LPC: Institutional demand spurs mid-market direct lending platforms

By Leela Parker Deo
NEW YORK, May 19 (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.