Andalusian Credit Partners 2023 Year-End Letter

By Andalusian Credit Partners
January 22, 2024

Looking back on 2023, we saw high interest rates and macro forces around the world have a profound impact on the U.S. economy and financial markets.

At the start of the year, most economic observers thought the U.S. would either enter a recession at some point in 2023, or already was in a recession, which was reflected in the pricing of assets. But these concerns, driven primarily by the expected and realized impacts of the higher interest rate environment, have now seemed to abate – we are not seeing the customary signs of a recession, such as large layoffs or declining home prices. As 2023 ended, markets increasingly started to “price for perfection,” with a growing expectation among investors of a “soft landing” in 2024 as interest rates begin to edge down and consumer worries recede.

As we see it, the question investors should be asking is not when but if: Not “when will interest rates start to come down?” but “what if interest rates do not come down?” Not “when will the risk of recession pass?” but “what if a soft landing is not a forgone conclusion?”

Our Executive Chairman, Roger Ferguson, thinks the expectation of a soft landing and potential rate cuts by the Fed are setting investors up for a few different scenarios.

  • First, the economy and the Fed must successfully follow through on the expected soft landing – no easy task – which would lead to expanding multiples, rising equity prices, and firming credit conditions.
  • Second, investors need to assess what this new environment means for their risk tolerance. Maybe market conditions continue to improve, or maybe the “priced for perfection” story does not get validated. How are market participants thinking through that probability?
  • Certainly, we believe that maintaining some level of defensive positioning will remain prudent for most market participants, regardless of whether future conditions validate the current optimism.

Sharing his views on the year to come, Roger notes, “We believe that 2024 is going to be a year when forces outside of market control play a large, maybe outsized, role in the overall economy. We believe that there will be some volatility running up to the U.S. election in November, and whatever happens after that no one knows. But there are also ongoing questions around China, Russia, the Middle East and more, and for the first time in a long time geopolitics could play into market performance in real, demonstrable ways.”

All the talk about recessions, wars, unrest, and other geopolitical distractions in the U.S. and on the world stage amounts to one thing for investors: Risk. As a new middle market direct lender, we see opportunity within private credit as traditional banks and borrowers adjust to an environment of heightened risk.

Our Managing Partner and ACC Board Chair, Joseph Otting, feels that Andalusian Credit Partners’ timing provides a strong opportunity for originating investments at favorable pricing.

“I’ve spent most of my career in banking and lending to middle market businesses,” he says, “and in effect that's what we're doing here at ACP. We’re lending to middle market companies that are very similar to the types of customers you would see on the banking side, except there is a little bit more leverage in the transactions we do than those that are generally done in the banking business.”

  • We are seeing a continued path where certain lending activities are exiting the banking sector because they are viewed as non-economic for a bank given regulatory frameworks, pushing that activity toward private lenders. This trend toward non-bank lenders is likely to continue, with the potential for regulatory changes such as Basel III to turbo charge that shift.
  • We believe that we are also in an environment of high credit quality because there is generally less leverage, more structure, and more favorable terms for lenders in the middle market direct lending space today, as opposed to the environment we had been in for the last five to seven years where conditions were very favorable to borrowers.
  • When interest rates, leverage and loan terms are considered in a historical context, 2023 is not the outlier that it might appear to be. The market isn’t out of balance but moving back to a more conventional environment for lenders and borrowers, and thus we believe the investment opportunities that exist today are likely to persist.

Joseph adds, “When it comes to risk management, we bring structure, experience, diligence, and discipline to this market. We analyze and understand credit risk and do not use a trader mentality to underwrite our investments.”

Chief Risk Officer and Chair of the ACP Investment Committee, Kris Gagnon, sees parallels in this market to what he faced during his decades overseeing risk and credit at Bank of America and OneWest Bank, among others.

Kris says, “Successful credit risk management is based on adhering to certain fundamentals. If credit risk/reward is managed in a disciplined, consistent manner with rigorous client selection, the firm can deliver strong long-term performance for stakeholders.”

  • Properly underwriting and managing credit risk will result in a portfolio that performs well versus the market through all credit cycles. There are several factors that can lead to excess risk taking in the credit market. The key is to recognize when the market is overheated and remain disciplined to the firm’s risk appetite to ensure the desired long-term performance of the portfolio.
  • As mentioned, private debt funds have been taking significant market share in leveraged lending from commercial banks, a trend which we expect to continue, especially in the non-sponsored market. While banks are encumbered by regulation, private debt funds are able to utilize their underwriting standards to make investments in companies based on their economic merits.

