The Searchers Guide to working with Debt

Paul Carman - Private Capital Group: Transforming Debt Lending Landscapes

• Tom McGhie • Season 2 • Episode 1

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Ever wondered how the financial landscape has shifted from the late '80s to today? Join us as we sit down with Paul Carman, the trailblazing founder of Private Capital Group in New Zealand, who takes us through his riveting journey from the heart of UK banking to the innovative world of private credit. Paul shares his firsthand experiences with NAB and Japanese banking groups, offering a rare glimpse into the leverage loan and private equity markets of the late '80s and '90s. Discover how a fund business he created within a Japanese bank evolved into a cutting-edge private credit operation, shaping the financial strategies pre-and post-global financial crisis.

Our discussion then shifts gears to Paul's ambitious venture in New Zealand, shedding light on the unique regulatory environment and market maturity that set NZ apart from its global counterparts. Paul eloquently explains the nuances of direct lending opportunities, the dynamics between the NZ and Australian markets, and the pivotal role of SMEs in this evolving landscape. Learn how innovative methodologies from search funds and private equity transactions are being tailored to catalyze growth in New Zealand’s nascent but promising private credit market.

We wrap up our conversation by diving into the complex world of business transactions, focusing on acquisitions and carve-outs. Paul emphasizes the crucial alignment needed between lenders, equity providers, and management teams, and the importance of clear communication and robust risk mitigation strategies. To cap it all off, Paul and Tom share their excitement for an upcoming event, expressing their eagerness to connect with everyone and enjoy a well-deserved beer. Don't miss this chance to gain valuable insights from one of the financial industry’s seasoned veterans.

Tom McGhie:

Welcome to the Searcher's Guide to Working with Debt. I'm Tom Magee. This year, at the UTA Forum, I'll be hosting a panel discussion with a number of experienced finance professionals seeking their views on how debt providers navigate business turbulence. So for this season ahead of the UTA Forum, I wanted to take the opportunity to connect with each member of the panel and provide some background and context to who will be part of the group. Today we're speaking with Paul Carman, who is one of the founders of Private Capital Group, based in New Zealand. Hi, Paul, it's great to connect and maybe we could start with some of your career to date and why you started Private Capital Group.

Paul Carman:

Yeah, thanks, tom Pleasure, to have the chance to catch up and thanks for the opportunity. I'm a Kiwi who did what a lot of Kiwis and I guess Aussies do out of university really is go on a bit of OE, and I went across to the UK with the idea of having a bit of time in the city, whatever that might entail, and turned up early 20s and ended up working for NAB for a few years in London and to date that that was sort of late 80s, early 90s. So yeah, a long time ago. And what I was fortunate enough to really fall into was an opportunity to be involved, initially through NAB and then through one of the Japanese banking groups, some exposure to the leverage loan private equity financing market. And the long story short was that I joined a group that was focusing on cash flow lending mid 90s and at that point there was somewhat of a step change perhaps in the private equity market in the UK and Europe. Step change perhaps in the private equity market in the UK and Europe. And we were just caught that wave. The institution I was with Fuji at the time, the Zuhos it became allowed us to invest some capital as a limited partner in private equity funds and we use that as a way to get close to those private equity firms in the context of lending to them as they were making acquisitions and investing their fund. And as that market grew and as we grew with it, we had a first-hand view of how the market went from uk into europe and and perhaps how some of those european names or north american names, names or North American names moved out into Asia and elsewhere. And really we kind of rinsed and repeated a model of investing in the funds that we thought were at that point the ones most likely to do the right sort of deals and succeed. And then really growing that leverage business by expanding the team, putting people in the grounds who either had some experience of doing leverage or from those from those locations. So we were trying to be local in all the local jurisdictions and having, as it were, a, a, an over an overlaying team that that tried to keep some consistency in what we were doing and and that that was really the the start of of us a 20-30 year period in in london first of all, which with nab and then with fuji and mizuho. That gave us exposure into, into that world and what was relevant.

