Opportunities in Indian Private Credit for Fixed Income Investors

Date & Time: 12^th March 2021, 05:30 PM – 06:30 PM IST
Speakers: Rakshat Kapoor – Fund Manager & CIO, Centrum Alternative Investment Managers & Soumyo Roy – Investment Team, Centrum Alternative Investment Managers
Moderator: Kamal Manocha – Chief Strategist, PMS AIF WORLD

With equity markets at an all-time high, some investors might be looking for other investment alternatives for potential double-digit returns, with high risk, of course. In this context, the Fixed Income/Debt Market offers opportunities in the Private Credit space. But this asset class requires a deep-dive, understanding, knowledge, and longer time horizon.

This blog crafted by PMS AIF WORLD shares insights from the webinar conducted to learn this asset class, directly from fund managers of a very successful alternate investment fund focused on the Private Credit space from Centrum Alternative Investment Managers, a team with a focus on specialized private lending to Indian corporates. The fund managed by this team is a SEBI registered, category II AIF and Centrum Capital is the sponsor for this close-ended fund with an indicative tenure of 4 + 1 years.

Private Credit, as an asset class, has gained a fair bit of traction in the last few years in India. This is more akin to Private Equity as an asset class. Mr. Rakshat Kapoor, Fund Manager & CIO (with 22 years of experience in structured finance) shared the need and relevance of this asset class. He mentioned that many businesses finance their projects via debt, and many do via equity; many times it happens that businesses do multiple capital expenditure projects but the revenues of these projects are not aligned with the debt that is borrowed for the same. Historically, NBFCs used to fill in this particular gap; now private credit funds like the one he manages, come in and fill in this temporary gap of the cashflow mismatch. Basically, Private Credit is like a capital that corporates borrow to fill in for the “non-vanilla” situations which are not filled in by NBFCs, at present.

If one looks at the credit space in India, one can broadly classify into two buckets:

1. Well established, Profit-making companies in need of a certain kind of capital outside of their regular/traditional banking
2. Stressed companies which need some rescue capital

Centrum operates in the first category; focusing on the performing space.

Elaborating on his point, Mr. Rakshat Kapoor talked about a transaction that his team handled recently. It pertained to a consumer electricals company (a known name that has developed, well-known retail & distribution presence on pan-India basis, a reasonable size of ~ Rs 2000 crores to 2500 crores revenue, selling multiple products). A company that has been growing at about ~20-30% in revenue over the last couple of years and has been maintaining steady gross profit margins of roughly 20% to 25%. For the next level of growth, the company was eyeing an equity infusion, and in the midst of it, Covid event occurred. As a result, some discussions got delayed, and company thought for a temporary period to raise debt. The company thus opted for the raising through the route of Private Credit AIFs for a short period (1 to 2 years) mainly because timely injection of capital would help it maintain margins, to ultimately help the company raise equity 1 to 2 years down the line. In terms of risk, return, and security, the macro & micro factors around business growth were analyzed and it was understood that company has been steadily growing and was at a stage of margin expansion.  Investment was done in the main operating company and to its promotors. Deal was structured as a 2.5-3 year kind of lending transaction.

Basically, for private credit transactions, company is analyzed based on the sound equity profile, steady growth in business, rising cashflows, and so on. Such transactions are backed by assets, shareholding, real estate, and so on to make it a well-collateralized lending; as fundamentally, the source of finance being debt, downside protection is critical.

A thought may come to mind, that why would such a sound company not raise funds from the regular route? Answer is simple, that its business demands high working capital in general, and this is fulfilled by bankers, but now in Covid times, with which the working capital requirement further rises, so, for banks to further lend, is a challenge, but for Private Credit funds, that is akin to Private Equity, this is viewed as an opportunity.

In such deals, the repayments schedules are structured and aligned with business cash inflows and given the sound equity profile, the chances are that the company may raise equity from private sources, as is with the recent transaction described, so there may be an early exit as well.

These kinds of private credit transactions, evaluated from the perspective of a private equity construct, are “deep dived with diligence and are well secured, well collateralized and are cashflow-backed.”

Commercials on these kinds of transactions are not too wide and private credit funds get paid only a couple of basis points higher than what banks lend at.

