McGinty Road Partners is an opportunistic credit fund gaining recognition for targeting mid-teens net returns with downside protection thanks to an uncompromising focus on collateral. Against a backdrop of mega credit firms growing AUM, McGinty Road is nimble and differentiated, targeting heavy-duty equipment and asset-backed investments.
McGinty Road allocates across three opportunistic credit strategies: equipment finance, secondary loan portfolios and select public corporate credit. The three sub-strategies all have potential to deliver consistent double digit returns throughout the cycle, though returns and allocations can vary. In 2020 and 2021, portfolios of secondary loans generated deal level gross IRRs between 20% and 29%.
Our returns can be higher because equipment finance opportunities are relatively under-the-radar and do not get attention from bigger credit funds.
Jeff Leu, co-founder and CIO, McGinty Road Partners
McGinty Road is named after the address of Cargill’s headquarters just outside Minneapolis, Minnesota. McGinty Road’s five Partners all worked at the firm’s investment division, Cargill Financial Markets Group and CarVal Investors (which was ultimately sold to a different management team in 2018).
McGinty Road is not a typical spin out. Its Partners – including CIO, Jeff Leu, former President and Founding Partner of CarVal and CFO/COO Tiffany Parr, who was featured in The Hedge Fund Journal’s 2021 ’50 Leading Women in Hedge Funds’ report produced in association with EY – all left CarVal at different times (between 1998 and 2016) and for different reasons, but they share a common pedigree and entrepreneurial vision. Leu and Parr are joined by John Seibel, a 30-plus year veteran in equipment finance, Dave Ellingrud, who leads the loan portfolio acquisition business and Jim Musel who covers the corporate credit sub strategy. The Partners have a long history of working together and deep experience in their respective verticals.
Starting with $40 million of outside capital in 2017, McGinty Road has raised capital into two commingled funds and two funds of one since inception. “We focus on smaller deals that are similar to the strategy we employed at Cargill back in the 1990s,” says co-founder and CIO, Jeff Leu, who spent 28 years working closely with the Cargill family and executives. “We can find $5-10 million deals to build a diversified portfolio with strong risk adjusted returns at our size, but it would be hard to deploy $3 billion right now.”
These niche deals are targeting mid-teens net annualized returns and are sometimes enhanced by moderate leverage at the deal level. According to Leu, “Our returns can be higher because equipment finance opportunities are relatively under-the-radar and do not get attention from bigger credit funds, which may lack the expertise to underwrite the equipment collateral. Most funds steer clear of these deals. We believe private credit, especially in our niche, is a good place to invest right now considering the uncertain markets.”
McGinty Road’s competitive positioning in its equipment origination business is often to provide transitional lending, which conceptually bridges borrowers to a cheaper solution even if it is not a bridge loan per se. “We will typically charge higher interest rates than banks because we underwrite complex situations and companies early in a turnaround after experiencing financial difficulties,” says co-Founder and Partner, Dave Ellingrud. The firm will often provide financing for 12-48 months after which borrowers might revert to a traditional lender charging less. “Around one third of borrowers will prepay the loan before maturity, to refinance at a lower rate, but may then return to McGinty Road at a later point in the cycle when they cannot quickly or easily get financing from a bank. Banks are often apprehensive to finance equipment because these deals can be relatively complex, or too small, and banks often prefer to focus on single family and commercial real estate lending. We only work in a sandbox where we understand the collateral and can make a timely decision,” says Ellingrud.
In 2020 and 2021, portfolios of secondary loans generated deal level gross IRRs between 20% and 29%
“Returns may not vary dramatically over time, but we may lean into a particular strategy depending on the opportunity set and then pivot to others,” says Leu. There are no fixed weightings for the sub-strategies and the manager can be opportunistic. “There is a logic to different strategies at different points of the cycle and we focus on where we can find the best risk adjusted returns.”
Prior to the COVID-19 pandemic, equipment finance origination deals made up 60% of McGinty Road’s book. “We did not know what the catalyst for a downturn would be, but we knew we were late in the cycle and were positioned defensively,” says Leu.
The portfolio withstood the stress of the COVID-19 crisis allowing McGinty Road to take advantage of opportunities to pick up discounted paper on the secondary market, as well as corporate loans. The listed corporate debt opportunity around COVID-19 was ephemeral. By late 2021, it was clear that corporate credit was very late cycle with very tight spreads and not a lot of opportunities.
Yet the opportunity to acquire loans from banks could even expand. “Now there are a lot of financial institutions with loans to sell, and we expect this will continue for at least another 18 months. The best opportunities to acquire loans from banks can occur 18, 24 or 36 months after the trough of the downturn, as we saw in 2010-2011,” says Ellingrud.
The cyclical outlook for the core strategy remains strong. “We are also seeing a resurgence in equipment finance originations. There is significant demand for new and used equipment as companies expand,” says Leu.
Sourcing a diverse range of deal-flow benefits from an alliance with Allegiance Finance Group (“AFG”), a specialty equipment lending group founded by one McGinty Road partner, John Seibel, in 2001, before Leu joined in 2010 to build up the business. AFG has originated over $500 million of loans over the years.
McGinty Road has a right of first refusal over AFG deal-flow. AFG itself is more likely to retain smaller deals, with lower target returns of 6.5% to 7%, which are not such a good fit for the fund. AFG co-invests alongside McGinty Road in some deals, in which case it is treated like any other third-party investor. AFG is also one of a handful of operating partners, who carry out servicing and collection of the loans.
