2017: More capital won’t help everyone

David Golub talks about potential inflation in private credit and why his firm left the mezzanine space.

As non-bank lending ballooned in 2016, the sheer amount of new capital coming into the space may present a significant challenge for the private debt direct lending industry in the coming year, according to David Golub, president of Golub Capital and CEO at Golub Capital BDC.

Golub told Private Debt Investor that the new money entering the space and 2016’s weak M&A volume contributed to “credit market inflation” which may continue. This could potentially tighten spreads and increase leverage in 2017.

Alongside the credit market inflation, Golub said the private debt space could continue to see “banks losing [market] share to non-banks, buy-and-hold solutions gaining in popularity versus syndicated solutions, and one-stops [continue] gaining popularity versus complex capital structures”.

For mezzanine debt in particular, these trends may compound the main challenge for lenders in this particular space, which is an overcrowding of competitors chasing too few deals.

“The big story in junior debt is the proliferation of players in the space,” Golub said. “I put together a list of players in the middle-market junior debt space, and I was surprised at how easy it was to make a list of 75 active players. That degree of fragmentation makes for a very competitive market.”

Over the first three quarters of 2016, subordinated or mezzanine debt closed-end funds took in the largest share of capital compared to other strategies. Those vehicles raised $17.88 billion, compared to $15.15 billion total for senior debt and $16.98 billion total for distressed debt, according to the PDI Q3 2016 Fundraising Report.

That report also showed that the amount of subordinated debt private funds are seeking grew to $79.33 billion in Q3 2016, up from $64.26 billion in Q3 2015.

Golub added that the firm decided to reduce its investments in junior debt because the “pricing had come down post-crisis and attachment points had become high” and that “we continue to think the middle-market junior debt environment is generally unattractive”.

However, the mezzanine market may be attractive to other issuers and investors for its risk-adjusted yields, according to Randy Schwimmer, head of origination and capital markets at Churchill Asset Management, which targets senior financing in sponsored deals.

Schwimmer noted the relationships between a private equity sponsor and its alternative mezzanine lender can be important. “When companies run into problems, sponsors are comfortable the mezz lender won’t just take the keys,” he said.