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What's the Alternative? | Episode 25 | The Private Credit Revolution with John Sateri
29 Plays1 day ago
Private credit is growing faster than ever, and in this episode of 'What's the Alternative?', Shana Orczyk Sissel sits down with John Sateri from The Gladstone Companies to uncover why. From small companies transitioning to market leaders to the intricacies of private credit, this conversation dives deep into an exciting and evolving sector.
Shana and John discuss his extensive background, the evolution of Gladstone since his start in 2007, and the unique advantages of private credit as opposed to traditional banking models. They break down the benefits and limitations of interval funds and BDCs, as well as the significance of understanding due diligence in this investment space. Tune in to gain insights on why private credit could be the key sector to watch in the coming years.
Key takeaways:
- ·Understanding interval funds and their advantages in the market.
- The hands-on approach required in private credit investing.
- How private credit is displacing traditional banking capital.
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Transcript
Introduction to Private Credit Investing
00:00:04
Speaker
At the end of the day, what interest and interests me most about private credit or investing in you know private companies is really the fact that um you're ah going along and underwriting and participating in small companies growing from medium size to large or from small to medium and helping them um you know get to the next stage.
00:00:33
Speaker
Welcome to another episode of What's the Alternative? I am Shana Orzek Sissel, founder and CEO of Bondry Capital Management, a platform to help advisors allocate and in a scalable way to alternative investments.
00:00:47
Speaker
Today, our guest is John Citeri from Gladstone, where he is a managing director. He's been with the Gladstone company since April of 2007, joined at a very interesting time. Prior to Gladstone, he directed independent consultancy, providing special situation investment sourcing, underwriting, and disposition services to institutional investors across a variety of asset classes, including some of the areas we're going to talk about today.
00:01:18
Speaker
From 1989 1998,
00:01:21
Speaker
John worked at Wells Fargo in a variety of areas, including commercial lending, special assets, and lastly, capital markets, where he was vice president and senior portfolio manager, overseeing a team responsible for underwriting, servicing, and managing asset-based loan portfolios with over a half a million dollar in commitments to highly leveraged, growth-oriented middle market companies.
00:01:42
Speaker
He's on a number of boards and holds a bachelor's in administration from the University of Hawaii, which is cool because Hawaii is awesome, and a master's degree in real estate development from the University of Maryland.
00:01:54
Speaker
With that, I'd like to bring John in. Welcome to the show, John.
00:02:01
Speaker
Thanks for having me Looking forward to our conversation. Awesome. Well, ah thank you for being on the show. Gladstone is one of our newest partners.
00:02:11
Speaker
um And one of the things that makes Gladstone so interesting is the Gladstone companies have been doing um alternatives in a accessible wrapper for a long time.
00:02:24
Speaker
ah Your interval fund is fairly new, but you've had business development corps that trade via ticker on traditional indices, as well as preferreds, non-traded preferreds. for a while in spaces like agriculture, real estate development, and private credit.
00:02:38
Speaker
um Talk a little bit about your background in the private credit space, sort of what makes you so interested in private credit, why you think it's so interesting today, and um how the Gladstone Company is is sort of approaching private credit. Sure, no,
John Citeri's Journey and Insights into Private Credit
00:02:52
Speaker
I appreciate it. you know As you sort of read through my bio, I've been sort of doing the same thing for a very long time.
00:02:58
Speaker
And um at the end of the day, what interest and interests me most about private credit or investing in you know private companies is really the fact that um you're going along and underwriting and participating in small companies growing from medium size to large or from small to medium and helping them um you know get to the next stage. And unlike public market investing, private company investing just requires a lot more handson rolling up your sleeve we have to
00:03:31
Speaker
develop the diligence and information ourselves as opposed to kind of relying on readily publicly available information so we engage with all sorts of third parties to dive deep into the business models, the operating performance, and the industry to learn about new businesses every day. And that's really what we do is, at the end of the day, we're students of business models, right? And it's very interesting and you learn something new every day. And that's kind of what attracted me and kept me in the business all these years.
00:04:06
Speaker
Well, it's interesting because as I noted, you joined the Gladstone Companies in April of 2007, which is, you know, in the private credit world, that's that's a real interesting time. Can you talk a little bit about the experiences you've had at that time? Obviously, private credit has become a much more important part of capital markets today than it was prior.
