KBRA Affirms Preston Hollow’s Ratings
15 Dec 2023 | New York
KBRA affirms the BBB issuer ratings of Preston Hollow Capital, LLC (“PHC”) and its a wholly-owned subsidiary PHCC LLC d/b/a Preston Hollow Community Capital (“PHCC”, together with PHC, “Preston Hollow”, “PH” or “the Company”). KBRA also affirms the BBB rating on the unsecured notes issued by PHCC as well as the K2 rating on PHCC’s up to $200 million Secured Commercial Paper Notes Program (“CP Notes”). The rating Outlook is Stable. Preston Hollow is a private investment company founded in 2014 and headquartered in Dallas Texas, specializing in direct and secondary market investments in municipal securities.
Key Credit Considerations
Preston Hollow’s ratings reflects the Company’s deep and experienced management team with decades of municipal finance and real estate lending experience, a primarily senior secured, well-collateralized and covenant-heavy investment portfolio diversified by region and sector, acceptable leverage with a long-term target of up to 2x Total Debt-to-Equity and approximately 1x Recourse Debt-to-Equity (excluding non-recourse secured funding), strong underwriting and risk management, strong earnings metrics driven by stable net interest income and low impairments to-date, permanent equity capital from established institutional investors and an adequate funding/liquidity profile with significant unencumbered assets.
The Company’s long-term funding strategy is focused primarily on non-recourse term matched trusts (TMTs) and Tax-Exempt Pooled Securities (TEPS) which provide a long-term source of borrowing. KBRA views this funding as relatively stable given maturities are long-term and generally matched with the maturities of the collateral, there is no mark to-market collateral posting required, and TMTs/TEPS are fully non-recourse to PH. In addition, the rating considers PH’s demonstrated strong underwriting with low losses and successful workouts of distressed credits to-date. These strengths are counterbalanced by the risks related to the business of investing in illiquid noninvestment grade or unrated municipal debt, relatively high single credit concentration (top 5 credits comprised approximately 33% of the portfolio at 9/30/23), high dividend payouts and a largely secured funding profile although PH diversified its funding sources with unsecured debt issuance in 2022.
The issuer rating of PHCC is the same as PHC’s given PHCC is the wholly-owned operating subsidiary of PHC and holds substantially all assets and liabilities of the Company. The unsecured notes rating is equalized with the issuer rating reflecting the Company’s acceptable target leverage and significant unencumbered assets which supports potential recovery prospects. The Notes include a covenant requiring the ratio of unencumbered assets to unsecured debt to be greater than 1.50x (3.6x coverage as of 3Q23).
The short-term K2 rating reflects the Company’s BBB issuer rating, the secured nature of the CP Notes that are recourse obligations of PHCC, and KBRA’s assessment of the Company’s liquidity management. The CP Notes are secured and overcollateralized by eligible securities including municipal securities at appropriate advance rates. KBRA believes PH has adequate liquidity management to support the current size of the CP program. PH’s liquidity management plan includes maintaining a minimum level of contingent liquidity and staggering CP maturities. PH will ensure that:
- PHCC has no more than $15 million in total par value of CP Notes maturing within any seven-day period.
- PHCC has no more than $50 million in total par value of CP Notes maturing within any 30-day period.
- The total amount of CP Notes issued will not exceed $200 million.
- 30 days prior to the maturity date of any CP Note, the Company will maintain cash & cash equivalents or unfunded capacity under PH’s existing credit facility equal to cover 100% of CP Notes maturing within the next 30-day period.
- At 3Q23, the Company maintained adequate liquidity ($14 million of unrestricted cash and $191mn committed undrawn bank facilities) that covered $24mn of CP Notes outstanding. In addition, PH had $1.0Bn of unencumbered assets.
The Stable Outlook reflects the Company’s stable performance, low leverage (<1x Debt-to-Equity at 3Q23), manageable level of non-accruals, low historical credit losses and minimal impairments expected in the near-term, and adequate liquidity with significant unencumbered assets.
The rating Outlook is Stable, therefore, a rating upgrade is not expected in the near-term. Over time, significant market share and portfolio growth, significant improvement in single credit diversification, increased portfolio exposure to higher-rated credits and increased diversity of funding sources while maintaining leverage at or below target levels (and well-below covenant levels) and stable asset quality metrics could lead to consideration for an upgrade.
The Outlook could be revised to Negative or the rating could be downgraded if a significant downturn in the U.S. economy or changes in U.S. tax policy have material negative impacts on PH’s portfolio, credit losses and/or portfolio concentrations increase materially, or leverage increases materially above target levels which could cause performance volatility; KBRA notes that higher leverage would increase the sensitivity of the rating to a deterioration in asset quality. A material weakening in the stability of funding, including weakening of TMT/TEPS terms that increases refinancing and liquidity risk for PH or a change in management coupled with a shift in investment strategy, investment process and/or risk management could also lead to a downgrade. The unsecured notes rating could be notched down if unencumbered assets coverage of outstanding unsecured notes deteriorates approaching or below 1.5x.
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