Paul Carman:

What is relevant, I think, for private credit is that after the telco crisis, a couple of things were happening simultaneously. One is that bustle to was starting to bite banks, balance sheets, and secondly, in the US at least, they've been quite a dislocation of bankers. And what that meant in practice was, as the markets came back in 2002 and 2003 or thereabouts, we saw a lot of US investment banks being very aggressive around underwriting risk for private equity transactions and they had not been there before and what slowly became clear was that these investment banks were really trying to wonder right risk and syndicate that risk out to this growing leverage loan clo market, which really is, in today's speak, private credit. Of course people talk about clos with a degree of sharp intake of breath, but the leverage loan CLO market, as it grew, she ended up performing remarkably well through through GSC and the like, but that's another part of the story. What it meant in practice was that we were sat in in this large Japanese bank with a big balance sheet, having grown what at that point was really a European leveraged loan business with private equity relationships that were deepening and were strong, looking at an opportunity to how do we more globalize that? And yet the balance sheet pressure was quite acute. That and, and yet the balance sheet pressure was, was quite acute. And we we went to the institution and said that we think the way to do this is is, rather than feeding other credit managers the way that the us banks were doing, which which fitted their, their purpose, we were primarily a bunch of guys and girls who had grown up doing credit originating and holding portfolios literally running from the bank, not the third parties, and would it not make sense to create our own intra-team fund group? And we got support to do that.

Paul Carman:

And in late 2003, 2004, we set up within the leverage business what became a third-party fund business, and that was really unbeknownst to us at the time, a kind of bit of a watershed from an internal point of view. But also there were two or three others in the London market at that time thinking the same way, and so we kind of again caught a wave of this growing opportunity to grow third-party funds which were really allowing investors access to a loan market that up until that point they really had no access to. That up until that point they they really had no access to, and and so in the ensuing period up to the gfc. We we kind of grew a dedicated fund group, we grew a dedicated team. We did a number of what we would recognize today as as clos leverage loan clos. We had an opportunities fund, we had a mezzanine fund, we had a private equity fund of funds.

Paul Carman:

All of it predicated off the relationships that we had with private equity and with the wider leveraged loan market, and that really became the experience and the exposure that we had to private credit where in one sense, we had a day job for want of a better phrase a bank balance sheet and then those assets that were also highly desirable for investors in the CLOs. We were able to migrate those assets across, in part at at least, to those funds and in the intervening period we'd put a team into Hong Kong and in Sydney to replicate what we had done in London. On the bank side, notwithstanding the capital limitations, we started to put a team into the US and a team into Tokyo and into Japan. So what that meant in practice was these initial private credit funds that we managed gave us the opportunity to deploy capital into the European markets, in part into Asia-Pac and places like Australia and New Zealand, and to an extent into the US, and so that was really where we grew up for want of a better phrase, tom and our exposure, if you fast forward from that point through the GFC our Japanese regulator at the time was reasonably got themselves a little bit uncomfortable with potential conflicts.

Paul Carman:

So we ended up selling that business to a uk private equity firm called 3i. So so my job at that point I'd sort of help to drive and structure those deals, raise the capital. I was cio of the the fund business, and so we sold it to 3i and and that was that for a period of time. What we were able able to do is continue to operate on a managed account basis for some of the larger investors globally outside of the fund, private equity groups who we'd invested with over a number of years and led a number of financings for and got to know very well as they were thinking of creating a private credit strategy. We had a really nice series of discussions over many, many months as we were doing the diligence on that, getting quite far down the road. The Reserve Bank in New Zealand put out some guidance around what became the Capital Review of 2019.

Paul Carman:

The translation around that was that I mentioned Basel II. Basel II had ostensibly required banks to hold 10.5% cap adequacy against their loan book. And then there are a series of coefficients with respect to credit rating and maturity which drives an amount of capital that banks need to allocate for the individual deals they do, and that had driven, not just in the bank where I was, but just across the market in general, this progressive growth of private credit. And that was all based off a 10.5% cap adequacy level, and the Reserve Bank in New Zealand was talking about doing something much more onerous for the banks and it transpired that they were thinking around an 18% capital adequacy.

Tom McGhie:

And it's probably worth Paul jumping in and just explaining that the BAL2 framework was a reduction from the prior BAL1, a commonly known framework as well, right? So in effect the growth sort of came from a reduction in some of those capital elements, and then obviously the trajectory from there post-GFC was different.

Paul Carman:

Yeah, I think banks were grappling with. Where do you want to put risks? There were liquidity risks coming in, there were credit risks coming in, and when you looked at the aggregate impact of all of that, in the context of the banks lending on a sub-investment grade basis, lending to businesses unless you're talking at the multinational corporate level, you know just just became a much. It became a business. That wasn't necessarily more complicated. It had a wider range of outcomes and, in an environment where gfc had bitten quite hard, it just became very easy for for banks to make the decision, which was why would we go into areas with greater degree of volatility when we can actually spend much more time and effort putting money into perhaps investment grade business or underwriting of deals that will lead to bonds and distribution? So not just tackling the credit coefficient, but the liquidity coefficient and also the maturity coefficients, and that's what turbocharged. I think what was happening in RBNZ is slightly different in the sense that obviously we've got four very large and strong banks in New Zealand that are owned by four Australian banks, and so no doubt there were various discussions about whether those groups hold their capital. Is it which side of the Tasman is it? Is it North or the South Island or the West Island of New Zealand and I think, in understanding what central banks, reserve banks, are trying to solve for themselves is their last resort obligations. And as a consequence of that, you know you, you might deduce that in a market like nz, where there are four dominant banks with a high degree of concentration in no real alternative market, that those capital requirements, under rbnz's interpretation of what people might refer to now as basil three or three and a half or four, depending on how you want to view it really, just put to our mind, presented a huge opportunity insofar as we'd seen how that had played out for a big bank like mzuhu, we'd seen how that played out for the us, european, uk markets and was starting to play out in places like Australia. And yet the size of the New Zealand market is obviously rather moderate in the context of the Australian context and extremely moderate in the context of North America or Europe.

Paul Carman:

And so, as we were looking at these initial soundings from the Reserve Bank, we took quite a bit of counsel from some of the great and the good, as it were, in places like New York and London private equity shops that were broadening discussions with others as to what would the likely reaction for those sorts of groups be to what was, to our mind, a significant opportunity in in new zealand. But look through the lens of groups that might be many hundreds of billions of dollars in in in the context of the size of the prize in nz, and what we really heard from those groups was yeah, we'd love to do stuff in in any jurisdiction, but when you overlay that, with nz being sme dominated, there being a modest private equity community, the size of of deals that the larger offshore groups want to do, or perhaps the size of deals that fit with the funds that they have, means NZ's a very difficult market for them to cover. And so for us that sounded like a great context or backdrop to, in effect, back to the future, start up something in a jurisdiction where all this was was somewhat new, the way it had been very much in london 20 years prior, and so that that was really the, the, the pretext, the context against which we set pcg up in late 19. And yeah, why? Why we decided it was time to come back home and set up shop and perhaps try to be part of an ecosystem which hadn't exist to that point.

Paul Carman:

If you accept the logic that central bank regulation of commercial banks is not going away, and look through the lens of what's been happening in other jurisdictions which have achieved a degree of maturity, couldn't you reasonably conclude that NZ would follow that pattern? And if the larger funds offshore would find nz difficult for reasons of the shape of the local market, then, being one of a handful of people who might set up a shop in nz where we were kiwis and had a focus on on that jurisdiction and perhaps an appreciation of what it meant to run funds, given we had done that, you know, from scratch, scratch and had successfully exited that, albeit something we were compelled to do as opposed to being a choice to do what we thought would give us a good shouting chance of getting up and running and really progressing with implementing that hypothesis, really, tom.

Tom McGhie:

So in that context you obviously you've talked about sort of the regulatory frameworks and and sort of the other external forces that gave you the opportunity, but sort of where now does a private capital group fit in the Australian New Zealand market? In terms of you know yourself and competitors and what your focus is yeah, I think it's.

Paul Carman:

I mean, look, I think australia is, depending on how you you want to view it, but you know five, seven, possibly 10 years ahead of where new zealand is for a whole variety of reasons. You know you've got a much more developed pension market supermarket relative to our equivalent, kiwisaver. That creates a huge degree of facilitation. You've got private credit firms that have really been operating for seven, eight, 10 years and NZ's much younger in that journey and really, if you take property out of that equation, private credits really only started to take hold in the last couple of years, and there are three or four other people out there. We're all, broadly speaking, doing similar things, but we're fishing in slightly different ponds system and the fact that most of the private credit funds at this stage, or private credit groups, have a single fund focused on a single strategy, and some of that might be around working with banks on syndications. Some of that might be around more loan to own type strategies. From our own view, we advocate for direct lending and the reason we do that is that we really think that in a private market it affords you huge access to data that is often unavailable if it's a public asset, for the obvious reasons. And so we've positioned the business around working with equity and management teams to understand what are they solving for, so that we can do old-fashioned things like spend time with them and really try to tailor a financing to fit the cash flows and the opportunity they're solving for. Now that might sort of sound glib and obvious, but I think what's different in NZ to what we had seen a lot of in the UK and the US was in those jurisdictions a lot of the initial growth of the market was very much private equity related. It was supporting private equity firms in the deployment of their fund related. It was supporting private equity firms in the deployment of their fund, and so pe became a huge part. You know an overwhelming majority of that deal flow and and and.