Bitten by bad experience from credit mutual funds, investors today, mostly look at risks first and not returns when it comes to debt investments. Based on this notion, with respect to encountering and managing the risks, Mr. Rakshat explained the set of rules that his team follows. For instance, his fund is a very sectoral-driven fund (they’ve been looking at chemicals and cement for a long time); thus being a sectoral expertise driven team, the macro outlook is what drives the initial decisions. Once the sector is narrowed down upon, the next task is to zero down on companies that provide investment opportunities.

A lot of time is then put into understanding the company and its core business, its equity profile, which helps in assessing the future risks and how to tackle them. Apart from that, it is imperative to look at cashflows, margins, earning profiles, and so on. The process of ‘risk underwriting’ is very rigorous and not only the fundamentals but there are external diligences are also taken into consideration and evaluated.

With respect to security, assessment is done based on what is realistically achievable and what is ‘releasable’. Evaluation process before transaction is somewhere between 2 to 3 months, and post-transaction, monitoring the fundamentals of company is done on monthly and/or quarterly basis. This involves – monthly sales, type of products getting sold, gross margins, working capital status, cashflow status, and so on. All this helps with red flags much early, which is very much needed to keep the risks in control; and quarterly newsletters shared with clients keep them informed on what’s going-on, in the fund. Mr. Rakshat pointed out that despite the checks, bad events do happen, but his fund has made 7 private credit investments so far, and out of which 3 have been successfully exited much earlier than scheduled. So, risk – strategy and risk – hypothesis has paid rewards. Thus, against a normal belief of very high uncertainty involved in private credit transactions, these are well assessed, secured, structured and monitored as explained.

Mr. Soumyo who is part of senior investment team at Centrum and brings 12+  years of experience, talked about the present situation of low interest rate economy.  As per him the rates are going to remain soft making the traditional investment avenues like FDs, debt MFs delivering max 5-7% . So when investors look for options in the fixed income space to generate higher returns, Private Credit funds give an opportunity to aim a double digit returns, at higher risks of illiquidity and credit. But these risks are a matter of long time horizon and understanding, both of which are available to the target profile of High Net Worth investors.

Both Mr. Rakshat and Mr. Soumyo endeavored to reason credit space from the perspective of MF structure vs an AIF structure, and pointed out that for a mutual fund, credit opportunities is one amongst various types of debt schemes (liquid, ultra-short, short, dynamic, bond funds, credit etc.). Most of these are pure yield or interest rate plays, and risk management is achieved by creating a highly diversified portfolio of more than 100+ issuers. But credit opportunities is a specialized play and so for a mutual fund to evaluate, manage and monitor credit profile of large number of issuers on on-going basis from credit worthiness perspective is difficult and what happens more often than not, in MF structure there is small team, that is managing a credit fund or at times, same team manages an interest fund as well as a credit fund.

Against this, private credit AIF offers full-fledged and specialized team with core focus and forte as structuring private credit (in terms of evaluating credit risk, structuring deals, and recovering the money), and because portfolio construct is fairly concentrated with around 10 to 12 deals, the hand-holding of each transaction in terms of due-diligence, underwriting, and on-going monitoring is well managed from end to end. Also, in credit funds, at times what happens is that the repayment gets delayed if an expected event doesn’t occur on time, and in such situations, MF investors panic as any such delay gets reflected in the fluctuating NAV. This leads to redemptions and puts pressure on the mutual fund manager. During such situations, AIF manager is able to tackle with better patience, prudence and flexibility. This is because AIF manager is backed by more informed, high risk investors, and fund is largely closed ended.

Thus, for Interest rate play, mutual funds construct is better structure, as fund management teams, and product features, both are more geared for a market-oriented interest rate play, but for a specialized credit opportunities play, AIF construct is better and more conducive to underwrite & manage a credit deal. Credit opportunities are situational, and require very different research and handling from deal execution to monitoring to exit, and so Private Credit AIFs offer superior risk adjusted returns.

Mr. Rakshat concluded that going forward, especially in India, the capital requirement of the companies will continue to grow, as economy & companies will expand and in this journey some will face challenges and thus will emerge as specialized credit opportunities from time to time. While banking eco-system will fulfill regular financing needs like trade finance, working capital, project loans etc., for specialized form of financing, private credit as an asset class will emerge in a big way in India.