No return for banks to US lower mid-market debt

The US banks that withdrew from the lower mid-market in the wake of the financial crisis are unlikely to make a comeback, according industry experts speaking at PDI Germany forum in Munich this week.

During a panel discussion about how the US private debt market is perceived by European investors, Patrick McAuliffe, head of direct origination at New Star Financial, noted that  investors regularly ask how active US banks are as lenders to the traditional mid-market (typically defined as companies with an EBITDA between $15-50 million).

“The banks will never come back to that space,” said McAuliffe. “The quality personnel at the big New York banks could do it but it wont move the dial for them. There is not enough fee revenue in that space for them.”

He added: “The few regional banks [that were in the market] dismantled their leverage financial groups. Given the pace of a private equity transactions now, it would never work at a regional bank. The move to non-bank lenders in private equity-backed transactions is absolutely permanent.”

This point was echoed by Ken Kencel, president and CEO of Nuveen affiliate Churchill Asset Management, who said that consolidation has meant that the US banking space is now dominated by the four to six major banks, all of whom are focused on driving fee income and holding as few loans as possible.

“if you look at the broadly syndicated market, even though the banks are originating and underwriting those deals, they hold less than 10 percent of the loans,” he said. “So they are in the business of distributing loans.”

He added that the buy-and-hold investment approach of direct lenders was no longer a model that worked for the banks from a cost to capital perspective, and that the dynamics is moving even further in the direction of private debt managers.

“Not only do [the banks] not have the people, but the economics of the middle market is dominated by a half dozen players that can hold $100 million plus per deal. The banks are now simply abdicating that market to the direct lenders,” he said. “One phenomenon we are seeing play out is that the upper end of the market, which historically would have been clubbier and done by 7-8 middle market lenders, has become a syndicated market.”