How Epsilon is taking advantage of opportunities the banks can't reach

Epsilon's Joe Millward explains the facts behind banks’ corporate lending and the opportunities companies like Epsilon are seizing.
Vishal Teckchandani

Livewire Markets

A common narrative in the world of private credit is that major banks are retreating from business lending as it is more complex for them to provide loans to corporations as opposed to homeowners.

However, Joe Millward, Founder of Epsilon Direct Lending, challenges this view, pointing out that the major banks are not retreating but rather expanding their corporate loan books. In fact, both Commonwealth Bank of Australia and National Australia Bank have reported significant growth in their corporate loan portfolios over the past year.

While banks' loan books are growing, they still face challenges in certain areas, primarily due to regulatory constraints and the increasing need for more bespoke, flexible solutions. This is where private lenders like Epsilon Direct Lending come in.

Epsilon specialises in providing loans to medium-sized businesses, particularly those looking to grow through acquisitions. With a focus on faster, more efficient decision-making and personalised service, Epsilon is positioned to seize opportunities where traditional banks struggle to compete.

In this episode of The Pitch, Millward offers insights into the dynamics of corporate lending, the challenges faced by banks, and how private lenders are managing risk and identifying valuable opportunities.

Edited transcript:

Joe, a lot has been made of the banks retreating from corporate lending, but you've got a different take. Can you share the facts with us?

Sure - it's not just me that has a different take, it's the publicly announced results that the major banks publish that have a different take, so it's interesting that the narrative suits a number of private credit funds.

We believe that the banks are retreating because that creates a natural opportunity for them to suggest that they're playing where they used to play, but the data doesn't support that, the facts don't support that.

I've actually brought some data points with me and anyone can look these up, they're freely available. Just going off the most recent results from CBA and NAB, CBA's corporate loan book, which is the area of the world is where most private credit funds are playing, that's grown 10% in the last year. It's gone from $160 odd billion to over $170 billion in one year alone.

NAB, similar kind of numbers, $197 billion up to $217 billion, corporate loan exposure. The banks are not retreating.

While they aren't retreating, they do have limitations when it comes to private lending, is that right?

I wouldn't call them limitations, I call them shortcomings and restrictions that are placed by regulators. They're two very different things. So the regulators, mainly APRA, set the amount of risk that banks can take and the amount of capital they have to set aside in order to take that risk. 

That means that it's very expensive from a return on equity perspective for banks to pursue certain segments of the market; normally the riskier segments.

Then there are what the shareholders of the banks and the board of the banks are seeking to achieve, which are improved returns on capital, return on equity and return on shareholder funds.

So if you're a CEO of a major bank, you're going to be focused on cost to serve customers, automation of decision-making, simplification of the products that you offer the market. Banks are more inclined to offer homogenised products and less customised products, they're less efficient at delivering highly customised products and riskier products to the market.

Joe Millward, Founder of Epsilon Direct Lending
Joe Millward, Founder of Epsilon Direct Lending

What opportunities is this creating for Epsilon Direct Lending within private lending?

We focus on providing loans to medium-sized companies for the purpose of growth. The banks want to support this segment, they want to fund medium-sized companies in supporting their growth. 

Typically, these companies are growing through acquisitions, and acquisitions are quite complex to structure for, to lend for, so that creates an opportunity for a non-bank lender like Epsilon to participate in that market.

The banks aren't as efficient, as I mentioned, in providing capital to less homogenised assets. Assets like mortgages are easy, because they're standardised terms and conditions. Acquisitions are different every single time, and so we compete based on a service, a value proposition, a service proposition to borrowers.

If they want efficiency of decision-making, they want speed, certainty in the provision of capital and they want a direct relationship with the decision-makers, that's what we offer that we don't think the banks are as good at offering.

How do you manage risks within your portfolio given the unique nature of each borrower?

The purpose of the loans is to support growth, so that's a positive purpose. We're not refinancing an existing loan, we're taking a view on the company's sustainable, predictable earnings after the acquisition has taken place, and we're really unpacking all the risks that might impact the sustainability and predictability of the cash flows that the company generates, and that is what underwrites our loan. It's the future cash flows that we believe the company can generate.

