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.

Private Debt Investor - PEI article
 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.
 

US regulators tighten grip on Wall Street lending

More scrutiny of Tech deals that are done by Private Equity firms and are supported with debt.  Aivars Lode

US regulators have started to audit loan books of Wall Street banks on a monthly basis in a major push to curb aggressive underwriting, according to Reuters IFR Magazine and Loan Pricing Corp.

Having already turned up the heat on banks after rebuking Credit Suisse, regulators will now be able to dole out punishments quickly if they deem that these guidelines have been contravened.

“Forgiveness is easier to get than permission,” said Richard Farley, a leveraged finance partner in law firm Paul Hastings.

“Monthly audits mean the regulators can tell the banks to stop right there and then, and tell them the consequences if they don’t.”

Farley said there was a whole array of punishments the regulators could deliver.

“They could change the CAMELS rating of a bank, which measures its compliance and risk management and determines whether it is safe and solvent and could impact a bank’s cost of capital if lowered,” he said.

“They could also get tougher on approving bank’s capital plans and their ability to pay dividends, as well as fines. They could even revoke a bank’s Charter and remove their membership of the Fed,” said Farley.

Until very recently, the Federal Reserve, the Federal Deposit Insurance Corp and the Office of the Comptroller of the Currency (OCC) have monitored banks’ behavior annually in Shared National Credit (SNC) reviews that take place over the summer.

The focus of the audits will be on whether banks are adhering to guidelines, spelled out in March 2013, which say that a loan can be criticized or considered “non-pass” if a company cannot amortize or repay all senior debt from free cash flow, or half of its total debt, in five to seven years.

Leverage over six times is also seen as problematic.

The Fed, the FDIC and the OCC were not immediately available for comment.

Tightening The Screws

Bankers, who have complained for months about an uneven playing field between banks watched by the OCC and the Fed, welcomed the news.

“All the banks want is a level playing field and more consistent feedback about what doesn’t fit inside the box. There’s still too much left for interpretation at the moment,” said one market source.

“This means banks will not have to wait another year for feedback following the SNC review. There is a lot more ongoing feedback and the regulators in general are just being more active…and giving guidance that is more specific.”

Two market sources said the regulatory audits were monthly.

“Regulators are asking dealers to provide them with monthly reports of things that have closed during that month,” said one.

“They are looking at the deals that have closed, relevant credit metrics and amortizations. Rather than relying on third party information providers, regulators are gathering the information themselves.”

The audits are understood to be more broad based, and go beyond just looking at loans that banks have made, in order to get a better understanding of how each lender views different credits and how their business operates as a whole.

Another market source emphasized how regulators are already embedded in banks, by drawing comparisons to the overhaul of asset-backed security lending after the financial crisis. The focus now, he said, had just shifted to leverage lending.

“The audits look at the deals the banks have turned down, look at how the banks rate and classify each loan, and the process they go through to approve the credit. It’s about looking at the deals banks decide to do as well as those they don’t,” said the first source.

Unregulated Territory

There is no doubt, however, that banks still have different interpretations of what the guidelines mean and which deals to push on.

Credit Suisse has been seen as the worst offender but JP Morgan caused a stir last week when it teamed up with unregulated lenders to underwrite a highly leveraged financing backing the $4.3 billion acquisition of business software maker Tibco.

Market sources said that the deal could contravene regulatory guidelines, as the leverage is well in excess of eight times.

Another source, however, said that JP Morgan must have been in close dialog with regulators before signing up for the deal.

Two other private equity firms have also stepped up to underwrite the Tibco buyout. Two market sources named Apollo as an underwriter on the deal, and a third named Merchant Capital Solutions, a capital markets business created by the Canada Pension Plan Investment Board, KKR and Stone Point Capital.

Apollo and KKR declined to comment.

Some people said that dynamic could become more common as regulatory moves shift risk away from banks into the shadow banking sector.

“If banks are living in fear of regulators constantly, this could accelerate shadow banking stepping in to take their place,” said Farley.

Reporting by Natalie Harrison and Michelle Sierra of Reuters IFR Magazine and Loan Pricing Corp.

How many other PE funds will have losses?

Whilst this article is about fund raising strategies we wonder how many more PE firms will have blown up funds?  Aivars Lode

The carrot and the stick (or just the carrot):
The news that TPG Capital is offering incentives to limited partners to commit to its seventh flagship buyout fund didn’t come as a surprise to many LPs.

The firm is trying to recover from two struggling funds, which took some devastating hits from the loss of Washington Mutual and the former TXU, now in bankruptcy court under the name Energy Future Holdings.

TPG Capital is a prime example of a firm with a shaky recent track record doing all it can to attract investors into its latest fund. However, the idea of using incentives to draw in bigger checks at a quicker pace has become an almost routine part of marketing these days, according to numerous LP and advisory sources interviewed by sister publication peHUB.

What was once a headline-grabbing novelty among mega-funds struggling through a tough fundraising environment post-financial crisis has become part of the package general partners bring to the negotiating table.