00:04:28
Speaker
to the financial crisis as changes in the way that traditional banks lend have kind of opened the door to non-traditional lenders for a lot of businesses. And so how have you seen it evolve from when you joined the Gladstone companies in 2007? Sure, no, that's a great question. And I think it's,
00:04:45
Speaker
um ah a good topic for Gladstone because when I joined Gladstone, you mentioned some of the other fund structures and wrappers we use, including business development companies.
00:04:55
Speaker
You know, there were probably two dozen or so BDCs out there. You know, since then, post 2010 thereabouts, of course, that population of, um you know, formation structures has exploded. And, you know, when we started or when I started in 2007, Gladstone was already around in its current form since 2001.
00:05:18
Speaker
It was certainly an interesting time because um at that time we had you know the but GFC and you had a lot of you know stress that um came on a lot of middle market and lower middle market portfolio companies.
Private Credit vs. Traditional Banking
00:05:35
Speaker
And um ah what we learned from that experience is as a principal investor, as being very close to the businesses,
00:05:44
Speaker
um you know, we didn't panic. We tried to figure out how to um help the businesses get to the other side. Now, you know, 2008 was obviously different than other cycles we had been in because there was also a liquidity crisis.
00:05:58
Speaker
um So for BDCs, it was difficult to raise public equity, which ah that's probably a good segue in a little while in terms of why we decided to also have an interval fund.
00:06:09
Speaker
But you know the lesson learned from 2007-8 is that, look, as long as you ah diligently deploy capital and stick to your knitings and you know do what you've been taught to do, you can get to the other side. And it may not be ah high growth strategy from an assets under management perspective, but it withstands the test of time. And I think if you look at the body of, you know, BDCs and other funds out there right now, you know, we're one of the few, I think probably less than 5% that have experienced that dates back that far. So, you know, we've we've been around a while, we've seen it all.
00:06:50
Speaker
And, you know, one of the, um, you know, selling points for Gladstone is simply that is like look we want to help the businesses grow right and we're here to provide growth capital and fundamentally what we do is we um invest in a plan that either management has to grow the business or plan that management and the private equity firm is developing or has a thesis around or one that we're sponsoring so We're very much focused on sort of a long-term horizon of investing, and that's kind of what it takes when you're dealing with smaller, private, lower middle market companies.
00:07:31
Speaker
I think what you said is really interesting. There was something you said there that I found particularly interesting um as it relates to what you went through in 2008 and that you've really got your hands dirty, but working with your companies, which is very different than the traditional banking model. Yes, some banks have workout groups or whatever,
00:07:50
Speaker
But I do think one of the benefits of private credit for business, a small business or otherwise that might have difficulty tapping the banking system, is that private credit teams tend to be willing to go in there and and work around and help the company. you know if it finds ah itself in a stress situation, find a way to ensure that the company can make through it through that.
00:08:15
Speaker
um Even if in the short term, maybe you don't get paid or you do something like that. But really, the focus is ensuring that the company will be able to pay back the debt, even if in the short term, it's under stress. Can you talk a little bit about you know the advantages of doing that and why you know that can be really helpful to people investing in private credit? Sure. No, that's that's a great point. You brought ah brought up banks and you know I'm a recovering banker. And the challenge with commercial banks is the focus for a long time tended to be around making loans and focusing very much on the collateral, right? And banks are very highly levered, you know, eight, nine, 10 times leverage, and there's very limited capital um that you can play around with. Whereas, you know, even LP funds, BDC certainly have very low leverage and interval funds have even less leverage.
00:09:10
Speaker
It gives you more cushion and opportunity to, work through the downs and get to the other side, as I mentioned. So when we talk about you know trying to support a business, whether it's going through a systemic low or a economic bump in the road, you know all we're really doing is we're reverting to our original thesis and interest in the business, right? Do those key pillars still hold true?
