23 July 2014
The Australian Financial Review
Copyright 2014. Fairfax Media Management Pty Limited.
Prominent investor Mark Carnegie has teamed up with fixed income dealer FIIG to create Alternate Debt Services, which will link high-growth companies with private debt from investors chasing yield.
MH Carnegie & Co, Mr Carnegie's venture capital and private equity fund, and FIIG, which has been arranging bonds for small caps, both say they have identified a "market gap" where borrowers are too risky for bank loans or simple corporate bonds but are not risky enough to produce the returns of more than 20 per cent demanded by Mr Carnegie's equity funds.
ADS will structure and arrange high-yielding debt (senior, junior and mezzanine), hybrids and preferred equity, offering investors returns of 10 per cent to 20 per cent.
Mr Carnegie said there was "a huge amount of demand on both sides" for borrowing and lending in this range, a market that "essentially has been seeded to the prop desks of all sorts of hedge funds".
This was due to the conservatism of the big four banks, said Mr Carnegie, who suggested their lending is restricted to safe and easy situations and that the majors are not willing to experiment or try something different.
"The way I describe commercial bank lending in Australia is finance in the missionary position," Mr Carnegie said.
Mr Carnegie, who on Tuesday was also continuing the fight to break up Brickworks and Washington H. Soul Pattinson after an unfavourable tax ruling and opining about the presidential election results in Indonesia given his investments there, revealed to The Australian Financial Review he is also keen to target the $27 billion of bank profits recently identified by Macquarie analyst Mike Wiblin as being up for grabs by competitors to the major banks willing to try to new things.
"Australian banks have made a tonne of money and they just haven't felt like they have needed to chase [risks with 10 to 20 per cent yields]," Mr Carnegie said.
FIIG chief executive Mark Paton "has seen the demand, and we know from institutions there is demand as well", Mr Carnegie said. "But we didn't feel we had the expertise to do it without [FIIG]. We are a consumer of this product, not a producer."
Mr Paton and Mr Carnegie have known each other for 20 years, going back to Mr Paton's time at ANZ Banking Group and Mr Carnegie's days in investment banking.
Competitors to ADS include the Macquarie Bank group, run by Ben Brazil, Intermediate Capital Group and Babson Capital, but ADS is seeking to provide lower entry points for borrowers. It will be willing to write debt strips from $20 million up to $100 million. The use of funds will vary, and may include acquisition finance, refinancing or working capital.
"A lot of companies that don't have a credit rating and are not publicly listed really struggle to get additional credit, the banks will only lend them so much. But often their credit profile is a lot stronger than their publicly listed counterpart. Where do they go? They can go and raise private equity but now they can go and raise private debt," Mr Paton said.
The blended returns would be determined after FIIG conducted credit analysis and provided an indicative price range, with investors ultimately determining the yield according to demand for that risk, he added. Policy for conflicts of interest
Mr Paton said it "was not the intention" for ADS to lend debt into the capital structure of companies in which Mr Carnegie held equity, which would boost his return on equity.
On the potential for conflicts in this situation, Mr Carnegie said: "We want this to be stand-alone money coming in from us and our co-investors into this, and not have the conflict. There are certainly a lot of our portfolio companies that could access this service. Then, what we have to do, is obviously recuse [ourselves] and leave it to [ADS] to work out whether or not it is going to work . . . There is a deep enough pool of people other than us who are going to command this service."
Mr Paton said two institutional investor clients of FIIG had already "pledged" $100 million each to invest in opportunities identified by ADS and "we expect that [figure] to be much more significant, as there are a number of indicative discussions happening with others."
Mr Carnegie said his clients were "enthusiastic about it, but they want to see a structure and want to see deals".
ADS, a 50/50 joint venture between MH Carnegie & Co and FIIG, will be run by Neil Sutton, who has been recruited from Gresham Private Equity. ADS says it already has over a dozen opportunities in the pipeline and expects to announce a deal in the coming months.
Mr Carnegie said he would see about 30 deals a year that would not provide his minimum return of 20 per cent but that he was enthusiastic about.
Mr Paton said demand for high-yield debt from borrowers and investors would continue even if interest rates increased, although higher rates would increase competition in the space.
"There is always going to be a gap between bank debt and equity," he said. "What will impact on it is like now where banks have pulled in their horns on credit risk appetite it leaves more high quality around in order to fund an alternate solution to. We have seen a lot of transactions recently that in another credit cycle the banks would have done.
"Whereas now they are saying they have heaps of demand and are constraining supply.
"When credit cycles move and banks loosen the reins there will be more competition for transactions."
Mr Paton said a number of FIIG investors, including rich individuals, family offices, boutique investment funds, SMSFs and institutional funds, who had bought corporate bonds with yields between 6 per cent and 7 per cent, were now looking to invest in higher-yield instruments.
"They are hungry for debt. What we have seen over the last 12 months institutional funds investing in syndicated loans where previously that has been the domain of the banks. As those funds are trying to improve their returns in a low interest rate environment, they are looking for alternatives and this sort of product is in the sweet spot."