And while in 2010 and 2011 GPs needed that extra push to get over the finish line to their target, today GPs need that extra bit of zip to help differentiate themselves in what has become the most crowded private equity fundraising environment of all time.

According to the PE/VC Partnership Agreements Study 2014-2015, published by Thomson Reuters, about 14 percent of North American buyout funds offer special incentives to come into a first close, while the figure is 35 percent for funds of funds and secondary funds. Nearly one in five (18 percent) North American buyout funds offer fee breaks for bigger commitments, as do 42 percent of funds of funds and secondary funds.

“The market has gotten much more creative about incentives and creating urgency around (fund) closes,” said Neha Champaneria Markle, portfolio manager with the private equity fund group at Morgan Stanley Alternative Investment Partners. “There are a number of things that can catalyze action, whether it’s offering co-investment, offering preferential treatment in a secondary, (or) offering certain terms that might be meaningful to a specific investor.”

TPG’s special offer

TPG Capital is aiming to raise between $8 billion and $10 billion for its TPG Partners VII, a big step down from its $19 billion sixth pool that was generating a 1.39x total value multiple and an 11.9 percent internal rate of return as of June 30, 2014 for backer Oregon Public Employees Retirement Fund.

To incentivize LPs to cut big checks and come in early, TPG Capital is offering management fee discounts based on size and speed of commitments. All investors in the first close get a 10 percent discount, plus an additional 5 percent off for commitments of $100 million or more; an additional 10 percent for more commitments of more than $250 million, and an additional 15 percent for commitments of more than $400 million, Buyouts reported in September.

This is reminiscent of some of the big European shops who, shortly after the world began emerging from the financial crisis in 2010 and 2011, started offering early close discounts. Cinven, Permira and BC Partners all tried to incentivize LPs to get their commitments in early.

First-close discounts “highlight one of the biggest challenges sponsors have in fundraising—getting some impetus to getting to that first close. That is often the hardest part of fundraising,” according to Jordan Murray, a partner at law firm Debevoise & Plimpton.

“As a private equity sponsor, you’re trying to get investors off the sidelines, to give up liquidity and that free look they have on the portfolio. The longer they wait out there, the more options they have for their money,” Murray said.

Incentives do get the attention of LPs. One private equity investment officer at a U.S. public pension said if his team is looking at two GPs they want to commit to, the one that is offering incentives will get first look.

“If we don’t have the right amount of incentives, we’ll hang around the hoop and when time permits, (start working on the fund); if there is an incentive, we might reallocate resources if we’re properly incentivized,” the LP said.

- PE HUB

Vista Equity to buy Tibco Software for $4.3 billion

It will be interesting to see what happens to this deal in four years.... there is no way these numbers work.  Aivars Lode

Business software maker Tibco Software Inc on Sept. 29 said private equity firm Vista Equity Partners would take it private for $4.3 billion in the largest technology buyout this year, according to sister news service Reuters.

Vista will pay $24 per share in cash for Tibco. That would be a 26 percent premium to the stock’s closing price on Sept. 23, the day before Reuters reported that Vista was one the firms vying for Tibco. Tibco shares closed at $19.51 on Friday and rose more than 20 percent in premarket trading on Monday.

Palo Alto, California-based Tibco develops software that companies use in real-time data analysis involved in processes such as inventory keeping and cross-selling products. Its board had been under pressure from activist investors to sell the company.

The parties said they expected the deal, which is subject to approval from shareholders and regulators, to close in the fourth quarter.

Tibco spoke to more than 20 potential buyers, including some strategic technology companies, according to a source familiar with the situation.

This would be the second large leveraged tech buyout of September. Thoma Bravo took Compuware private in a $2.5 billion deal on Sept 2.

Still, there have been few leveraged buyouts of public companies in the last two years as a stock market rally has made most of them seem expensive for private equity funds trying to generate a multiple of their investors’ money.

Founded in 1997 as a subsidiary of Reuters Holdings Plc with backing from Cisco Systems Inc, Tibco went public in 1999 under Chief Executive Officer Vivek Ranadivé.

Ranadivé, an MIT computer scientist from India and owner of basketball’s Sacramento Kings, in 1986 founded Tibco’s predecessor, Teknekron Software Systems Inc, where he spearheaded the automation of Wall Street’s trading floors. Reuters acquired the company in 1994 for $125.1 million.

Tibco’s share prices has fallen 25 percent in the last 12 months as the company’s products, including flagship data platform Spotfire, have come under competitive pressure.

In June, the company named former senior Hewlett-Packard Co executive Todd Bradley as president. Two months later, activist investor Praesidium Investment Management Co LLC wrote to Tibco’s board calling for a sale, while Starboard also held shares.

Bradley left the company on Sunday, it said in a filing.

A review of strategic alternatives at Tibco started on Aug. 16, the company disclosed on Sept. 3.

Goldman Sachs was Tibco’s financial adviser. Vista was advised by Bank of America Corp, Deutsche Bank, Jefferies, JP Morgan and Union Square Advisors. Wilson Sonsini Goodrich & Rosati was Tibco’s legal adviser, while Kirkland & Ellis advised Vista.

Reuters