Debtwire recently caught up with Ashwin Krishnan, co-head of North America private credit and head of opportunistic credit at Morgan Stanley Private Credit, in a conversation debating the merits of sponsored versus nonsponsored deals and formalized partnerships for deal origination. Morgan Stanley Private Credit, which had USD 18bn of committed capital as of 1 January, is part of Morgan Stanley Investment Management, the asset management arm associated with the bank.

Tell me a bit about how your strategy is different from funds in the private credit ecosystem.
The part of the private credit ecosystem I am principally focused on is credit capital solutions or what we call opportunistic credit, which simplistically means our ability to provide a variety of debt and debt-like capital solutions to private issuers, mostly middle-market companies. We think that segment of the market allows us as investors the ability to do deep fundamental due diligence. We underwrite every situation; we don’t rely on third parties to do our work for us—be it private equity sponsors or investment banks. The flip side is that these businesses tend to be smaller than those that can tap the capital markets—businesses that range between USD 40m and USD 80m in EBITDA generally speaking. We have a use case agnostic model. We’re not focused just on LBOs but have an all-of-theabove approach.

Does it matter if the company is sponsored or nonsponsored?
On the margin for us, not so much … There are people in the private credit universe who will only do sponsored. And there is a smaller subset of people who will only do un-sponsored deals. We are equipped with the tools to be able to unpack the fundamentals of any business. While it can be helpful to have an institutional equity investor in a company via private equity ownership, it’s not the be-allend-all of our analysis. Ultimately, if two companies have the same attributes, same characteristics and same sort of underlying performance against varying economic backdrops, then we should be able to assess and price the risk at which we invest capital into that company, irrespective of sponsored or unsponsored.

If you isolate expected rates of return on any given investment, that would be typically driven by what one’s views are on a specific company and what one thinks is a fair rate of return for that particular investment. If the company has private equity, sponsorship, or non-sponsorship, we don’t think that rate of return should materially change. But I’ll be the first to admit that that’s how everyone looks at it. There are significant participants in the middle market who will ascribe a significant discount or premium to PE sponsorship, depending on how you’re calculating it.

Can you tell me about a scenario where you offered, recently, a more creative type of solution than a bank or a more straightforward direct lender wouldn’t do?
We worked on a healthcare situation recently. A really attractive business with good underlying KPis. There was a sizeable equity investor in the business. However, they were not a traditional financial sponsor. And by virtue of that fact, and some other nuances as to how this particular sector was perceived in the private credit market, we had the opportunity to structure an off-market transaction where we were able to start with a blank sheet of paper, go to the company, its management and ownership and really start from the top.

They wanted to reduce the cash interest burden that they were paying out to the existing senior lender, who was not a bank, but very similar to a bank in the private credit universe. That was objective number one.

They wanted to also pay down a portion of that senior lending facility. They wanted to bolster their balance sheets with cash coming in to help fund a couple of attractive potential acquisitions. So, we led by providing them three parallel term sheets for them to evaluate and for us to ideate with them on. We finally arrived at a hybrid where we invested some junior debt, and then some senior equity to effectively meet our respective needs, ie, our capital allows them to accomplish their goals while we structured that capital in my opinion in a way for our investors to achieve a fair rate of return.

Do you have strict guidelines on when you would offer payment-in-kind as an option?
We want to create a portfolio that has a reasonable amount of cash yield, but we’re not necessarily handcuffed by it. I would say in the last six or nine months of the 10 or 11 transactions that we have led, 75% of those have had a cash-heavy component and the remaining 25% have had a significant PIK component.

Conversely, the senior secured direct lending market, which is dominated by business development companies, for instance, has defined parameters in terms of achieving dividend yield thresholds and hurdles, and therefore, by definition, they may not have the same flexibility to do PIK securities. On the other hand, more private oriented funds may have a higher degree of freedom. By and large, the senior secured lending models have the ability to PIK in a limited number of cases. Based on what I’ve observed, and it’s not empirical data, the split is say 85% cash, 15% PIK. Whereas the more opportunistic capital solutions-oriented strategies have a much higher degree of freedom, as high as 50-50. And in some cases, providing all PIK securities.

Are you exploring any banking partnerships as many of your peers have announced formal relationships recently?
We don’t have any formal partnerships. There are plenty of people in the commercial banking sector we have teamed up with that we will likely look to team up with in the future. The private credit universe, depending on where you play, tends to be somewhat of a clubby place. You run into the same firms from time to time. Our prerogative is to continually be expanding the network of people we interact and do deals with to maximize the size of that investment funnel and partnership funnel.