Paul Carman:

Whilst that's still true today, as those markets perhaps have grown and evolved, that has broadened and, you know, grow, and yet in, I think in the new Zealand context, there's still a relatively modest private equity community, and so what that means for us is growing origination, working out where borrowers are in their own thought process, because we don't have a jurisdiction which is rich in placement capacity. Yes, there are some very credible M&A houses, investment banks, if you will, but it's still a market which is dominated by S&Es. And so we've got this growing ecosystem. I think where so far it's relatively young, it's a cottage industry. In New Zealand. Where so far it's relatively young, it's a cottage industry in New Zealand, there are people with a lot of experience in lending and that's great. You know, we're all for a growing market.

Paul Carman:

Our niche within that is to try to use the fact that we've been a fund manager before in this asset class to try to identify where the trip hazards might be. And and one of the reasons that he you know, search funds or eta is is interesting is the methodology that that community applies to a greater, lesser extent and has a lot of similarity, a vast number of differences, but a lot of similarity with with how PE look at transactions. That's true. Yeah, these are acquisition related. They're diligence heavy. It gives us the opportunity to join those processes early.

Paul Carman:

And not that we know all the answers to all the questions, far from it.

Paul Carman:

But in the time that we have been active in in our careers, we've been through a number of cycles.

Paul Carman:

You, you see things that might repeat and that certainly helps to put a lens around sectors or natures of deals that at least give you the opportunity to test test any of those thoughts through diligence and again really to identify where those, those traps might be, that that, that that an acquirer or a lender might fall into again.

Paul Carman:

Not that we've got a crystal ball that knows all the answers to all the questions, but I think we really like that ability to to work hand in glove with equity and with managers or operators of businesses, and that's one of the reasons why we prefer that direct lending route than some of the other opportunities to acquire assets you know through through market and syndication and the like.

Paul Carman:

We'd rather have that more intimate relationship and so, yeah, I think that's how we try to position it and in that context that overlap of when we look at different types of deals that come our way, there might be capital expenditure requirements for businesses, there might be acquisition opportunities for businesses, and then there are succession acquisition opportunities, and a lot of that work is in the wider financial buyer universe, ranging from search or ETA through to PE, where we've had the good fortune to spend a lot of time the PE, where we've had the good fortune to spend a lot of time, and certainly I'm going to pick up on a sort of theme that you started on there and you know will be core and central to the UTA Forum this year.

Tom McGhie:

You know we are going to talk a little bit about. You know navigating business turbulence and certainly you know know when things are not necessarily going to plan in your experience and sort of some of the traps that you were just describing there and the way that you work. You know hand in glove with managers, with equity, and obviously we we try and charge the batteries in the crystal ball as we're originating. You know transactions and, and you know cover obvious things with diligence. But in your experience, what are some of the com? You know sort of common ingredients or common themes or commonalities of of issues that you know occur and and sort of what are the, the common ways in which you see that getting back on track and working with equity and management yeah, I think there's, there's.

Paul Carman:

There are a couple of sides to it, tom, and I think you know one side would really be around. What are the things that are happening in the business? And, yeah, I guess put things are happening outside of the business or in the market in which the business operates. And so I think, on the former, alignment's always really important, whether that's alignment between the lender and the equity provider or the equity provider and the management team. Identifying and seeking that alignment I think is is really quite important. But it depends on the type of deal that that's happening, if this is a carve out out of a wider business or is it an acquisition of the whole business. That leads to some complexity on the former, where perhaps the new co, the, the business being acquired, has to think about manager information and reporting and and systems and process and how that carve out works. And so you know, I think, where where risk, where risk exists is, you know, through, arguably, the, the the larger the number of the moving parts tends to, tends to have more opportunity for things either to to trip or to compound a trip. But I think, again, that's eyes wide open and and sort of understanding what is the nature of, of that transaction, both from the debt provider and the equity provider, as to what has been seen before in the nature of this individual transaction, around those sorts of around that context of what has created this transaction and therefore, how are those tasks going to be dealt with? For instance, if it's a carve-out, how is management information? What is going to be replicated there? As a lender, what information are you going to get in an initial period and how do you solve for that collectively with something which has an appropriate check and balance? By the same token, isn't tying people up with, with requirements to do things that are just impossible to do in an initial period? You know there's there's maybe an analogy there with what we saw happening with pe in the early days in europe, where they would they would often be buying businesses out of a group and they would spend the first 6, 9, 12 months really going in, deep diving, putting in their own processes, maybe with accountants, or putting in what we might, in summary, define as best practice, which was perhaps a combination of the PE firms thought processes, but often what one of the big four were doing on the accounting side to get their arms around that.

