Menacing clouds have enveloped the market. Inflation persists, stocks are reeling, and some believe a recession looms. While these threats haven’t had a material impact on liquidity, and new business backlogs remain healthy, past downturns tell us economic uncertainty can have an inverse effect on the availability of capital. Alternatives, however, do exist for more complex credits that may not fit the mold for more traditional cash-flow based financing.
Enter opportunistic financing. Investors have historically equated flexibility in the debt market with event-driven strategies, designed to step in during economic dislocations, acquire distressed debt at significant discounts, and make directional bets on the economy and the markets. As was demonstrated during 2020 – marked by extremes to both downside and upside scenarios – traditional “opportunistic” strategies no longer provide the flexibility required by investors in such a dynamic environment, not with the increasingly abbreviated investment windows or extended bull markets aided by interventionist monetary policies. Moreover, borrowers may be remiss to seek funding from less traditional sources of capital, namely hedge funds or distressed credit players more interested in controlling the fulcrum security than funding growth.
But among managers whose DNA is in direct lending, the “opportunistic” playbook now embraces an “all-weather” strategy that for investors can deliver consistent uncorrelated returns across any market environment, but provide borrowers access to capital when other alternatives become closed off.
Opportunistic financing is geared around non-traditional credits and differs from traditional distressed strategies because lenders aren’t trying to “time” the market to take advantage of economic turbulence. For instance, a “typical” credit that might be pursued through opportunistic financing is best characterized by “atypical” investments with bespoke structures and high complexity. These targeted segments provide a steady pipeline of deal flow and prevent capital from sitting on the sidelines, where it would otherwise create a drag on returns amid an indefinite wait for the next cyclical shift. And for borrowers, this focus on complexity versus distress aligns interests and investment timelines.
A Niche in the SPAC Backtrack
Consider the slowdown in the market for special purpose acquisition companies (SPACs). Despite a run of successful transactions that brought several high-profile companies onto the public markets, the activity hit a speed bump in 2021 and has been slowed further in 2022.
The slowdown, however, spells opportunity as sponsors behind blank-check companies solicit extensions of their closing dates. For instance, in one deal, Monroe’s opportunistic fund provided a bridge loan to help MoneyLion Inc. continue to invest in growth despite the delay in completing its merger into Fusion Acquisition Corp. From the borrower’s perspective, the second lien financing provided much needed liquidity to grow as it moved forward with negotiations and completed a transaction. The fund, meanwhile, was able to secure an attractive credit, underwritten against a very conservative loan-to-value ratio at a yield in excess of traditional private debt. Along with providing credit ahead of SPAC mergers, deSPAC transactions are also facing liquidity needs when their stock prices fall, making it harder to raise additional equity to invest in growth.
The underwriting skillset provides other instances to serve financial sponsors. Monroe’s opportunistic strategy has also provided “fund loans” to managers seeking to extend the investment periods of assets in their portfolio. Without the capital infusion, the GPs would either be forced to sell a company to recycle the capital back into their portfolio or approach their LPs for an extension to the follow-on investment period. Beyond just helping GPs avoid a challenging request, fund loans – secured against the underlying portfolio and priced in the high single digits — can augment IRRs, not unlike subscription-financing arrangements that have become quite common. Similar opportunities are available to extend credit to proven fund managers who have a need for bridge loans— in some cases to close deals before they complete a fundraise.
Real Estate Opportunities
Real estate is another area of interest and recent deals have backed proven investors building single-family rental properties. The thesis is augmented by the appreciation of existing-home prices in which it’s often cheaper to build a house than buy existing properties.
Alternatively, other opportunities are more indicative of the distress in certain pockets of real estate masking the value of the underlying assets. For example, we recently backed an investment in an office property located in West Palm Beach, Florida. Given the near-term uncertainty of work-from-home trends, as well as portfolio struggles facing traditional real estate lenders, we were able to step in quickly to gain comfort in the location, the specific asset, the equity investor, and a deal structure that protects against the downside.
We’ve helped to facilitate a securitization play that revolves around real estate commissions. The platform, headed by a veteran of the life-insurance settlements niche, is effectively investing in the right to be the listing agent for single-family properties – paying an upfront fee to homeowners for exclusivity to list the houses for the standard selling commission – and pooling future agent fees to create a collateralized investment that offers high spreads and predictable distributions. It’s very similar to other securitizations, such as litigation finance or insurance settlements, where conviction can be found through fundamental analysis and a large, diversified pool of assets.
An Inflation Hedge
From an investment perspective, the uncorrelated nature of an opportunistic strategy provides a natural hedge against inflation that’s only amplified by exposure to areas such as real estate and other asset-rich sectors. The floating-rate terms of most credits can augment current yields in the event of rising rates, while the value of underlying collateral offers comfort if inflation becomes more acute.
Meanwhile, a credit-driven approach with a strong asset base provides protection against the cycle through asset coverage and the opportunity for enhanced yields in the event liquidity dries up. Things such as litigation-, fund-level and, GP-stake financing, as well as specialty finance, are generally uncorrelated to broader economic conditions and remain very attractive during recessionary or growth periods. During dislocations, purchasing loans and asset pools at discounts, providing DIP financing, and other special situations are quite attractive.
But “special situations” do not have to imply high risk or lender of last resort. And through an all-weather strategy, versus “distressed” capital, borrowers can be confident interests remain aligned.