The McGinty Road Loan Portfolio strategy is collateralized by small scale business assets, industrial equipment and commercial real estate. In commercial real estate debt, McGinty Road looks for reasonably liquid and mainstream collateral. “We stay away from very rural areas as well as trophy assets and special use properties that are difficult to value,” says Leu. Pricing needs to be compelling, so McGinty Road is selective. “Stress in the leisure space has not percolated into discounted prices for hotel properties. They did not even drop below 90 and are being priced to assume a bounce back to prior values. In contrast, motorcoaches can be acquired at bigger discounts because there is a lack of capital in the space,” points out Leu.
McGinty Road targets deal level gross returns of 15-18%, based on scheduled payments, but this IRR can be boosted by at least one or two percentage points if loans are paid off before maturity. However, the underwriting is designed to ensure strong returns under a range of repayment timing scenarios. “The return profile is not overly dependent on exit timing. On top of interest payments there are interim capital repayments, amortizing loan principal. Half to two thirds of returns come from regular cashflows, and one third of returns come from exit,” says Ellingrud.
In normal market conditions, equipment will see some depreciation, so collateral values are a moving target. The loan values should fall at least as fast as the collateral values to maintain a conservative discount to asset values.
Stress in the leisure space has not percolated into discounted prices for hotel properties. They did not even drop below 90 and are being priced to assume a bounce back to prior values.
Jeff Leu, co-founder and CIO, McGinty Road Partners
Appreciation of some collateral in 2020 and 2021 has been serendipitous and is an aberration relative to longer periods of history. McGinty Road has seen used equipment collateral selling at a relative premium to pre-pandemic levels due to long lead times in new manufacturing and supply chain inefficiencies. Equipment price inflation has been something of a windfall for an acquired motorcoach portfolio, since new motorcoaches cost 10-15% more than in 2019, and tractor prices are up by as much as 25-30% versus 2019, while some other types of used equipment have appreciated by less. However, McGinty Road’s depreciation curve modeling does not rely on any inflation. “We are underwriting that the inflation premium dissipates. We assume a reversion to the mean because we expect that the supply chain will come back into equilibrium,” says Ellingrud.
The industrial sectors lent to are traditional industries with hard tangible assets, mainly equipment and commercial real estate, rather than industries such as technology or healthcare where assets are more often intangibles such as patents or royalty streams. Collateral includes a range of transport related areas such as trucking, railcars, aircraft, shipping and motorcoaches; industrial vehicles such as cranes, tractors and barges; old and new forms of energy and power including oil services, renewables, electricity and generators; and various manufacturing, industrial, infrastructure and construction sectors.
There is a rule of thumb limiting exposure to 20% per industrial sector, though the approach is very much bottom up. McGinty Road also ensures that collateral is versatile and can be used in multiple industries, to mitigate the risk of sector specific downturns. “In the past, if we’ve lent to a cyclical industry, we look for general use equipment that could be redeployed into multiple regions and industries such as infrastructure or construction,” says Leu.
In terms of downside protection, McGinty Road lends at a discount to hard collateral values and would expect to foreclose at a profit on the rare occasions when it comes to that. Occasionally McGinty Road also purchases equipment directly, such as motorcoaches in 2020, 2021 and 2022.
Foreclosing on collateral, repossessing, and remarketing it, is a last resort. “The goal is to get the credit to reperform. Sometimes borrowers will make us whole to avoid having to sell the equipment,” says Ellingrud. McGinty Road will often have a personal guarantee from borrowers, up to the full amount of the loan, with full recourse, but rarely must enforce it. “The guarantees help to keep borrowers’ co-operative and can also expedite manoeuvres such as transferring assets to new owners,” says Leu.
McGinty Road cannot recall any instances of fraud over their careers, and even bad actors are also very rare. “We find that 99% of borrowers are good people who want to do the right thing, so we can be flexible in figuring it out. We might offer some payment holidays or reductions in rates as a more friendly and patient way to resolve delinquencies,” says Leu.
There have been asset specific issues with items of collateral, but these did not upset the big picture economics. “For instance, an individual motorcoach or tractor might have been missing an engine, but the overall portfolio was still very profitable,” says Ellingrud.
Loans have occasionally gone through bankruptcy workouts, usually in the US Chapter 11 regime. “Sometimes borrowers might use Chapter 11 as a delaying tactic. On the equipment side we had one borrower file bankruptcy where we ended up getting the equipment back and sold it again at a gain. One benefit to leases over loans is they must be affirmed or rejected quickly in a bankruptcy and are not crammed down,” says Ellingrud. Where courts are involved, Delaware is the main domicile, but it is more common to resolve matters out of court.
The hit rate is very high. Of 28 deals done pre-COVID-19, all have been repaid and seen full returns (though a few fell short of target returns none lost money). Just three corporate credits bought pre-COVID-19 have caused unrealized losses.
The underwriting is bottom up, asset specific and intended to be resilient to macroeconomic scenarios. “If overall US economic growth is half the projected level this year, we would still expect to get our returns. We are prepared for headwinds such as rising interest rates, new COVID-19 variants, supply chain bottlenecks. What is more relevant is local economics, such as how a particular block of properties on a street performs, or how individual motorcoach operators perform,” explains Ellingrud.
For now, Delaware and Cayman commingled fund structures are meeting investor needs. The first funds were private equity style closed ended and have some common holdings due to their overlapping investment periods. “An evergreen open-ended structure is being launched to cater to investor groups who are accustomed to a hedge fund style vehicle and want more optionality over timing redemptions or runoffs,” says Head of Investor Relations, Caroline Closmore, who featured in The Hedge Fund Journal’s 2021 ‘50 Leading Women in Hedge Funds’ report.
McGinty Road also has several funds of one with mandates to fit specific investor needs. Some structures reinvest income while others distribute it. Co-investments may be offered for specific transactions. The firm raised assets for several vehicles in 2021 and will be raising capital in 2022 to reach $500 million.