Stafford Private Credit in a nutshell*

Generally, private credit by its lack of outright ownership in assets also does not necessarily attract sustainable or responsible investors. However, as the assets under management by private credit managers increased over the past few years, they started paying more attention to sustainable practices in their investment processes. We are seeing an increasing number of private credit funds with a sustainable focus and sustainable focus in traditional credit strategies where credit can take a control position, particularly in specialty finance strategies.

As we evaluated the non-performing loan (NPL) opportunity, we became convinced it was an area to generate attractive returns and could have a positive impact on society. Investors/asset managers make money on NPLs by buying these pools of loans at a substantial discount to face value and engaging special servicers to administer and recover borrower payments. This is an active and labour-intensive asset management strategy. The process of acquiring portfolios of NPLs requires an infrastructure that can source, screen, underwrite, finance, migrate, service, and ultimately monetise thousands of borrowers, loans, and assets across multiple geographies. During the acquisition phase, specialist managers have the capability to underwrite the underlying credit pools forensically in-house and can then choose to highlight or reduce exposure to specific sectors or loan characteristics, such as legal jurisdiction, property type, etc. Once purchased, the managers can interact directly with borrowers and have a choice of various workout strategies, each adding the potential to extract additional returns in these investments.

There are two principal approaches to recovering value: asset resolution or through borrower-based resolution.

• Most managers follow an asset resolution strategy which has little regard for the borrower. Asset resolution is the least preferable option because it extends timelines to payment. Examples of asset resolution include "cash for keys", short sales, or even deed in lieu. The worst outcome would be to move to foreclose due to longer timelines.

• Borrower-based resolution strategy, however, aims to convert an NPL into a reperforming loan through some form of loan modification which is advantageous to the original borrower. Here the borrower needs to be willing and able to make payments and, in many cases, an overall reduction in the debt outstanding and a manageable payment plan is all that is required to make the loan performing again. The borrowers usually are highly motivated to rehabilitate their delinquency given the impact on their credit scores and/or potential risk to the equity they have built up in their homes.

Non-performing loans require "special servicer" skills which is a very different activity from a normal servicer (which simply collects payments). The special servicers execute an asset management plan on each individual investment agreed with the manager. They usually charge a flat fee but also receive a percentage of the return that they generate. Most of the compensation received by the special servicer is derived from performance, so incentives are aligned.