00:09:40
Speaker
And if so, then it's simply a matter of either um bringing in additional talent, bringing in additional capital, restructuring the stack in order to get the team to the other side. Whereas when you're talking about banks and you mentioned workouts and you know I used to sit in one of those seats. It's a much different environment. You have to clean the balance sheet, right and there's a lot of pressure to to get rid of those kinds of assets. Whereas as a private credit investor, where we're more focused on the enterprise value and the cash flow generation of the business as opposed to necessarily
00:10:17
Speaker
the hard collateral that you can liquidate, then it sort of gives you a different view in terms of the world and as well as the horizon for business, right? And that's and what I would say is kind of the main difference. And um I can't,
00:10:33
Speaker
over-emphasize the fact that you mentioned BDCs are relatively low leverage fund structures versus banks and even versus some um LP fund structures and certainly compared to CLOs. So that that really informs how you're able to sort of go in your toolbox and fix a problem.
00:10:54
Speaker
I think one of the things that you said there is something that I'm not sure a lot of folks appreciate about private credit versus public credit. And when you're dealing with traditional banks, commercial lenders versus private credit, non-traditional non-bank lenders, which is you said that a lot of it ah is focusing on the enterprise value of the business and the cash flows of the business and not necessarily as their collateral.
00:11:21
Speaker
um And that, I think, to your point, allows you to, if a company is going through a difficult time, if their cash flows you know have some issues as it's relating to like client invoicing or whatever, to sit down and work with the company to get them back to that right place because you're not worried about, like okay, what can we liquidate?
The Role of Private Credit in Capital Markets
00:11:40
Speaker
Which might very well, as you point out, put the company in a worse situation, not a better situation. Um, and in a way you charge a higher rate because of that aspect of the business, but also as you point out, not having leverage, I think all of those things are really interesting. When you look at the current environment and how much private credit has grown in importance to capital markets in general, know, what are the key things you see today that continue to get you excited about private credit? Sure. um you know One of the things that excites me is that over time, um private credit and alternative capital has been displacing commercial bank capital. right so Just because of the flexibility, the the focus on the enterprise, the ease of being able to interact with management, the board, the sponsors,
00:12:37
Speaker
um you know, the flatter organizations at private credit funds in terms of rendering a decision, speed by which you can get back to a client or customer.
00:12:49
Speaker
You know, we don't have multi-layer investment committees or credit committees or, you know, these structures that are really predominating now through these large bank systems, right? You know, people have to go through various layers and there's a lot of time lag. So naturally, private credit and alternative capital has been displacing, you know, the proportion of lending activity or investment activity compared to commercial banks.
00:13:21
Speaker
Now, commercial banks still hold the bulk of, you know I think, loan assets out there, some number near $13 trillion, dollars I think. And I think private credit is somewhere probably around one and a half to $2 trillion. dollars So it's still um small. So we have a long runway of growth ahead of us. And um you know that's kind of exciting. Now, you mentioned, um you know cost of capital, you know, certainly um cost of capital for any LP, any BDC, or even interval fund is going to be a lot different than a commercial bank simply because, you know, we don't have free deposits um to lend out, you know, at SOFR plus, you know, two or 300, right? We are raising debt, we are raising equity, and we have to deploy that at
00:14:12
Speaker
you know, a spread that's closer to five, six, 700 basis points, sometimes more depending on where you are in the capital structure. But, um you know, what I think we see in the market is that for sponsors or even management teams, when you have someone that is aligned with you to support the plan, whatever that growth plan is, then it is worth that extra um, interest expense, whether it's cash or pick or whatever the case may be, um, in order to enhance at the end of the day, the equity value.
00:14:49
Speaker
Right. And, um, and that's really what we're here to do and what private credit is here to do.
Transition from BDCs to Interval Funds
00:14:55
Speaker
And a lot of times if we have conviction and we, um, have the,
00:15:01
Speaker
ability to get equity co-investments we do that right because not only does that align us with the ownership but we have an opportunity to get an accretive yield that acts as a additional opportunity for special dividends down the road or it can even ask as act as a buffer against you know losses right we we're going to have losses and some things are inevitable, but you know that's the ah added flexibility that these private credit funds, including us, have relative sort of the commercial bank um rigid parameters that they have to operate under, and rightly so because you know they're holding our deposits. you know We want them to be in ultra safe and very conservative end investments, especially in light of the amount of leverage banks have.