We typically partner with private equity firms who will be contributing a significant amount of equity capital, first-loss capital, in seeking to acquire the company alongside us when we provide a senior secured loan. 

We ensure that those loans, when we structure them, when we execute the loans after we've originated it, those loans have really strong buffers,  equity contributions, servicing levels, interest cover ratios, debt service cover ratios, and so on, are in place.

Then on an ongoing basis, we ensure that we have great access to the company after we've performed substantial due diligence in providing the loan. So we get monthly P&Ls, cash flows and balance sheets from all of our borrowers, we regularly speak with the management team, we regularly speak with the owners of the business to ensure things are on track, and then we seek to assist. 

In the most extreme scenarios, use our security positions, our documentary protections to protect our downside when things aren't going to plan.

Why are private equity deals a good indicator of quality in a portfolio?

Let's first define what we mean by private equity sponsor from our context. These are sponsors that are buying performing medium-sized companies, that's who we deal with. There are sponsors that deal with underperforming companies or larger companies, but that's not our segment. What they're doing is committing equity capital in order to buy a company. 

That's first-loss capital, and they're seeking to see that company grow through a combination of improvement in margins and earnings, and then potentially grow through acquiring more competitors and expanding into new products and geographies.

Because a private equity firm is putting in equity capital, first-loss capital, and we're providing a senior secured loan, they've got a lot more to lose than we do if things underperform. Typically, these private equity sponsors that we deal with, all instances in fact, have really strong investment track records, they're supported by institutional investors and they've got very well-established due diligence processes before they make an investment.

When we decide to lend to a company, we have access to all of that information, which helps our underwrite case, and then we overlay our own additional level of conservativeness in ensuring that the company can repay us ultimately. 

Contrast that with a non-private equity-owned firm, you might not have the same level of institutional capital, rigour around due diligence, professionalism, track record in repeatedly buying and growing companies to support you, and so therefore, we believe it's a good indicator of the strength of a company.

How do you find these deals?

We've worked with a lot of the established medium-sized private equity firms in Australia over 15-20 years through our careers together, the three founders of Epsilon, and we've all worked in Australia for quite some time, and so a lot of the private equity firms come to us, we get a lot of repeat business.

But outside of that, mergers and acquisitions, M&A lawyers, M&A advisors, there are some intermediaries that source debt financing for companies, they're all sources of deal introductions, origination for us. 

We also know a lot of businesses, because we've been around and we've lent to a lot of companies, and so you find that shareholders, CEOs, CFOs, they move around in the industry and they normally seek quality offerings from lenders and that's why they come to Epsilon.


Specialist corporate lenders

The Epsilon Direct Lending team specialise in lending to support the growth of middle market companies.

Visit their website for more information.

