Responsible investing is ‘fundamental’ to private credit underwriting
Responsible investing is a critical part of private credit underwriting and needs to be treated as a part of the core investment analysis, according to Vai Patel, head of responsible investing at Benefit Street Partners.
Speaking to PA Future, Patel said responsible investing is often discussed as something separate to core investment analysis, but shouldn’t be.
“Responsible investing is part of disciplined underwriting and about identifying factors that can affect a borrower’s value, cashflow resilience, refinancing options and downside protection over the life of a loan,” he said.
“Private credit is a risk pricing business. We can’t afford to look just at historical financial statements or short-term earnings. We need to understand the wider risks that could impair a company’s ability to service debt, refinance and operate effectively, while maintaining the support of customers, regulators, employees and sponsors.
“Many of the risks we need to consider sit under the responsible investment umbrella and they are important because private credit is not the same as public equity. Lenders don’t benefit from upside performance in the same way as shareholders, but they have significant exposure to downside.”
He said that if a borrower has weak governance, poor health and safety standards, cyber vulnerability, regulatory compliance issues, unmanaged climate exposure or poor supply chain controls, these may not look material early on, but can become material very quickly when things change.
“In a high rate, low growth environment, they can quickly become credit concerns, with implications for valuations and recovery potential. Responsible investing is therefore fundamental to private credit underwriting and should never be treated as a marketing label or values-based screen,” he said.
“Rather than asking whether an investment is ESG or non-ESG, private credit managers need to understand the financially materials risks and opportunities for individual borrowers in the context of their sector and the economic cycle, and reflect this in their investment view.”
Read more: Reimagining wealth: The shift toward purpose-driven impact
In private credit, Patel said responsible investing can also improve engagement between private credit managers and management teams.
“Managers have access to information and a dialogue with companies that is often different to public market investors, creating an opportunity to ask better questions during due diligence that translates into better monitoring of relevant issues for the life of a loan,” he said.
Patel believes that investors are increasingly sophisticated in their assessment of responsible investment claims, but there are still a number of questions they should be asking to scrutinise how private credit managers embed these factors into the investment process.
For example, whether they are part of due diligence, if they are discussed at the investment committee, how they are monitored post investment and whether they are relevant to loan pricing and terms, covenants and portfolio management.
“Investors should also ask managers to show them examples of where their analysis of responsible investment factors has changed an investment decision or the way a risk is being managed,” he said.
“The next phase of responsible investing in private credit will see managers need to place more focus on providing evidence of integration. Responsible investing should therefore not be seen as separate to fiduciary duty, but integral to how managers protect capital, price risk and make more informed lending decisions.”
Read more: HL responsible investing survey reveals gender and age divide