Peeling back the curtain on the fastest-growing asset class in the market

Recently, my colleague Hans Lee brought you the first instalment of a three-part series unpacking the private credit landscape.

That introductory wire can be viewed by clicking the link below:

Private Assets

What investors should know about private credit (but probably don't)

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Today, we’re diving a little deeper by exploring how deals are put together. Every private credit manager has a process and will tell you about the number of deals they reject, but each process is different – and sometimes quite guarded.

Kevin Hua and Justin Lal will peel back the curtain on how the Keyview team does it. What is real, what is marketing speak, and how many of the deals are really being rejected?

The John West approach

The tagline "It’s the fish that John West rejects that makes John West the best" made John West tuna famous.

Well, the equivalent line in private credit is “We reject 95 of the 100 deals that come across our desk.” And whilst Hua and Lal broadly agree with this idea, they are more concerned with the process than the marketing line.

“Ultimately, deal selection comes down to the rigorous credit analysis process we apply to every transaction, which first priorities ensuring investor capital is protected in conservative downside scenarios, and maximising the return on the investment for the level of risk.

“If the combination of these two objectives is not met, we will happily decline the transaction”, says Lal.

He goes on to add that Keyview’s assessment of credit risk consists of two separate yet connected stages.

Firstly, the investment team conducts the assessment of credit risk. They have accumulated years of experience in large institutional settings analysing complex credit investments and gaining valuable skills from difficult work-out transactions.

This is then combined with the screening of potential investments with Keyview’s Investment Committee, “who bring decades of private credit expertise to analysing and managing risk at both the asset level and at the portfolio level”, says Hua.

Throughout these stages, if the team believes there is cause for an investment to result in a potential capital loss, “we would rather walk away from these deals at the outset”, says Hua.

Take risk, get paid

While the due diligence progress is rigorous, Lal and Hua acknowledge that sometimes the team will take on a more challenging deal provided it passes successfully through the process and offers an appropriate reward.

“We will consider such deals at times, provided we believe we can structure and manage the risks associated with the investment, and get overpaid for the risk we are taking.

“We see this as a key point of difference for Keyview relative to other private credit funds”, say Lal and Hua.

The management of that risk requires thorough structuring of the loan terms and covenants upfront and may also involve establishing a proactive plan to enforce security, to ensure adherence with the original strategy, or protect an investment.

“We have done this on numerous occasions by appointing insolvency practitioners as part of our due diligence, to ascertain the steps required to enforce security, or understand what assets may be worth in a fire-sale environment, before we have even closed the investment”, says Hua.

In terms of reward, Hua and Lal want to ensure Keyview is overpaid for the added risk. They see this as involving a triangulation between determining what Keyview believes the market rate of return would be for a lower-risk proposition, ensuring the return premium compensates for potential deals’ level of complexity, and subsequently comparing this return to other investments that offer a similar rate of return.

“As an example, we have executed transactions that have delivered a high-teen gross return to investors for a slightly higher risk proposition”, says Lal.

“These investments will typically still be senior secured and offer excellent capital preservation, however they offer a material return premium versus a subordinated loan opportunity with a worse capital preservation proposition”.

Relationships

Another common refrain from private credit managers is that "relationships are paramount".

Keyview is no different, commenting that in their experience, borrowers (and their advisors) want to work with credit providers who are "commercial, transparent, reliable and follow-through during the entire life-cycle of a transaction". They add that an intimate understanding of the borrower and the real motivations behind them pursuing the transaction is important, as it “gives us insight into how they will behave during the life of the loan”.

With all of that said, Keyview also acknowledges that relationships are important when times get tough and that, try as they might, relationships are not immune from breaking down. Things can become strained when someone owes you money.

“If a borrower is having issues with a loan, we attempt to find a solution that can work for both parties (with the paramount priority being to protect our investors’ capital). A stronger relationship will allow for that and be able to withstand such uncomfortable situations,” says Hua.

“Occasionally, that may not always be possible. In some cases, such as when we need to enforce security on assets, that impacts the relationship”, says Hua.