00:15:55
Speaker
No, that makes perfect sense. you know we You talked about BDCs versus interval funds. yeah One of the trends right now in private credit is the interval fund and actually even ETF structures.
00:16:07
Speaker
um I have my own opinions on the fully daily liquid forms and you know the limitations there. um And also the impact it could possibly have on private credit as a whole um in terms of its key attributes like kind of disappearing.
00:16:25
Speaker
um But let's talk a little bit about that BDC to Interval Fund um ah kind of move that the Gladstone Companies has made. You've had the traditional BDCs in the market for a while. you know Typically the issue with BDCs is that you don't always correlate to the market that you're invested in because they are still equity tickers trading on equity exchanges. So they get really difficult for people to kind of get the true benefit that they are expecting in the way that they expect through those structures. um
00:16:59
Speaker
Where the Interval Fund is a lot closer to the traditional LP private product, ah private placement structure um with some wiggle room there. Can you walk us through kind of the thought process on launching the Interval Fund as we're seeing more and more of that?
00:17:15
Speaker
And one of the things I'd love for you to touch on is like the important limitations of the Interval Funds because the number one thing that I worry about with interval funds is not so much whether or not they're a good thing or a bad thing, but more ah there's nuance there.
00:17:29
Speaker
And I'm not sure that most people understand the nuance to an interval fund. Sure. i mean, first, you know, I'll take the first part about, you know why Gladstone and why do we go with an interval fund, you know, opportunity here. And um For us, we have the BDCs and you know we are operating um our capital, our equity capital in a publicly traded, very liquid environment.
00:17:55
Speaker
And that works when everything is operating normally in the capital markets, you know. But when it doesn't or when it's disruptive, it is volatile, right? So you will see, you know, NAV fluctuations depending just simply by what's happening out there, not necessarily ah things specific to your assets, to your fund or what have you.
00:18:19
Speaker
Now, what that does is what the challenge that that creates sometimes is your ability as a ah BDC to access the equity markets, you know so you're not trying not to sell new shares below NAV.
00:18:35
Speaker
and to continue to support, as I mentioned, the plan for the businesses that we invested in. Right. So when we talk about trying to invest in a business, either when things are you know challenged or even when things are and going well, part of what we do is we provide follow on growth capital, right? The simple you know example is, you know here's a platform business and it's going to buy other similar platform businesses. Now, we're not going to extend the capital to them upfront, but as you find the next opportunity and you want to buy it and create synergies and improve your margins and scale and get a higher potential multiple on exit, you know you have to buy stuff. and
00:19:22
Speaker
for us we do that oftentimes in the form of either an accordion facility which is uncommitted capital or ah ddtl delay draw term loan which is committed capital so um when you have disruptions in the equity capital markets that ah make it difficult for you to raise equity to continue to invest in your businesses that's somewhat of a problem right i mean you want to Especially because during those times of equity disruption is usually probably the best time to do some of the things you're talking about. It's a good time to buy stuff, exactly.
00:19:54
Speaker
so yes um So the Interval Fund provides you know a different end sort of um market in terms of holders. It's obviously a non-traded security.
00:20:07
Speaker
And from an investor standpoint, it obviously is not going to exhibit the same kind of volatility either. Now, um if you think about interval funds and you're invested in it and you're interested in having some exposure to private debt or private capital in your portfolio, right?
00:20:28
Speaker
And what you're really saying is, look, I don't want to go and buy something on the, you know, the S and P 500 where some, so I have to buy a company essentially at a high teens or 20 times EBITDA margin.
00:20:44
Speaker
I want my end money to be in something that is purchased effectively and levered even less at six, seven or eight times because I want the opportunity of that multiple arbitrage for that business to grow.
00:20:59
Speaker
So what that really means is that you're buying into the concept of a longer term horizon than trading in stocks, right? When you're talking about investing in these small businesses, that doesn't happen overnight. It takes three, four, five years to institutionalize, to pursue the plan, to build out the management, to build out the systems, for the people around the board to provide the adult supervision, so to speak, to get it to where they want it to be.
