.
Through bespoke, selective investing like Remora Capital Partners, investors can enjoy both the Golden Age or any other phase for Private Credit investing. Importantly, this can be accomplished without participating in the fringes of the market.