........
Epsilon Direct Lending disclaimer The information contained in this video has been prepared by Epsilon Direct Lending Pty Ltd (ACN 636 861 464) (EDL, Manager or Epsilon). Epsilon is a corporate authorised representative (number 001281871) of Epsilon Investment Management Pty Ltd (ACN 680 224 284) the holder of AFSL number 564491 and is given to only 'wholesale clients' (as defined in the Corporations Act 2001 (Cth)). By receiving or viewing this video, you are representing that you are a ‘wholesale client’ and that you will keep this video and the information therein confidential including not to provide it to retail clients. No financial product advice is provided in this video and nothing in it should be taken to constitute a recommendation or statement of opinion that is intended to influence a person or persons in making a financial product decision. Any advice given by EDL, its associates or related parties in connection with this video is general advice only. Purpose This information in this video is intended to provide a general outline in relation to the Epsilon Direct Lending Fund (EDL Fund) and the Epsilon Direct Lending Senior Loan Fund (SLF) (collectively “Funds”) only and is not intended to be a definitive statement on the subject matter. This video is not intended to be relied upon by recipients given the contingent nature of the content matter. The information in this video does not take into account your objectives, financial situation or needs. No verification or due diligence exercise of the information contained in this video has been undertaken. This video contains a summary of the proposed investment terms of the Funds and certain other documents. Prospective investors should not construe the contents of this video as tax, financial, legal or investment advice. This video does not purport to be complete, accurate or to contain all information which its recipients may require to make an informed assessment of whether to invest in the Funds. Before acting on the information contained in this video, or making a decision to invest in the Funds, potential investors should make their own enquiries and seek professional advice (including financial product advice from an independent person licensed by the Australian Securities and Investments Commission (ASIC) to give such advice) as to the investment in the Funds and its appropriateness in light of their own circumstances. This video does not constitute an offer for the issue, or sale, of any securities. Neither this video nor the information contained in it or any other information supplied forms the basis of any contract or any legal obligation. Contents Forward-looking information in this video – which can be identified by the use of forward-looking terminology such as “may,” “can,” “will,” “would,” “should,” “seek,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” “target,” “believe,” or the negatives thereof or other variations thereon or comparable terminology including statements of intention, projections and expectations of investment opportunities and rates of return – is provided as a general guide only and should not be relied upon as an indication of the future performance of any investments managed or arranged by EDL. No representation is made as to future performance or volatility of any investments managed or arranged by EDL. In particular, there is no guarantee that any investment program outlined in this video may be successful. Persons should rely solely upon their own investigations in respect of the subject matter discussed in this video and carefully consider the risks before deciding to invest. Any past performance information given or financial models of prospective returns in this video is given for illustrative purposes only and should not be relied upon as (and is not) an indication of future performance. Any comparative index shown is provided solely for informational purposes as an indication of the performance of various capital markets or alternative investment strategies in general. Comparative indices are not benchmarks, nor should one conclude that the investment strategy will or will not be correlated with an index. Comparisons of alternative investment strategies to indices are subject to material inherent limitations. In particular, the universe from which the components of an alternative investment strategy are selected includes a significant element of “survivor bias”. Accordingly, indexation of alternative investment strategies tends to overstate the beneficial aspects of these strategies while obscuring certain risks, including the “risk of ruin.” This video may contain hypothetical performance results, which have inherent limitations. Further information about assumptions made in deriving these results may also be found throughout this video. No representation is being made that the Fund’s portfolio will or is likely to achieve results like those shown. In fact, there can be significant differences between hypothetical and actual results. One deficiency with any hypothetical construction is the benefit of hindsight. Whilst due care has been given to minimize the effect of hindsight upon the results, it cannot be eliminated. In addition, hypothetical investing cannot consider all risks associated with being able to faithfully execute the investment strategy as and when the model indicates. There are other factors related to the proposed investment strategy that cannot be fully accounted for in the preparation of hypothetical performance results and potential investors should be way of placing undue reliance on the hypothetical results. Fees and costs stated in this video are exclusive of any applicable GST. All dollar amounts are in respect of Australian dollars (unless specified otherwise). EDL gives no recommendations or opinions about whether or not an investment is suitable for you. Further, EDL gives no express or implied representation or warranty as to the accuracy or completeness of the information, opinions and conclusions contained in this video nor the value of any investment that it arranges or manages. In preparing these materials, EDL has relied upon and assumed, without independent verification, the accuracy and completeness of all information available to EDL. Investors should consult their financial adviser in relation to any material within this document. Exclusion of liability EDL, Epsilon Direct Lending Holdings Pty Ltd and their founders, directors, employees and agents (Group) do not accept liability for any loss or damage suffered or incurred by the recipient or any other person or entity however caused (including negligence) relating in any way to this video including, without limitation, the information contained in it, any errors or omissions however caused, or the recipient, or any other person or entity, placing any reliance on this video, its accuracy, completeness, currency or reliability. The Group does not accept any responsibility arising in any way for any errors in or omission from this video or for any lack of accuracy, completeness, currency or reliability of this video. The Group does not accept any responsibility to inform the recipient of any matter arising or coming to their notice that may affect any matter referred to in this video. The Group does not authorise any person to make any statements or representations that are not expressly contained in or contemplated by this video. Any liability of and member of the Group to the recipient or to any other person or entity arising out of this video is, to the maximum extent permitted by law, expressly disclaimed and excluded. Livewire disclaimer Livewire gives readers access to information and educational content provided by financial services professionals and companies ("Livewire Contributors"). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

1 contributor mentioned

Vishal Teckchandani
Senior Editor
Livewire Markets

Vishal has over 15 years' experience in financial journalism and has a particular interest in property, exchange-traded funds (ETFs), investing strategy and financial history.

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.

Comments

Sign In or Join Free to comment