MONTHLY MUSINGS – JANUARY 2023
Welcome to the inaugural release of Monthly Musings, where we provide Roadnight Capital’s perspective on the various issues and themes we see as we deploy capital for our clients.
The start of a new year seems to make everyone excited about predicting what the next year will bring. While a big part of what we do at Roadnight is forward looking we believe that it is just as important to look back and take stock of what we learned so we can harness our learnings to get better.
A good friend of Roadnight, Josh Ludski from River Capital, provided such a reflection on LinkedIn and inspired this musing (a shoutout to Josh and the River Capital team for letting us include his reflection):
During 2022 Roadnight realised four things:
1) For private businesses, it is challenging to find funding if you need between $0.5m and $10m – In the segments we focus on, there has been a substantial reduction in financing availableas the big 4 banks have:
• centralised their credit processes and tightened lending criteria making it harder to get bank funding
• focused on getting more bang for their capital deployed by doing larger deals (i.e. a $30m loan is as much workas a <$10m deal)
Meanwhile, alternative financiers either focus on <$0.5m deals and use technology to automate and assess credit or only focus on >$30m loans to deploy more capital with their available resources. As a result, even if the appetite for credit has not changed (which we do not think is the case), we are seeing very little competition from other lenders.
We believe this factor allows us to generate 500bps+ in additional yield on private debt when compared to similar levels of risk on larger loans. We do not expect these strategic drivers to change for the foreseeable future and even see the loan size continue to increase.
2) Private debt is not set and forget – the credit process in making an investment decision is only the first line of defence in ensuring repayment as it has us looking at primary, secondary and tertiary repayment sources as well as a liquidation analysis. The second line of defence is the monitoring process where we update and re-evaluate those repayment sources as we get new information. However, monitoring by itself is not enough. To proactively protect your position, it is necessary to structure the investment to provide the right triggers to take early action if the potential sources of repayment could be impacted.
3) Coming in with preconceptions can cause you to miss an opportunity or misprice the risk – No one business is the same as another. Having preconceptions about a business, business model, or sector can cause you to miss risks or an opportunity to earn a great risk adjusted return. To avoid both these errors you need to look fresh at each opportunity. Roadnight seeks to do this through our preliminary assessment and credit process, which focus on:
• Assessing each potential borrower a number from different perspectives – cash flow generation, asset support, liquidation analysis and recovery in GFC or worse economic environments
• Modelling what it takes to suffer an impairment and in each case, assessing the potential for this to occur
• Use these learnings to structure the transaction and set the covenants
4) Focus on the opportunities in front of you, not the overall environment. We heard all year about how bad the economic environment was and how things will only get worse. Even though we saw many unviable opportunities that would require restructuring, we did not have enough capital to fund all the deals that made it through our credit process. In the end, less than 10% of the opportunities we have seen made it through our credit process and were funded.
