Private credit in specialist markets: lending where the collateral is a licence

Private credit in a regulated specialist market is a different discipline from private credit in a general mid-market. The borrower's most valuable asset is a licence, a registration or an approved facility. None of those can be pledged in the ordinary way. A lender that does not understand how the licence is obtained, kept and transferred is lending against an asset it cannot value. The firm lends in these markets because it originated in them, and because most lenders will not follow it there.

At 31 March 2024 the structured credit book comprised 11 facilities with US$127 million committed and US$104 million drawn. Borrowers are licensed distributors of veterinary medicines, contract manufacturers of sterile pharmaceuticals, seed-genetics companies with registered varieties and specialty-materials producers with approved formulations. Facility size runs from US$8 million to US$35 million. Tenor runs from three to five years. Margins run from 650 to 900 basis points over the reference rate, with arrangement fees of 1.5 to 2.5 per cent.

Security is built around the licence rather than over it. The firm takes a pledge over the shares of the licensed entity, a negative pledge over the licence itself, and a step-in right that allows a pre-approved replacement operator to run the facility while a transfer is arranged. The regulatory transfer of a manufacturing licence in the jurisdictions where the firm lends takes four to nine months. The step-in right bridges that period. It has been exercised once, in 2022, and the facility was repaid in full 11 months later.

Covenants are drawn from the regulator's own tests. A pharmaceutical borrower reports its inspection outcomes, its batch rejection rate and its complaint rate to the firm on the same cycle it reports them to the supervisory authority. A distributor reports licence renewals and cold-chain excursions. These measures lead financial covenants by two or three quarters. A rising batch rejection rate in the first quarter shows up as a margin decline in the third. The firm acts on the first signal, not the second.

Loss given default in these markets is lower than the pricing implies, provided the lender can keep the licence alive. The firm's base assumption is a loss of 35 to 45 per cent of principal on default, against a general mid-market assumption nearer 55 per cent. The difference is the licence. A licensed facility with a replacement operator retains most of its enterprise value; an unlicensed one retains its equipment. The step-in right and the pre-approved operator are the difference between the two numbers.

The market is not large and the firm does not intend it to be. The book is capped by the Risk & Valuation Committee at 35 per cent of the proprietary balance sheet, which stood at US$402 million at 31 December 2023; the book was at 32 per cent. The constraint is not capital but knowledge. Each facility requires a credit analyst who has read the borrower's inspection reports and a sector specialist who can judge them. The firm employs both. That is the advantage, and it is structural.

Published 2024-04-09 by the Commercial Finance division. Research is prepared for eligible counterparties and does not constitute advice.