Annual Review: North America

North America’s biggest private debt players enjoyed record fundraising and deployment in 2015, but the second half of the year provided a warning of a storm brewing on the horizon.

Equity market volatility, a high-yield tumble and energy losses all took their toll, leaving few places to hide, especially for publicly traded asset managers and business development companies (BDCs) forced to mark down their portfolios.

Of course, many of these players say the marks do not reflect the inherent credit quality of their book and the deals will come good. But these headwinds create a trying environment for lenders heading into 2016.

While distressed players are more optimistic about investment options, other traditional lenders are noticeably nervous.


The money raised for private debt funds in 2015 eclipsed the 2014 total by 21 percent: reaching $102.75 billion, up from last year’s $84.9 billion, according to PDI Research & Analytics. This represented 139 funds that held a final close in 2015, compared with 126 in 2014.

Some would argue that there are too many funds being raised, though Michael Ewald, head of mid-market lending at Bain Capital’s Sankaty Advisors, would not necessarily agree. He points to banks continuing to reduce dealmaking as leveraged lending guidelines become stricter and clearer.

“The banks ignored leveraged lending guidelines for some time initially,” says Ewald, though banks started paying more attention when Credit Suisse got in trouble with the Fed in 2014 and other regulatory bodies clarified guidelines.

In addition, most BDCs were trading below book value in 2015, which limited them to recycling their existing portfolios. “The BDCs couldn’t issue new stock, so they were a lot less active. The new senior direct lending funds that were raised counteracted that a bit,” says Ewald.

“In many cases you saw second lien coming back into the middle-market and subordinated debt masquerading as second lien. It undercut some folks that do junior lending like ourselves and you saw second lien pricing starting to widen out, which ultimately led to a lot of opportunity for sub debt lenders.”

Unitranche transactions also continued to be popular. Most of Golub Capital’s $8.4 billion in origination volume in 2015 went into the instrument.

GSO Capital, winner of this year’s junior lender of the year category, also saw record activity in subordinated debt, deploying $1.2 billion in 2015. GSO, Highbridge and Crescent are all now raising large successor mezzanine funds.


Last year saw a lot of M&A activity among lenders and alternative asset management firms, with some of these deals reaching completion as others fell apart.

General Electric, which set out to sell most of its GE Capital units, had divested $157 billion worth of assets by January. Antares Capital, which many describe as “the crown jewel” of sponsor finance in the US, was sold to the Canada Pension Plan Investment Board (CPPIB). Industry experts believe this transaction underscores how valuable non-bank lending has become.

In addition to the GE Capital sales, there were several other M&A deals that involved purchases of debt players, such as GAM and Renshaw Bay, Fortress and Mount Kellett, PennantPark and MCG, Conning and Octagon, as well as Sankaty buying Regiment Capital’s CLO book.

At the same time, there were several large M&A transactions that fell through towards the end of the year, including Ares and Kayne Anderson, Apollo Global Management and AR Global, and Benefit Street Partners attempted takeover of TICC Capital Corp’s investment advisor. With more carnage anticipated this year, more deals like these are expected to be tabled with an equal expectation that some will fall apart.

In December, many alternative lenders told PDI that they were getting numerous calls from private equity sponsors seeking to refinance deals that the original bank lenders were stalling on.

David Golub estimated that there are about $10 billion-$15 billion worth of these hung deals in the market waiting to be refinanced and that the banks will either have to sell the paper at a loss or hold in the hope that market conditions improve.

The dislocation is creating opportunities for alternative lenders. Both Golub and Ares Capital led their largest syndicated deals in 2015. Golub worked on a refinancing of Behrman Group’s Data Device Corporation, while Ares led Bregal Partners’ dividend recap of American Seafoods. Both lenders said these deals set a new high-water mark and proved alternative lenders’ ability to compete with banks on large syndicated deals. Going into 2016, both managers say they see more such opportunities.

“When we’re in a market such as we’re in right now, filled with volatility and uncertainty, our ability to provide certainty of execution and size becomes very valuable to our private equity clients,” Golub said.

“We think this is going to be a continuing story into 2016: that we’re now winning deals that in the past might have gone to bigger competitors.”

With market turmoil continuing in the opening six weeks of 2016, the question on everyone’s mind is whether the US is heading into a recession.

Speaking last month, Oaktree Capital Management’s chairman Howard Marks said he did not think 2016 will be a recession year yet, though he sees some of the market headwinds creating more opportunities for a distressed investor like himself.

“[Last year] was generally challenging for the credit markets. The carnage in commodities, coupled with macroeconomic concerns about possible slowing growth worldwide, particularly in China, led to broader market volatility, which emerged at the end of the second quarter and persisted through year-end,” Marks said.