00:21:29
Speaker
And if the plan for the business and the investment is a four or five, six year plan, then you as an investor in ah and the stock of the interval fund should think of it in that term, right? As opposed to, um hey, I want to sell this tomorrow. So if you need immediate liquidity, you shouldn't you probably shouldn't be in an interval fund. But if you're looking for steady income and income is the key focus,
00:21:54
Speaker
then it may be a good alternative to get exposure to smaller businesses um know while at the same time um having a safety valve for liquidity. right and That's sort of what the unique element of the interval fund is simply that um you're not locked up similar to LP funds. You have that 5 to 25 percent you know, mandatory redemption where you sort of can glide path when you need to as an investor to liquidity.
00:22:27
Speaker
And, and that's why, you know, for us, we thought ah adding an interval fund structure to the family of funds here made sense. It diversifies our capital source and it, you know, is very consistent with how we invest in the first place.
00:22:45
Speaker
Yeah, I think what you said there was interesting. And I always like to point out to my audience, yeah, you have a liquidity valve to a point. um I think it's really important to emphasize that it is a limited liquidity and it does happen over time. So there's not going to be a scenario in most cases, I don't want to say 100% the time, where your client would be able to get their entire investment out.
00:23:11
Speaker
at once. ah it's It's going to take time. um and to your point for some drawdown um LP structures, um you might have no liquidity at all for a period of time, but also a secondary market that doesn't really exist in the interval fund world. So that's consideration. And then in private credit, there are evergreen private credit funds that have just very clear you know ah quarterly liquidity with 60 days notice kind of thing.
00:23:43
Speaker
um And so all of those things need to be considered. But I think the point you're making about um having a liquidity safety valve just is ah is an important one um to emphasize the never or highly unlikely to be the entire investment in a single quarter.
00:24:01
Speaker
um and And that is something that I don't know that we emphasize enough. Yeah, I think um what we look for the same way, you know, the companies that we invest and look for, you know a partner, right, to help them get to get from to Z, so to speak. um You know, the way that interval funds um are set up is that as an investor, you can see exactly what we invested in, right? And it's very digestible and understandable, at least for a firm like Gladstone, that
00:24:33
Speaker
invests primarily in proprietary kind of lower middle market businesses, right? So you can go on the website and say, all right, we've invested in a business that processes, you know, all the honey for the East coast of, you know, the United States, right? So, or makes weather measurement instruments, you know, it's like really what, um um you know, most of the businesses out there are and you're, your're you're, you're,
00:25:00
Speaker
a part of it. Now you can't invest as a retail investor directly into those private companies. The vehicle is through an interval fund, through an LP fund or through a BDC for the most part. And, um, the difference between an interval fund and let's say a traditional LP fund is that interval funds, you know, like BDCs have the, uh, layer of,
00:25:26
Speaker
public registered chartered, you know, company um um framework where, you know, we have to abide by, you know, the the audit standards, the public reporting standards, everything else. So, you know, from a valuation standpoint, from a compliance standpoint, from a governance rigor standpoint, it's, you know, like investing in, know, most other public companies similar to
Investment Strategies and Due Diligence
00:25:53
Speaker
BDC. So you get a little bit of both, I would say.
00:25:57
Speaker
Yeah, that's a good point. Let's dive into where you invest. So you talked a little bit about lower middle market. I'd love to walk through you know um that area of the market, know define it for our audience and then talk about how the due diligence works for that part of you know the capital markets and those types of clients from a lending perspective. Sure. Look, um everyone has a different definition, but in terms of what the lower middle market is, right? this is how low Yes, that is 100% true. I've had lower middle market people tell me that that is loan size is between a million and two and a half.
00:26:33
Speaker
And I also had somebody tell me it was between five and 10 million. ah So yeah, it can be- I would i would would define it this way. I think you know anything under 150 to 200 million in enterprise value is you know lower middle market, right?
00:26:49
Speaker
And for For Gladstone specifically, ah we try to contextualize the size of the business in terms of EBITDA or cash flow. So we'll say roughly between three and $30 million. dollars Now, do we have some businesses that are slightly less and some that are larger? Yes.
00:27:09
Speaker
Um, uh, some of them have grown during our whole period to the point where they are in excess of those parameters, but those parameters are relevant only because they inform the check size that we would write. So if we have a $10 million EBITDA business and we don't want to lever something more than four times, we'll write $40 million dollars check size, which is sort of at the middle ground for at least our BDC. Certainly the interval fund right now is not going to be writing checks that large because we're just starting to raise equity.