He goes on to add that while this is unfortunate, “ultimately, we have a priority to protect our investors’ capital. And that’s something that does not always get discussed when managers talk about their relationships.”

Fools ignore complexity

Keyview operates in the area of private credit known as ‘special situations’ and, as the name infers, these situations are not uniform and can have varying layers of complexity, such as the following;

• Complex security structures, which require a loan to be structured in and around existing financing arrangements
• Governance-related issues, such as dysfunction or disputes between shareholders
• An eclectic group of assets that are not necessarily related (e.g. portfolio of assets comprising real estate, operating businesses, etc.)
• One-off shocks to a business / early signs of financial distress, typically resulting in deviation away from a business plan

Hua has been in the private credit space for more than 20 years, and Lal for more than 14 years. They believe that the skills required to analyse such investments are more akin to private equity (i.e., owners of assets/companies who intend to implement strategic improvement initiatives to drive performance) while not compromising on the technical credit skills required to structure loan investments.

As for the outlook, a common criticism is that the Australian economy has benefitted from good times and structurally declining rates for two decades - and that will turn at some point. Lal and Hua acknowledge that while Australia has not seen a sustained distress cycle, many companies have faced financial distress due to one-off circumstances, even when markets have been booming.

They go on to point out that when things inevitably become more challenging, the biggest factor will be liquidity.

“What you previously thought was a saleable asset or company suddenly has no willing buyers as liquidity has dried up in the market”, says Lal.

In anticipation of such situations, Keyview’s process incorporates the following:

Investing time upfront to understand asset/company values under highly distressed scenarios, and potentially finding means to establish a “floor” in value. They recently provided a loan against a real estate asset with which there were concerns around liquidity in a distressed market so Keyview entered into an arrangement upfront with another party who agreed to purchase the asset for a significant discount to valuation that would result in the loan being fully covered.

Getting on the front foot – taking action at the earliest sign of distress versus waiting for a problem to snowball can be a significant factor in preserving capital value before liquidity fully dries up

Being prepared to own and invest back into the business – one of the hardest decisions to make is putting new money into a distressed investment to support working capital and/or other growth initiatives. This comes back to the private equity-like skillset, and having the ability to own/manage investments when liquidity truly dries up. Keyview would only consider such scenarios where the team believes there is an opportunity to maximise value in the trade-off versus having to hold an investment longer than anticipated.

What’s under the hood?

One of the other criticisms of private equity and private credit managers is their inability or reluctance to talk about the deals they are doing. In some cases, this can’t be helped because of confidentiality agreements, but for investors who are used to dealing with equity managers, who openly discuss and continually need to justify a company’s position in a portfolio, it can be a tough swallow.

For Keyview, at a broad level, the portfolio is roughly comprised of 50-75% of “special situations” or complex transactions, and the balance in more traditional private credit investments. This structure has delivered over 12% per annum since inception, net of fees.

“While markets generally have been up over the last five years, we have come across our fair share of complex investments that have required work-out style steps to preserve capital and extract higher returns”, says Lal.

One such investment occurred in March 2022. The Keyview Flagship Fund closed and funded a c.$20 million senior secured construction loan, against a partially completed and distressed apartment development in Carlingford, Sydney.

The existing builder became insolvent on the back of increases in construction prices and delays through COVID-19, and the site was fully demobilised (including the removal of the tower crane) for over four months, with no activity.

A new builder was appointed with Keyview’s consultation, who was suitably qualified to complete the project and the loan was successfully repaid in May 2024.

The final outcome was a gross investment return (before fees) of around 18.4% internal rate of return (IRR), and 1.36x money on invested capital (MOIC), which materially exceeded the original underwriting forecasts of 17% IRR and 1.15x MOIC.

“This special situation provides a case study in our ability to structure and navigate highly complex situations, while not compromising risk and maximising investor returns” says Hua.

Managed Fund

Keyview Credit Opportunities Fund

Alternative Assets

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Managed Fund

Keyview Flagship Fund

Alternative Assets

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