Q&A: Bain Capital's Jonathan Lavine

Q: As a credit investor, what is your take on the current global macroeconomic environment, notably the impact of rising interest rates in the US?

A: It is a myth that rising interest rates lead to increased opportunities in credit. Basic economics tells us that rates go up when the economy is doing well. The problem is if they rise too fast. Every time rates are down, people think they are going up, and every time rates are up, people think they are going down. It's hard to predict and that makes it hard to control. Then there are all sorts of curveballs – trade tariffs, politics, oil prices. Broadly, the opportunity is based on what has accumulated in each market as a result of relative prosperity, where supply and demand of capital is most inefficient, and where the excess is in the system. For example, in the US capital markets, issuance of BBB debt – the worst part of investment grade – has historically been equal to high yield issuance. Right now, it is almost double the high yield market because a lot of companies borrowed when rates were low. They are right on the precipice because if they lose their BBB rating, they turn into high yield and it becomes harder for them to borrow and many of the mutual funds that own them will have to sell.

Q: How are opportunities developing in Asia?

A: There is a realization – whether it's lots of small NPLs [non-performing loans] in China or the 12 big corporate names in India that were pushed into bankruptcy as a result of the IBC [Insolvency and Bankruptcy Code] – that the system has not kept up with cleaning out bad credits. When that happens, it becomes an opportunity for investors, because those bad credits start to weigh down the system. If you had a culture of never fixing these loans and just ignoring them, then the stock of loans becomes greater than the flow should be. There are always going to be bad loans. That's why credit spreads are wider than investment grade spreads – you are taking default risk. The question is whether the default risk transpired and how have the bad credits been managed?

Q: Are the initial 12 bankruptcy cases pushed through under IBC intended to serve as a template for the Indian market?

A: I think so. The litigation around the enforceability of the IBC bidding process has moved very quickly. It's more than just being a test case, though. The government is saying to other companies, ‘If you think we won't put you into a bankruptcy process, in which you as the promoter will not be able to bid, then you are wrong. We just did it to 12 large companies. You can take your chances, or you can go and find private money now and fix your balance sheet.' We've done two deals where we have signed an agreement to keep people out of IBC, so the promoter can keep some vestige of what they had. When you make an example out of the big guys, a lot of smaller guys will think about their options.

Q: That implies a broader shift in corporate attitudes…

A: Yes, if it works – if they enforce it properly. If they allow it to be a free-for-all, they will have accomplished nothing. I think there is going to be a lot of rule-writing and rewriting over the next 12 months.

Q: Why did you choose to partner with Piramal in India?

A: That's how we address the corporate opportunity. NPLs we would do through our NPL teams. The joint ventures take two models and I would say a minority are like our arrangement with Piramal, where two like-minded investors focus on corporate restructurings. Others tend to be narrower alignments with financial institutions where they are going after one segment of the market – and they are doing it by investing into another entity rather than creating a true JV.

Q: There are also concerns that the NPL opportunity in China could prove to be another false dawn. Is there anything to suggest that this time will be different?

A: Yes, because the government and regulators have a long-term plan for how these are going to get sold. They know they need to attract private capital and they need people to be able to build scale. They also know there's some concern that if you buy a portfolio, 30% of it will turn out to be fraudulent. So, the portfolios are now cleaned, adjudicated, and there are rigid processes. Implicitly or explicitly, I suspect somebody has studied what worked and didn't work in Europe. The countries that set up processes managed by quasi-governmental organizations – such as NAMA [the National Asset Management Agency] in Ireland – have sold billions of NPLs in an orderly fashion. Where governments allowed the banks to sell NPLs themselves with no coordination, such as Italy and Greece, it has been messier. The processes we are being asked to undertake in China look very much like Ireland and Spain. The municipal AMCs [asset management corporations] have set processes on how to bid and they figure out who the likely bidders are and let them do their diligence.

Q: How do you do the on-the-ground asset servicing?

A: We have our own master servicer in Guangzhou. They can service what we are doing now, but they are also building their own network of connections. I don't think you can adequately address the market if you don't have your own servicing capability. We've hired people in China, but we've acquired platforms in other markets. In Thailand, for example, we bought Standard Chartered's NPL servicing platform alongside some NPLs.

Q: How active are you in Southeast Asia?

A: We liked Thailand because it has a well-worn path: creditors rights work and there are idiosyncrasies as to what banks do and don't lend to, which creates opportunities for our kind of capital to fill gaps. We've done some property lending elsewhere in Southeast Asia and we've looked at restructurings in Singapore. The lack of creditor rights is a problem in most markets. In Indonesia, for example, you need to look at your property right as well as your creditor right. It's a decision we make in a lot of places – do we buy a lease or a loan? We set a protocol for each market, until the information changes. Good investors will be willing to take lots of different kinds of risk, it must be priced right. If the creditor rights are horrible, you're not really a credit investor, everyone is an equity investor.

Q: Bain Capital Credit is one of the largest private lenders in Australia. How did this happen?

A: Unlike most foreign investors, we have Australian dollar-denominated funds, so we lend as a local. I started going to Australia more than a decade ago. We wanted to get to know the market and how to do business. We met with banks and other investors, and it became clear Australia was a creditor-friendly place with interesting supply-demand dynamics, and few people were putting manpower in there. We worked on some investments out of Boston and London, then we bought a portfolio from Lloyd's, which gave us more confidence, and we decided to set up an office. That's how we've done every geography in the world at our firm – you can't manage money by conference call and plane ticket. Australia is one of few geographies that started as a credit geography and then private equity moved in too.

Q: To what extent has this been helped by banks scaling back their services?

A: They are doing less junior capital and they like the fact that capital is coming in behind them. The sponsor market is also developing and the need for leverage is expanding. It is still a bank heavy market – most of the people we've hired came from banks, not from other funds – and what we bring is incredibly flexible and patient capital. We do junior debt, holdco debt, fund-less sponsor transactions.

Q: Is the opportunity set more diverse in Asia due to the lack of an institutional debt market?

A: The opportunity set is so varied in terms of company, security package, and economic drivers because it is a disintermediated market. It feels a lot like the US markets in the mid-1990s. When I started Bain Capital Credit, 80% of loans were held by banks and the other 20% was with mutual funds. There weren't firms like us. Now those numbers are reversed – 80% of loans are with funds like ours and with mutual funds and 20% are with banks. I think you will see that happen, market by market, in Asia as well.

Q: But this cannot happen without strong creditor rights…

A: While our teams have been successful in getting deals done under the current regulatory regimes, improvement in creditors' rights broadly would certainly help the environment. I remember when they started reforming creditor rights in European countries. People used to say they would lend in the beer-drinking countries, but not in the wine-drinking countries. There was a time when we wouldn't touch anything in France. Now France and Spain have come to grips with how to work out debt, although Italy is still not for the faint of heart. It starts when banks need to work out their loans and realize that because creditor rights are so bad everyone keeps rolling over debt. But it must come from a regulator or policymaker first.

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