Friday letter: The rise and rise of direct lending

Both a slew of announcements on new platforms and the hard data point to the rise of direct lending.

I joined Private Debt Investor two weeks ago. And over those two weeks, announcements about new direct lending funds have dominated our reporting. They have also dominated our top ten most read stories.

I am very excited about my new role here at PDI – to head up a publication about an up and coming asset class as the market grows, develops and forces people to pay it some attention is a great opportunity.

We’ve had a slew of stories about new direct lending moves by Sankaty Advisors, Angelo, Gordon & Co., Blackrock, Cowen Group and Benefit Street Partners. And all these in my first two weeks in the job have just served to boost that sense of excitement.

Sankaty are targeting a fund of $700m to $1bn to invest globally. The firm, the credit arm of Bain Capital, will focus the new fund on senior secured debt for mid-market companies. Michael Ewald’s direct lending team will manage the sector-agnostic fund.

Blackrock is in the very early stages of launching a direct lending strategy. They have hired Stephan Caron, formerly chief commercial officer at alternative lender GE Capital, as European head of direct corporate finance – a newly created role.

Angelo, Gordon & Co. have hired former Madison Capital Funding duo, Trevor Clark and Christopher Williams. The new direct lending platform will target mid-market companies with EBITDA of between $3 million and €5 million.

Not to be outdone, Cowen Group also announced their new direct lending strategy last week. The group will initially invest $125m in Cowen Finance, which will originate and syndicate loans to the firm’s corporate clients.

Also making a strategic hire to lead their move into direct lending is the credit arm of Providence Equity Partners, Benefit Street Partners. They have hired Tim Murray, formerly managing director at GSO Capital Partners, to effectively open an office in Houston, Texas and establish a mid-market energy company credit business.

Benefit Street is both moving to tap the trend for direct lending, and take advantage of the US domestic energy boom prompted by the rapid expansion of shale gas production.

All these stories are not a coincidence, the data backs up the anecdotal evidence. Funds raised for private debt strategies have grown over the last few years, up from $39.61 billion in 2011, to $50.85 billion in 2013. More importantly, the proportion of those funds dedicated to debt origination, rather than strategies focused on buying debt in the secondary market, has exploded.

In 2011, funds raised for origination made up 3.6 percent of the total. After a small increase in 2012, it surged to 25.6 percent. In the first six months of 2014, the proportion of origination funds raised has risen to 30 percent, according to research by PDI Research & Analytics.

The trend has been driven by both push and pull factors.

European banks, in particular, are deleveraging. Loan growth in Europe has been negative since 2012, with lenders shedding assets and avoiding taking on new exposure. That has opened up a clear gap in the financing market with mid-market borrowers especially under-serviced.

For banks globally, the new Basel III standards will require them to hold more capital against loans, making corporate bank loans, already sometimes a loss leader, an even less attractive business.

On the push side, many of those moving into direct lending cite the low yields on offer in other asset classes. Mid-market corporate lending has generally low default rates and companies in need of capital, will pay for it.

So far, so familiar – none of these factors are earth shattering news to most financial market participants.

The really interesting question is how many of these new direct lenders will manage to find the right opportunities to scale-up? The other issue is returns – will the apparent rich pickings of low risk with decent yield meet expectations?

And for me, the most interesting points – will these new ventures still be here five years from now? And what form will they have taken by that point?

It’s a vibrant and growing market. We’ll be watching its progress with interest.