00:27:44
Speaker
But the interval fund for Gladstone is a co-investment fund, so it will participate with the other two BDCs in the securities that they invested in. So that's kind of what I would describe as the lower middle market for us in terms of process.
00:28:03
Speaker
And what does it look like? I mean, the basic, um, uh, process is we get opportunities from a variety of sources. management teams, investment bankers, private equity sponsors, and other relationships, consultants, advisors, you name it.
00:28:21
Speaker
And these are opportunities where, you know, someone wants to sell their business or take out a shareholder. or buy another business. And um ah what we typically find, at least on the leverage side, is a sponsor that will have the opportunity under a letter of intent or commitment where they've locked it up for some period of time to do some additional diligence to prove out you know sort of the big rocks of what we would like to know and at the same time they'll go to the lending community the private credit community to gauge interest on it ah but what's different about you know investing in these private companies is we have to develop
00:29:09
Speaker
our own industry reports. So we'll commission third parties and dialogue with experts about a particular business model or a particular um um industry or a a particular ah segment in an industry. We'll do background checks on the management teams. We'll evaluate the management teams. We'll do quality of earnings because a lot of times these smaller businesses will not have had audits per se.
00:29:40
Speaker
um So we have to really dig deep into being able to rely on the financial information. And even if they have audits, oftentimes we'll do or commission a quality of earnings report because what we want to see is not only historically what they have done, but also what the plan is going forward and how those adjustments look on a go forward basis.
00:30:04
Speaker
And that's really the key element of our type of investing is that we are focused on what's going to happen in the future and what kind of capital structure to lay against what the business will look like in the future after the transaction, not what it was in the past.
00:30:25
Speaker
So, um you know, lot of third party reports, lot of diligence a lot of of management interviews, ah um spending a couple months learning about businesses, and then finally tailoring, you know, the amount of debt, the pricing of the debt, the amount of equity, the nature of the equity in a way that makes sense for that business.
00:30:49
Speaker
Yeah, that's, you know, as you're talking, it reminds me a lot. Obviously, Bondrian is a small startup technology firm, and we are out raising capital right now. A lot of what you're talking about sounds a lot like when we talk to potential investors, how they approach us, right? It's really about, you know, the plan, ah the execution of the plan, the the probability and the realistic nature of the plan.
00:31:15
Speaker
it make sense? Does the industry make sense? So, you know In a lot of ways, if you think about it, um as advisors consider these types of things for their clients, know it's it's sort of like a cousin or a relative of like the venture world and the private equity world. Similar approach just How you're investing your capital and where you sit in the capital structure is a little bit different.
00:31:40
Speaker
um With private credit, typically not going into that earlier stage startup world, but also not necessarily in that highly developed, you know in the lower middle market anyways, highly developed like growth equity, private equity kind of world either, where you're talking about like taking company perspective. private or acquiring like one large company acquiring another large company, things of that nature.
00:32:04
Speaker
So it kind of sits in that little sweet spot where again, you point out the income, you know, as people evaluate these types of strategies, what kind of income um and coupons are you looking at here?
Impact of Interest Rates and Market Changes
00:32:18
Speaker
and and In a rate environment like we see today, how do you know changes in overall rates impact um this market or if does it impact at all? Yeah, that' that's a great question. And it it certainly does. Maybe what I'll do is I'll you know go back um you know two or three years to kind of set the stage in mid-late 2022 when
00:32:42
Speaker
ah the Fed started raising rates, um you know a lot of things happened you know that was um beneficial to the alternative credit, private credit investors or funds in that by raising rates from zero to near 500 and around 500 basis points before they sort of flatten out, um what it did is it boosted the nominal income and the dividends that these private credit funds were able to pay to their shareholders.
00:33:13
Speaker
So it was a great time, very profitable, and you know a lot of investors in BDCs, interval funds, you know LP funds got used to you know, pretty rich double digit coupons, right? Because of the rate environment and because most of the exposure, most of the investments are in variable rate structures, right? So that's kind of how we manage, you know, our balance sheet.