Paul Carman:

I think that standardization is something which is not so much important just to have a standard process, but to understand why those processes are in place and and how they might be implemented and therefore, in the context of of a transaction, who are the professional service parties to work around and how does that work in a competitive environment and what happens pre-deal and post-deal. So I think there's a bunch of that internal, internal structuring how the business will operate as a business, which is obviously an important focus. And then I think there's clearly what's happening in the market in which the business operates. What's the predication of the deal and why is this asset available? Is there anything strange around that? Why is the founder selling? How do things like vendor loan notes or deferred consideration mitigate some of that risk, perhaps or otherwise? There's that element which I think is is always important to, to to discuss and you know we talk a little bit about. You know representations and warranties and how are those covered? How do you mitigate against the risk of non-collection of those perhaps and those sorts of issues that people are doing deals for the first time might not be front and centre, although clearly will be from the lawyers and, to an extent, an accountant's perspective around who's holding hands to get a deal done.

Paul Carman:

Then I think there's a whole bunch of credit-related issues that what you're really trying to do there collectively is work out what I guess a base case looks like, a most likely case looks like, and how does that case contemplate. What are the anticipated issues that a business might, might encounter? How does the structure allow and facilitate for those, so that you've anticipated such issues collectively and and have, if not a formal plan but a a loose plan around. If something were to happen, what might, what might that reaction be? Of course, your structure and your covenants and the like will will likely have contemplated all of that in the first instance, but I think it's always good to rehearse those sorts of issues. So there's no surprise. You know, after um, after you've walked down the aisle together or whatever, whatever you're proposing to do.

Paul Carman:

And then I think there's a whole bunch of issues around. What are the issues that come and bite you, that weren't contemplated, and what might those be, and, whether they're regulatory issues or things that you've seen happen before, how to at least air those discussions? Of course, if you try and cover every single risk off, you're never going to do a deal and it's just finding that sort of balance. So yeah, one thing's for sure the base case is never the actual case and it's always an important discussion to work out what happens if there's an upside, and what does that mean for a company's cash generation? You'll think about a company doing really well and achieving great revenue growth, but often that comes at some indigestion around cash. So have you contemplated that and how might that be handled? What about acquisitions and the like?

Paul Carman:

And I think those sorts of discussions are best had upfront and early and just really trying to understand what's everybody solving for. So yeah, it's impossible to have that crystal ball. If you find one, let us know, but I don't think they're necessarily great predictors of what will happen, but they give an idea of what might. I do think those are good discussions to have, as opposed to ones that are well, let's not have that discussion because we'll just deal with that at the time. Of course, you can never solve for all of the range of outcomes, but it's understanding what's back to this alignment point, I think, what's important for the financier, what's important for the equity provider. How do you find that ground where a deal generally becomes a win-win, where you feel there's some mutual support and people running in the right direction. Of course, there is the question of what happens if all of that is impacted negatively and yeah, there are a range of a range of stories. I'm sure that we can get into Things that we'll no doubt cover on the day.

Paul Carman:

Yeah, 100%.

Tom McGhie:

As with the forum. So look, that's really, really insightful and I think, maybe sort of to finish off, I mean you're coming over for the days in September. What are you looking forward to the most as part of the ETA Forum this year?

Paul Carman:

The one thing that has been interesting to us is a compare and contrast of how the private equity community works, generally speaking, relative to the search and the ETA community.

Paul Carman:

I think one thing that has struck us from, from the exposure we've had, is how collegiate the search and eta community actually is in terms of self-supporting and sharing ideas, best practice and and, to an extent, opportunity together and and so I think we're really delighted to be coming across for the time so we can hear other people's stories, grow that network together, understand what people are looking for, if there's any insights that might be relevant for anybody at any point that we can share and discuss, yeah, love to love to have that opportunity, but I think ultimately for us, it it's you know we're trying to set our business up for for a long time not a good time and you know, build, build, that sustainability and that that's ostensibly around people and network, and whether that's from London, from New York, from Sydney or from Queenstown, those principles are the same.

Paul Carman:

I think that help to shape businesses which hopefully have a degree of relevance or at least have a degree of use for the community, and I think our aspiration really is to try and be part of that ecosystem and work out where we can, where relevant, be additive for people. So, yeah, really looking forward to the chance to come across, spend the time with yourself and Pete and the wider community.

Tom McGhie:

Really looking forward to it, paul. Yeah, it's only now, I think, seven or eight weeks away, so not far to go, but looking very much looking forward to it. And, yeah, looking forward to also having a beer on the day yeah, me too.

Paul Carman:

Tom, thanks for the opportunity and I look forward to seeing everybody then. Thanks Paul, thanks Tom.

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