Nesbitt - Private debt: opportunities in corporate direct lending

1. Chapter 1
2. Chapter 2
3. Chapter 3
4. Chapter 4
5. Chapter 6
6. Chapter 7
7. Chapter 8
8. Chapter 9
9. Chapter 11
10. Chapter 12
11. Chapter 13
12. Chapter 14
13. Chapter 15
14. Chapter 16
15. Chapter 17
16. Chapter 18
17. Chapter 22

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STEPHEN L. NESBITT

Copyright 2019 by Cliffwater LLC. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress CataloginginPublication Data:

Names: Nesbitt, Stephen L., 1953- author.

Title: Private debt : opportunities in corporate direct lending / Stephen L. Nesbitt.

Description: First Edition. | Hoboken : Wiley, 2019. | Series: Wiley finance | Includes index. |

Identifiers: LCCN 2018049404 (print) | LCCN 2018050703 (ebook) | ISBN 9781119501275 (Adobe PDF) | ISBN 9781119501169 (ePub) | ISBN 9781119501152 (hardback)

Subjects: LCSH: Investments. | Small businessFinance. | Bank loans. | BISAC: BUSINESS & ECONOMICS / Investments & Securities.

Classification: LCC HG4521 (ebook) | LCC HG4521 .N427 2019 (print) | DDC 658.15/2dc23

LC record available at https://lccn.loc.gov/2018049404

Cover Design: Wiley

Cover Image: belov1409 / iStock.com

To the ones who make it all worthwhile: Lisa, John, Blake, Amanda, twins Ford and Ellie, and a dog named Kitty.

Corporate lending was traditionally the business of commercial banks, but the global financial crisis and ensuing regulatory backlash created an opportunity for nonbank private asset managers to replace bankers as primary lenders to a large swath of middle market businesses, primarily in the United States. The economic recovery, albeit slow, found many middle market companies looking for debt capital for growth or refinancing. With banks in retrenchment, these companies found asset managers to be willing lenders. Lacking the deposit capital available to banks, the new direct lenders in turn have sought capital from institutional investors hungry for yields closer to 10% than the 13% available from traditional sources. Though estimates vary, the size of the corporate direct loan market in the United States today is perhaps as high as $400 billion and growing.

This book is directed primarily toward investors interested in learning more about corporate direct lending. The author comes from the perspective of an investment consultant to institutional investors providing research and advice on asset classes, manager selection, and asset allocation. The book therefore follows the same path that fiduciaries to institutional capital walk in their own due diligence on a new asset class.

That research covering return and risk is updated along with a new chapter addressing liquidity.

provides a theoretical foundation for the threeasset view by splitting fixed income into separate credit and interest rate components using option pricing models developed almost 50 years ago by Robert Merton, Fischer Black, and Stephen Cox. Their concept that any credit instrument can be modeled as a riskfree rate plus a put option forms the basis for sensitivity analysis and simulation to better understand the behavior of yield, return, and risk for various types direct corporate loans and the value of covenants.

provides an explanation for the high yields in direct loans by dissecting them into six components, each associated with a distinct risk factor potentially found in loans, and each offering an extra yield, or risk premium, as compensation for the specific risk factor. This yield architecture provides investors with a method for understanding and comparing absolute yields.

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Investments that go terribly wrong generally have too much leverage or involve fraud. Many investors in direct corporate loans apply some leverage to enhance return. examines the impact of leverage on portfolio return and risk and provides guidance to investors on what leverage level might be appropriate. Unlike traditional stock or bond portfolios where return and risk characteristics are similar among managers, direct lending offers investors many options that can materially differentiate one portfolio from another.

discuss alternative forms for investing in direct corporate loans and some of the practicalities. Business development companies ( BDC s) are covered first because they are the most visible of direct lending vehicles. Other topics include manager selection, loan valuation, fees, and portfolio construction.