LPC: Institutional demand spurs mid-market direct lending platforms

Thu May 19, 2016 12:09pm EDT
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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 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.

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