February 11, 2013
Interviewed by: David Snow
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Shrinking Banks Spell Opportunity

The “shrinking” of traditional banks as middle-market lenders is opening up opportunities for fleet-footed alternative financial companies, such as THL Credit, led by CEO & CIO Jim Hunt. Affiliated with buyout firm Thomas H. Lee Partners, THL Credit was created in anticipation of a credit crisis, a view that proved “too prophetic,” says Hunt. Topics covered also include the “blank sheet of paper” that THL Credit likes to start with when structuring financings for unsponsored transactions, advice on what borrowers should look for in a lender, the importance of relationships, and what Hunt likes about the healthcare sector.

The “shrinking” of traditional banks as middle-market lenders is opening up opportunities for fleet-footed alternative financial companies, such as THL Credit, led by CEO & CIO Jim Hunt. Affiliated with buyout firm Thomas H. Lee Partners, THL Credit was created in anticipation of a credit crisis, a view that proved “too prophetic,” says Hunt. Topics covered also include the “blank sheet of paper” that THL Credit likes to start with when structuring financings for unsponsored transactions, advice on what borrowers should look for in a lender, the importance of relationships, and what Hunt likes about the healthcare sector.

Privcap: What opportunity prompted THL to start a credit business?

James Hunt, THL Credit: THL Credit, headquartered in Boston, was started in early 2007 with capital raised in anticipation of what we felt was a coming credit crisis. We turned out to be too prophetic. We did have dry powder throughout the course of the credit crisis, and then began actively deploying capital in the summer of 2009.

A couple of core founding principles. One were the importance of accessing public capital to fund alternative credit investments. Two, the power of affiliation with the private equity firm, and three, the importance of the US middle market as a reliable place to deploy valuated capital.

Privcap: Is there a particular type of deal or company that you provide lending to?  What’s an example?

Hunt: Absolutely. And THL Credit’s investors in both sponsored and unsponsored companies. Unsponsored is an entrepreneurially owned business. It could be a micro cap public company. And an example of an unsponsored transaction that we recently consummated was Anytime Fitness. It was owned by three owners. Our capital replaced one of the three owners who was seeking to retire. So we, in essence, provided a recapitalization of the business. Our capital came in as a credit investment allowing the two confident continuing owners to one, grow their control of the business, and successfully repurchase that stake in the business.

A sponsored investment could be first lien unitrage could be second lien, could be traditional mezzanine or junior capital in support of a financial sponsor, a private equity firm’s acquisition of a business. And that typically is a transaction that comes through direct origination from the financial sponsor.

Privcap: What particular strengths does the firm bring to a transaction?

Hunt: Well I think it’s an important question in that being unsponsored at our core, our culture is that of an unsponsored capital provider. It makes this more comfortable starting with a blank sheet of paper. We’re comfortable leading diligence, responding to issues that come up through the quality of earnings analysis, directly making customer calls. So in many respects, we end up as a better source for the sponsor in terms of capital because we really understand and empathize with the exact underwriting work that they’re going through.

In turn, on those unsponsored transactions, we’re very responsive to what the specific capital need is and being able to come up with the creative solution for the entrepreneur seeking our capital.

Privcap: What are some questions prospective borrowers don’t often ask, but should be asking?

Hunt: The first thing I would say is take the exact advice we do which is to know your borrower. They should know the lender. What’s their track record in being responsible, in consummating a transaction? And then the after sales service? Covenants will be missed. Projections and business plans will change. Is the lender responsive and dynamic to the changing conditions of the business?

Secondly, I’d want to know a lot about the industry expertise. Is this a lender who is skilled at providing knowledge and information that makes me a better borrower or private equity firm?

The third thing I’d want to know is, what is the condition of that lender’s balance sheet? How much baggage is in the balance sheet? Because what we did see during the course of the credit crisis is good companies with bad lenders or lenders that were in extremis themselves, found themselves under pressure to repay not because of the condition of their borrowing, but the needs of the lender to gain liquidity. So I think underwriting a lender is incredibly important.

The other thing I would add is I would look for a lender who is effective and credible with other capital providers. We’re traditionally a junior capital provider to the middle market. Oftentimes that means that we’re providing capital in partnership with a middle market lending bank. Do the lender have an effective working relationship, a preestablished intercreditor set of relationships with my perspective lender?

And then, additionally, lenders look for other smart capital. So it is greatly additive to the borrower to have a capital source that others regard as knowledgeable, effective, credible, and with a strong track record.

Privcap: Aside from obvious core financial metrics, what other factors play an important role in your underwriting?

Hunt: One thing I’d say that’s axiomatic it’s possible to do a bad deal with good people. It’s almost impossible to do a good transaction or a good deal with bad people. So at the core, we’re very relationship oriented. We care a lot about the nature, the provenance, the track record of people that we’re in partnership and you know, the word partnership is important to us. That’s exactly our view of every business relationship we enter into. So we want to fundamentally do transactions with good, skilled people with the very best of intentions.

Privcap: What trends are you seeing in alternative finance, particularly for the middle market?

Hunt: Well there’s been a systemic change to more providers from the alternative lending system. CLOs, C corp or traditional finance companies providing capital, banks have continued to shrink as providers of capital into the middle market. So other business development companies, which is what THL Credit is, alternative capital providers like CLOs and other firms that have been organized to be capital providers to the middle market will continue to pick up market share. And I think, additionally, other providers of stable long term capital, like insurance companies, will also continue to increase their market share.

Privcap: One of your areas of focus is healthcare.  Can you talk about the opportunities there?

Hunt: We know what’s interesting about health care and we are typically advised by specialist in industries and specifically health care. And in some respects our health care investing is typical of business outsourcing where it’s a service or a technique which cuts cost to the end user. Examples there, we’ve made investments in dental practice management. And the provision of dentistry across a number of offices– in the instance of the company in which we were invested, over 25 offices– and the consequence was the consumer got a better, more affordable, more consistent product through this particular dental practice management company.

Another example of a business what we think will continue to grow is ambulatory surgical centers where it materially cuts the cost to the consumer. So while general surgical costs are being squeezed under the Affordable Care Act, within the Affordable Care Act are material opportunities for growth, businesses like ambulatory surgical centers. Just one other example there is we’re an investor in a software firm which provides the tracking and the management services around at-home health care, another cost cutting example within the health care industry.

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