Book Review: Private Debt by Stephen Nesbitt
A brief opening note: I was recently made aware of an app called Libby, which allows you to borrow digital books, including audiobooks, from your local library. Using it has been a great experience so far. You can send borrowed books to a Kindle for easier reading. I have already saved ~$100 on books I didn’t have to buy because they were on the platform. Check it out. My library sent me a link to sign up with an “e-library card,” so I didn’t even have to go to a local branch and sign anything in person.
As for how books will be rated:
1/5 - Stopped reading or actively regret and advise against reading.
2/5 - Poor use of time, would not recommend it to others.
3/5 - Moderately interesting, would not read it again but would not discourage others from reading.
4/5 - Enjoyed and would recommend it to others, but not reading it again any time soon.
5/5 - Highly enjoyable, looking forward to reading again, would highly recommend it to others.
A quick review of Private Debt
Overall rating: 2/5
This gets a 2/5 rating because I am not its intended audience. I thought it was a good overview of the industry, but it’s unlikely to make me a better investor or person in ways I can identify.
Private Debt is published by Wiley Finance and authored by Stephen Nesbitt of Cliffwater, a consultant/due diligence firm specializing in alternative asset managers. The book covers the direct lending industry - these are typically senior loans provided to private equity sponsors to fund buyouts of middle market companies ($5-100M EBITDA). There is a prolonged discussion of direct lending performance, risk, and portfolio management. This is clearly a book written for asset allocators - there’s no discussion of credit analysis, everything is framed through mean-variance optimization, etc.
According to Nesbitt, direct lenders have expanded to fill a gap that was left by banks in the wake of the GFC. GE-owned Antares Capital was one of (if not the) largest direct lenders prior to the GFC, which is why many of these funds have GE/Antares alums at the helm.
Direct loans are typically floating rate, have 5-7 year terms, and an effective duration/life of ~3 years due to the prevalence of refinancings and M&A activity that results in the loan being repaid early. Direct loans are originated/held by private funds and BDCs. Current yields on these loan portfolios are ~10%. Realized losses are ~2% over time.
The Cliffwater Direct Lending Index (CDLI) is the data source used to analyze direct loan performance through time. Credit cycles are long. The direct lending industry as it exists today has not seen a real cycle because it was born in the aftermath of the GFC. The impact of COVID turmoil on the industry will be interesting to monitor. Perhaps lenders will be made whole by the $1T+ dollars of PE dry powder being deployed into portfolio companies - or perhaps levered private lenders will blow up.
The book classifies direct lenders into two tiers. The top tier funds have persistent outperformance related to advantages in credit underwriting and access to deal flow. Bottom-tier funds experience higher credit losses. Ares Capital Corp (ARCC) is one of the oldest BDCs and is noted as having an impressive track record. One way ARCC has created value according to Nesbitt is by acquiring portfolios of other distressed assets (read: Allied Capital) and successfully servicing/working out those loan books.
Poor performing funds are good targets for activist equity investors. This seems to be occurring more frequently. There may be opportunities in the future for activists or competent credit managers to acquire BDCs or loan books at a big discount to NAV through the upcoming/ongoing credit cycle. This may be a special situations bucket to monitor for the future.
Overall, not a fantastic use of time. I did find it interesting reading because credit investing has always been something I want to learn more about. However, I can’t say that I recommend it unless you have some personal interest in credit or are a newbie at an asset allocator or something.