High-yield bonds tumbled toward the end of the year, losing about 8 points in the second half, and making 2015 the third worst year in Oaktree’s 30-year history, Marks added. Continued energy concerns also took their toll on managers, with Blackstone reporting mark-to-market losses on its energy holdings.

A lot of this turmoil is prompting firms to gear up distressed funds. Several of the big distressed players, including Oaktree, The Carlyle Group, Oak Hill Advisors and Sankaty, have been in the market with large funds for some time.

Centerbridge Partners is also now raising a $6 billion Special Credit Fund III, a distressed series, while Oaktree is keeping its $10.5 billion Fund X open to new commitments. At the same time, the debt players admit that it’s difficult to time the inflection point correctly.

Asked on Oaktree’s earnings call when recession would hit, Marks joked: “We fired our economist. Actually, that’s not true; we never had one.”

On a more serious note, he added: “I just don’t think that we’re in for a recession this year. My feeling is that we’ve been limping along for several years now with an anemic recovery and it seems to be losing energy.”

The clock is ticking to comply with risk retention rules that come into force in December.

For many CLO managers, 2015 was spent either coming into compliance or thinking about how to get there.

CLO issuance fell to $97.4 billion in 2015 from $124.1 billion a year earlier, though many players point out that this still puts 2015 in the top three in terms of annual CLO issuance.

European issuance was also high, with US managers like GSO and Oak Hill doing more deals in Europe. UK-domiciled 3i Debt Management got three US and three European deals done in 2015.

“In the US, we started to invest sufficient capital in our deals to show that we have the resources to comply with risk retention requirements,” says John Fraser, the New York-based managing partner at 3i Debt Management US. The firm has been in compliance with European risk retention rules since 2013.

3i has been working on buying equity to meet the 5 percent of par value of the CLO’s capital structure, Fraser says. He and other large CLO players think issuance will be down this year. “We will participate in the CLO market to the extent that it makes sense for our capital and our clients’ capital, but we won’t try to force CLO issuance at pricing at levels that don’t make sense,” Fraser says.

CIFC issued five CLOs in 2015, with none being risk retention compliant, although co-president Oliver Wriedt tells PDI that is a testament to the market’s faith in the firm’s platform. CIFC has lined up credit facilities with banks in recent years and is now working with JPMorgan to get a fresh equity infusion or backer for the company.

Wriedt is confident in the firm’s ability to come into compliance soon. The firm is also raising money for a CLO secondary strategy, as Wriedt believes the market environment will bring more of these opportunities to bear.

Rick Jones, co-chair of Dechert’s real estate and finance practice, says he is working with many CLO managers on how to get to grips with risk retention compliance. Several managers are said to be looking to set up capital manager vehicles or majority-owned affiliate (MOA) structures to reach compliance. In February it emerged that Blackstone/GSO had set up a new US-focused MOA when it invited public shareholders in its listed European risk retention vehicle to expand their mandate to invest into the US vehicle.

Last year saw several BDC actors face the music. 

Fifth Street Asset Management’s two BDCs and their executives were slapped with shareholder criticism and lawsuits alleging that the firm mismanaged these vehicles to enrich management at the expense of shareholders. The firm is now exploring selling the investment advisor, as PDI has reported.

Prospect Capital Corporation, another fledgling BDC that has been planning to spin off some of the assets into a CLO vehicle, is now being investigated for its CLO marks by the Securities and Exchange Commission (SEC), according to a recent report from Asset-Backed Alert.

Most of the headlines involving BDCs in 2015 were around TICC Capital Corp, an underperformer whose manager was set to be sold to Benefit Street Partners (BSP). When competing bids came in from TPG Specialty Lending (TSLX) and Highland Capital Management, the two firms argued that the BSP deal was a rigged election and the transaction ultimately did not pass the hurdle for shareholder approval in December.

And the saga isn’t over. TSLX and Highland are still demanding new board members and strategic changes at TICC. American Capital, a Maryland BDC also accused of destroying shareholder value by an activist investor, is currently also exploring sale options.

While all this scrutiny is undoubtedly painful for the sector, analysts and experts believe it will ultimately weed out the bad apples and future M&A will ultimately be a boost to the industry. For now, most BDCs continue to trade at steep discounts to book value.

The convulsions and sliding share prices have not discouraged firms from setting up private BDCs, the most common way to enter the BDC market.

Sankaty is one of many setting up such a private BDC. It collected $700 million for the private closed-end fund by May 2015 and filed preliminary documents with the SEC for a BDC, planning to collect more capital via that structure.

With many firms setting up BDCs and new debt shops launching with several types of vehicles, product diversification is emerging as a key trend. “This will be a year of the haves and the have nots,” says Gary Creem, a partner in the multi-tranche finance group at Proskauer. “And the haves are all those that have multiple pools of capital.”