When The Wurzels sang “I’ve got a brand new combine harvester and I’ll give you the key!” in their 1976 number-one record, one thing lead singer Pete Budd failed to mention to the object of his affection was that the piece of equipment he was boasting about was likely to be rented rather than his to lend
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This is because the cost of a combine harvester, about £250,000 at today’s prices, makes it a prohibitive outlay for a piece of machinery the farmer is only likely to use for a short period each year.
The good news for those willing to rent out this equipment is that, aside from the reliability of demand, there aren’t many defaults in the agricultural machinery market.
As William Nicoll (pictured), co-head of alternative credit at M&G Investments, pointed out: “Firstly, the farmer tends to secure any loan on the land and you can’t run away with the land. And secondly these things are not worth as much as the farm, it’s one of those simple discussions: if you lease a combine harvester and the farmer goes into administration, you take the combine harvester back, but clearly the farmer has more assets than just a combine harvester.”
This is why agricultural-machinery leasing is one area of the market Nicoll is keen to gain exposure to in the soon-to-launch M&G Credit Income Investment Trust.
The trust was created by M&G in a bid to take advantage of opportunities in private and/or illiquid debt instruments which are incompatible with an open-ended fund structure.
Source: M&G
For example, even in today’s low interest-rate environment, the trust will receive a coupon of 5 per cent a year for an investment-grade loan it made to an agricultural-machinery leasing company for just two and a half years. Nicoll said this is an example of the favourable conditions the trust can command by negotiating agreements with individual companies, rather than competing with its peers in the bond market.
“The odd thing about this particular discussion was we had a small leasing company that came to us and said it was lending to farmers in quite a safe way – so it bought a combine harvester which it leased to a farmer, who paid a certain amount of rent before the company took it back and lent it to someone else.
“And what it found was that the banks wouldn’t lend it that much money against [the combine harvesters].
“The banks used to quite happily lend £50m, whereas now they will only lend up to £20m or £30m, so it was one of those times when you look at it and you go, ‘fine, we can now have a proper discussion with you, because we are no longer competing against the banks’.”
When the company first approached M&G, it asked for £400m to take over the leasing market in large areas of the UK, which Nicoll said initially sounded like a good idea. However, the credit team had to carry out due diligence before it agreed to this deal, the first step of which involved asking to view every lease the company had ever made.
The second step, which took a year to negotiate, was the fact the leasing company wanted M&G to lend it £400m even though it had just a handful of employees, “to which the answer was almost certainly no”, said Nicoll. As a result, the credit team had to work out a system whereby it would be given control of the assets if anything went wrong, a stipulation that the company didn’t agree to until after a year of negotiations.
At that point, the credit team told the company the return should be about 5 per cent.
“And that then ceases to be a discussion,” said Nicoll. “In that way we are then working out what we think is the right answer without four or five other people saying ‘we will do it for 3 per cent, we will do it for 2 per cent’ and so on.
“So you are setting a price, you are able to set your terms and you are able to do a deal, so it ends up being an investment grade-type deal, quite low-risk with a coupon of 5 per cent and you end up with something you couldn’t possibly get in the public markets with that sort of risk and return.
“Put simply, that took us 18 months of work. And we had to find £90m to go with that and we had to live with that. And it is only 2.5 years or so, it won’t be long until it goes, but that is the sort of thing you get extra return for but you couldn’t possibly put into a UCITS.”
The team at Winterflood said that the M&G Credit Income Investment Trust will be unique in its peer group in that it will have the broadest mandate within the listed investment company debt sector.
“We believe that the extensive resources of M&G make it ideally placed to manage such a mandate,” it said.
“By focusing on private or illiquid debt securities, which are ideally suited to the closed-ended structure, the managers should be able to enhance returns by capturing an illiquidity premium.
“The fund's yield target of LIBOR plus 4 per cent is attractive. While higher yields are available from sub-sector specific funds, we believe that the return objectives of M&G Credit Income compare favourably on a risk-adjusted basis, with NAV [net asset value] volatility expected to be relatively low.”