00:33:41
Speaker
um so as not to take sort of that that risk um the other thing so i i just want to interrupt if you don't mind because as you talk about variable rates i'm just curious you know the way that used to work is libor plus now libor doesn't exist anymore so how do you guys do um your variable yeah so we're we're sofer based for the most part you know and and think of it roughly date going back 30 years now sort of like as a fed funds type of uh um ah framework, but it's very similar to LIBOR. We just swapped it out.
00:34:13
Speaker
And SOFR right now, I think is at four and a quarter, 4.3, thereabouts, one month or so far. And then we add a a spread or risk premium to it. And depending on you know, ah the, the type of business, the size, the leverage, you know, that could be anywhere from, at least for private credit, you know, anywhere from the 500 basis points to, you know, seven, eight, 900 basis point. If you're for a second or, you know, junior lean type of a structure, ah versus I'll, you know, put it in context for banks, um,
00:34:52
Speaker
that might be doing SOFR 200 or 300. um Certainly in the broadly syndicated market, you see a lot of SOFR 300 to 400 type paper, but that's also a little bit of a different you know um end market.
00:35:08
Speaker
So that's you know the general pricing, but in terms of you know the rate environment, um in addition to you know the Fed raising rates in 2022, we're now at a point where that has sort of flattened out and is expected to go back down. right So you know we're projecting on a SOFR curve basis,
00:35:31
Speaker
Well, we had projected more than it actually turned out. It keeps getting delayed, a reduction of 25 to 50 basis points, you know, over the course of 2025. That has not happened yet.
00:35:45
Speaker
Maybe it'll happen in September or thereabouts. But the point of it is that by SOFR going down, um the company's borrowing costs will go down and the earnings of all the credit funds that are, you know, very much variable loan based pricing, it's also going to have to come down. So the yield will have to come down as well.
00:36:09
Speaker
So, uh, I only mentioned that because, um you know, people have gotten used to double digit, you know, private, uh, credit fund type yields, and that works as long as, you know, rates remain elevated.
00:36:25
Speaker
Now, we're very concerned about that as an asset manager from a borrower perspective because you know you sort of get to a tipping point. It's great for us to get more interest income, but it could strangle these small businesses to a point where you know it no longer works for their capital staff.
00:36:46
Speaker
So, you know, one of the things in the lower middle market um versus the broadly syndicated market, the amount of leverage that we are comfortable putting on the business tends to be a lot less, which by extension makes a lot of sense if you think about what we're paying or what the sponsor's paying for the business. So if you're paying six or eight times, you're not putting six times leverage. you know You're probably not putting five times leverage. You'd like to be in the three to four range. So um as long as you know it's adequately structured without too much leverage, I don't think you have to worry about um rates with regard to portfolio companies you know tipping, but it's it's a real concern as ah as an investor.
00:37:31
Speaker
Yeah. So, um, just for our audience, um, I think sometimes we take for granted that people know what these acronyms mean. LIBOR stood for London Interbank Offered Rate? London Interbank Offered Rate, I think is what it was.
00:37:44
Speaker
Yes. And SOFR stands for? Secured Overnight. Um, wow. ah Fund rate? Fund rate? Yes. right. Just see, i even I'm like, I have to think about it. But that as we use these terms, I think it's important. LIBOR ceased to exist a couple of years ago and SOFR took over as the standard rate because it's sort of the international average, if you will, um which is different um than the underlying U.S. Fed funds rate, which is...
Growth and Opportunities in Interval Funds
00:38:17
Speaker
what the banks tend to use um because it's most relevant to them. I think, you know, as we kind of come to the end of our time, um it would be super helpful to talk a little bit about um the Gladstone companies and sort of um how you guys are thinking about private credit. And as you kind of grow your interval fund business um you know where you think the opportunities a lot and for our audience's benefit the bdc's that the gladstone companies have ah go beyond private credit you have some real estate have agriculture things of that nature is there plans at the gladstone group depending on how the first uh uh
00:39:04
Speaker
attempt with the interval funds goes to potentially move some of those other types of assets into an interval fund structure? um no Yeah, I'll try to answer that, you know, sort of without making your compliance. Yeah, exactly. It's like, you know, someone's going to throw a pillow at me ah in a second.