While private credit was the hot topic at the start of 2023, fast forward 12 months and many think the market is overheated as capital has poured into the sector. Are there too many new managers? How can firms differentiate themselves? How do you set yourself apart to raise capital and win deals?

Aaron Kless, ACP’s Chief Investment Officer, believes that determining the answers to these questions requires going a layer deeper than the headlines.

"Direct lending is a growing and diverse set of markets made up of multiple independent but sometime overlapping products and borrowers, including the lower middle market, the core middle market, the upper middle market and increasingly large market deals that get the most attention,” he says. “Much of the capital that has been raised this past year has gone to very large, legacy lenders that are playing at the top end of the market, where competition is becoming fierce. We believe much of the 2023 fundraising and deployment has ignored the core middle market of companies with $20 to $60 million of EBITDA – not to mention non-sponsored borrowers.”

We believe ACP is differentiated because:

  • We are focused on the core middle market where we believe that the supply-demand balance for leveraged lending favors lenders and the competitive environment is far more attractive.
  • We are focused on having a balanced mix of non-sponsored and sponsored borrowers. When it comes to non-sponsored borrowers, we are working directly with independent borrowers in the middle market to meet their senior debt needs. At Andalusian Credit Partners, we believe that, given our team’s experience, we are well positioned to seek to capitalize on the growth of non-bank middle market non-sponsored direct lending.
  • We are focused on a few key verticals – sports, media & entertainment, and financial services – where we have differentiated experience and vast networks. We know each of those markets inside and out and have access to proprietary deal flow and unique insights in each.

We believe these differentiators will be important if the current optimism around the economy is validated, but they might prove even more valuable should the soft landing not be achieved.  We also believe that having a clean balance sheet may allow us additional opportunities in a disrupted market.

Private credit investing is always done against a macro backdrop, but this time in the market – with capital being raised against rising (and potentially falling?) interest rates – really underscores how important it is to get paid for risk. This is a time of great discipline. We believe our differentiated insights, knowledge, and expertise will enable us to maintain a very disciplined investment approach in the current market and beyond.

As we look back on 2023, our founding year, we came together with a vision for private credit in the core middle market, a strategy to build a business around it, and were able to successfully launch in a challenging and complex environment. It has been a remarkable process for us all, thanks in no small part to our exceptionally talented and seasoned team that includes professionals with backgrounds in banking, direct lending, private equity, asset management, and public policy making and regulation. We believe that we are well positioned to execute our business plan in 2024, with capital in place, a differentiated strategy, and a market that is increasingly attractive for deploying private credit.

We are looking forward to what the year ahead brings.

All the best in 2024,

Andalusian Credit Partners team

Important Disclosures:

The contents of this communication: (i) do not constitute an offer of securities or a solicitation of an offer to buy securities, (ii) offers can be made only by Andalusian Credit Company, LLC’s (“ACC”) offering documents, (iii) do not and cannot replace the offering documents and is qualified in its entirety by the offering documents, and (iv) may not be relied upon in making an investment decision related to any offering of ACC securities. All potential investors must read the offering documents and no person may invest without acknowledging receipt and complete review of the offering documents. You should always consult a tax and/or finance professional prior to investing. ACC does not warrant the accuracy or completeness of the information contained herein.

Certain information contained in this document constitutes “forward looking statements,” which can be identified by the use of forward looking terminology such as “may,” “will,” “expect,” “ intend,” “anticipate,” “estimate,” “believe,” “continue” or other similar words, or the negatives thereof. These may include our financial projections and estimates and their underlying assumptions, statements about plans, objectives and expectations with respect to future operations, and statements regarding future performance. Such forward‐looking statements are inherently uncertain and there are or may be important factors that could cause actual outcomes or results to differ materially from those indicated in such statements. ACC believes these factors include but are not limited to those described under the section entitled “Certain Risk Factors” in its PPM and any such updated factors included in its periodic filings with the Securities and Exchange Commission (the “SEC”) which will be accessible on the SEC's website at []. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements that are included in ACC’s PPM and other periodic filings. Except as otherwise required by federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise.