NEW YORK, June 13 Regulatory guidelines aimed at stopping banks from making highly-leveraged loans to risky borrowers and fierce competition from alternative capital providers is driving more financing partnerships which are reshaping U.S. middle market lending.
U.S. commercial banks and Business Development Companies (BDCs) - a fast-growing group of investment vehicles that lend to small and mid-sized companies - are increasingly working together on deals with higher leverage levels to get around regulators' concerns.
"In the changing regulatory environment in which banks can't stretch on leverage, we expect to see more partnerships between lenders," said Fred Buffone, managing director and head of capital markets at Fifth Street Management, an alternative asset manager and the investment adviser of two publicly traded BDCs, Fifth Street Finance Corp and Fifth Street Senior Floating Rate Corp.
Banks are seeking partners to underwrite junior debt, primarily second lien loans, which reduces the total debt arranged by the banks.
"There are opportunities where banks provide the senior debt and we provide the junior capital," Buffone said.
More than a year after it was issued, banks are still grappling with how strictly the Leveraged Lending Guidance will be applied by federal agencies and what penalties, if any, could be handed down.
Some regional and commercial banks are already taking a more cautious approach to underwriting to comply with the guidelines. BDCs are receiving more calls from commercial banks seeking to team up to underwrite deals with higher leverage levels, a BDC originator said.
Banks are looking for partners to underwrite second-lien loans on deals that are at or above the maximum threshold of 4.0 times senior debt to Ebitda and 6.0 times total debt to Ebitda set out in the guidelines.
Loans with higher leverage than the guideline levels are deemed to be "criticised assets," and regulators are currently examining the share of banks' loan portfolios that exceeds those limits.
Banks are seeking partners for highly leveraged loans to a range of mid-sized companies. BDCs have participated in deals with banks for companies with Ebitda ranging from US$10m to US$50m or higher, sources said.
BDCs, which have traditionally provided more junior capital, are now positioning themselves as senior debt providers and are widely expected to benefit from any significant pullback in bank lending.
In an increasingly crowded field of alternative capital providers, hotly contested battles for middle market loan mandates are being won by the ability to offer sponsors and borrowers a menu of financing options, creative structures across the capital structure and the ability to commit large hold sizes.
Other more formal partnerships between non-bank lenders and institutional investors looking to gain exposure to middle market companies are also developing. Partnerships range from separately managed accounts and side car vehicles (a type of co-investing vehicle) to traditional fund structures and new direct origination platforms.
The resulting pockets of capital allow a range of product offerings and the ability to commit larger tickets.
Private equity firm Oak Hill Capital Management and insurance giant American International Group (AIG) said Wednesday they teamed up to establish Varagon Capital Partners, an asset manager and direct origination platform focused on lending to middle market companies.
New York-based Varagon launched with an initial $1.5 billion investment commitment from AIG with a mandate to lend to companies with between $10 million and $75 million of EBITDA.
"Middle market participation will continue to grow," said a lender at a commercial finance company. "To play, and to survive, you have to have larger hold capacity and diverse funding sources." (Editing By Jon Methven)