By Leela Parker Deo
NEW YORK (Reuters) - Institutional demand for private credit is propelling capital formation in the US middle market, as a flurry of newly created direct lending platforms enter the mix and existing alternative debt capital providers continue to raise money and add scale.
One middle market participant that is fundraising said as much as US$15bn in new equity capital is being targeted, which combined with leverage could put purchasing power north of US$40bn over the next two to three years.
In addition to newly created platforms and investment strategies, existing managers are raising capital and building scale through separately managed accounts (SMAs). The amount of capital being allocated by large institutional investors – such as pension funds and insurance companies – in the form of SMAs and senior loan funds managed by established lenders, could well eclipse the dollars raised by new shops, sources said.
Comfort with the asset class, demand for yield and growing opportunities for alternative lenders to step in as banks retreat – due to increased regulatory constraints that limit their ability to take on risk – are attracting institutional investors to the middle market.
“Institutions are seeking to enter middle market lending now for two reasons,” said Sean Coleman, chief credit officer at Franklin Square (NYSE:SQ) Capital Partners.
“One, the top middle market platforms have demonstrated the ability to generate superior risk-adjusted returns through multiple credit cycles. These new potential entrants now recognize this and want to expose a portion of their assets to the category. Two, these institutions are also finding it difficult to earn decent returns in liquid credit markets given the persistent low-growth macro environment.”
LPs have come around to the middle market asset class. They are comfortable giving up liquidity in exchange for being paid a premium with tighter structures, said Mike Ewald, managing director at Bain Capital Credit, but it is also the case that there is a hole to fill where banks and traditional commercial finance lenders have exited the leveraged space in a big way.
NEW KIDS ON THE BLOCK
Among new middle market strategies launched this year are credit fund Owl Rock Capital Partners and Onex Credit’s new direct lending platform.
New York-based Owl Rock Capital was formed by Doug Ostrover, co-founder of GSO Capital Partners, the credit arm of Blackstone (NYSE:BX) Group; Marc Lipschultz, former head of energy investments at KKR & Co; and Craig Packer, former co-head of leveraged finance in the Americas at Goldman Sachs (NYSE:GS).
In April, private equity firm Onex Corp said it hired Walt Jackson, a veteran of Goldman Sachs Private Credit Group, to launch a direct lending platform that will provide non-investment grade loans to middle market and larger businesses. The strategy is an expansion of the firm’s existing credit platform Onex Credit, which invests in leveraged loans and CLOs.
AB Private Credit Investors (AB-PCI), the middle market direct lending platform of global asset manager AB that launched in 2014, is seeking to add US$500m in new capital.
AB-PCI has just under US$2.5bn in available capital across three funds to invest in US middle market companies, and is seeking to further raise its capital base to approximately US$3bn by year-end.
In March, longtime middle market lender NewStar Financial Inc, a commercial finance company, announced the sale of its asset-based lending business NewStar Business Credit, and commented on its strategic shift toward direct lending.
“The sale of the asset-based lending platform demonstrates a continuation of the company's transformation from a bank-styled, diversified commercial finance company into a more specialized middle market direct lender with a focus on managing assets for institutional investors,” NewStar Financial said in a statement.
SCALE MATTERS
Middle market participants said the challenge for new entrants in an increasingly crowded and competitive field, and the advantage for existing lenders, is the ability to build scale, as well as to access leverage and originate deal flow. SMAs, for example, provide lenders with additional pockets of available capital, enabling larger investments.
"Without scale, a fund won't matter as much to private equity sponsors,” said Ewald.
The amount of leverage a platform employs also varies, depending on the type of fund or mandate, with some electing not to use leverage.
“Different firms use different amounts of leverage. A firm can raise a certain amount of equity, but it may or may not be able to get financing,” Ewald said.