00:39:21
Speaker
I think you know This R Interval Fund is primarily um a co-invest fund with the BDCs to start out, yeah um but it will also co-invest and do direct investments depending on um the the sort of cadence of our equity raise.
00:39:38
Speaker
um um it is ah structured to sort of be a blend between, um, Gladstone capital and glass zone investment. Gladstone capital is more of the leverage fund where 90% of its capitals in the form of debt securities, 10% is equity.
00:39:55
Speaker
And then glass on investment is, you know, weighed a little bit differently, 75% debt. 25% equity. So definitely investing more in the equity securities of these small businesses. And um the Interval Fund is sort of designed to be right in the middle at 8550.
00:40:12
Speaker
And additionally, the Interval Fund has some broader, I guess, investment capabilities or mandates. um You mentioned um you know our farm REIT and then our commercial triple net REIT.
00:40:27
Speaker
um you know The integral fund is not going to be buying real estate, but it can invest in real estate debt. And you know we're sort of in an interesting time as far as real estate debt is concerned. And you know you mentioned it earlier, it's not a great time, but there are probably some good opportunities, right? So although the BDCs wouldn't be investing in the debt of you know real estate um concerns, the Interval Fund could, but it's not a primary mandate. It's really more opportunistic. And you know depending on um you know what happens in certain verticals of the real estate market, it could invest in that. um
00:41:08
Speaker
So I don't know if that answers your question, but. No, it definitely helps. um I think it helps our audience. You know, interval funds are so new to a lot of people. I think that um yeah even purchasing one has its own quirks, as I'm sure you're aware.
00:41:26
Speaker
um But it's it's an interesting opportunity because as I alluded to earlier, you know, we're seeing more and more people wanting to put private credit and these types of products that are in less liquid markets into more liquid ah structures.
00:41:41
Speaker
um And I think that there's there's real risks associated with that. And as our audience and the advisors that listen to this podcast are thinking about different ways that they can help all of their clients access private credit, think it's worth considering that you know to get the key benefit to private credit and really the income opportunities. um you know The Interval Fund is going to do that better than say ah fully daily liquid ETF that's going to have to have a large chunk of the underlying assets and something outside of private credit to be able to maintain the regulatory required liquidity needed for those products. So just food for thought for our audience.
00:42:25
Speaker
You know, most of the interval funds that have come to the market have been more in the real estate world. So um we're starting to see others, but, you know it's not a ton of interval funds, maybe 300 today. So, you know, it's just a worth considering working with a company like the Gladstone companies where they have a very long history in the space.
00:42:50
Speaker
And really it's just taking something they've been doing for a long time and putting it in a structure that makes sense for the underlying and the co-invest part is also quite interesting. So um I think that that's worth ah kind of emphasizing as well. Yeah, no, appreciate it. like Like I said, we're not doing anything new or different. We're only doing what we've always done. And that's, I think, kind of the key attribute about Gladstone and you know our organization.
00:43:14
Speaker
even though we invest in real estate at the end of the day we're very much focused on underwriting capital to the lower middle market it just happens to be that on the real estate side we're underwriting a single tenant that is operating in ah a piece of real estate where they need to manufacture the widget but what we do is exactly the same but instead of providing debt or providing equity we're buying the real estate and then renting it to them right so it's very much a lower middle market centric cash flow underwriting dividend oriented organization. That's what we'll continue to do.
00:43:52
Speaker
Well, I appreciate your time, John. i think our audience will find this very interesting as you guys are one of the leading providers of private credit in the Interval Fund structure um and are doing it in a really unique way. So thank you so much for your time.
00:44:08
Speaker
like to thank everyone for listening to this episode. um As always, hit that like and subscribe button. um Please leave a comment. Let us know what you thought of this episode. Let us know what you're interested in hearing, you know what is on your mind, and we'll work to make sure that we are putting out content that is timely, that our audience is looking for.
00:44:31
Speaker
So with that, I am Shana Orzek Sissel, founder and CEO of Foundering Capital Management. This was What's the Alternative, and until next time.
00:44:44
Speaker
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00:45:00
Speaker
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00:45:12
Speaker
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Speaker
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00:45:36
Speaker
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00:45:57
Speaker
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00:46:14
Speaker
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Investment Risks and Final Thoughts
00:46:28
Speaker
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