U.S. middle market direct lending strategies still raking in capital

(Reuters) – Investors continue to inject capital into US middle market direct lending strategies at a pace that could result in 2018 fundraising surpassing the record tallies seen in 2016 and 2017.

So far in 2018, US$35bn has been raised for middle market strategies, including direct lending funds, private debt funds, middle market Collateralized Loan Obligation funds and Business Development Company (BDC) equity raises, according to Thomson Reuters LPC data. Another US$29bn has been announced, but not yet closed. This comes on the heels of US$69bn for all of 2017 and a total of US$61bn for 2016.

Top tier asset managers and veteran middle market lenders continue to amass significant amounts of capital in response to unprecedented investor demand for the asset class for the third year in a row. Lending conditions, as a result, remain highly competitive, favoring managers with size, scale and track-record.

Global alternative asset manager Ares Management said on the firm’s August 2 second quarter earnings call that it raised US$1.4bn in a first close of a new US senior direct lending fund and that it anticipates a final close in excess of US$3.5bn by year-end, including additional equity commitments and expected leverage. Ares’ US direct lending business is managed through Ares Capital Corp (ARCC), a specialty finance company and the largest BDC by market capitalization and total assets.

Late last month, Ares also announced the final close of its fourth European direct lending fund, Ares Capital Europe IV, at a hard cap of €6.5bn, exceeding the fund’s initial €4.5bn target within six months of its launch.

“Our recent fundraising momentum is not surprising given the significant investor demand for alternative credit and our long-standing market leadership and successful track records in both the US and European illiquid credit markets,” said Ares Chief Executive Officer Michael Arougheti in the earnings transcript. “Investors are gravitating toward defensive asset classes with high current yields, low volatility and [that] benefit from rising interest rates.”

Twin Brook Capital Partners, the middle market direct lending subsidiary of Angelo Gordon & Co, is raising its third direct lending fund in as many years. The firm, which lends to lower middle market companies with between US$3m and US$50m in Ebitda, attracted over US$2bn in a first close for the AG Direct Lending Fund III, according to a source. Twin Brook pulled in US$2.3bn in 2017 and US$850m in 2016, respectively, for its two previous direct lending funds.

Twin Brook declined to comment.

GSO Capital Partners, the credit platform of global investment firm Blackstone, is poised to make a significant new play in the direct lending space after GSO concluded its investment sub-advisory relationship with asset manager FS Investments in April.

Blackstone announced in December 2017 that it planned to launch a new, internal direct lending business. To that end, the firm is aiming to raise US$10bn in equity and debt capital this year and into next, sources familiar with the matter said.

A spokeswoman for the investment firm declined to comment.

Blackstone, separately, is buying a 55% majority stake in Thomson Reuters’ F&R unit, which includes LPC.


Having accumulated deep pools of capital, lenders are under tremendous pressure to put money to work for their investors, even as investor protections in loan documents have eroded and deal structures have become increasingly aggressive.

“Lenders are forced to put money to work. Sitting on cash means nothing,” said one middle market lender.

The unitranche product, a loan structured to combine senior and junior debt into a single tranche at a blended cost of capital, has benefited from the tremendous level of demand coming from direct lending platforms. With so much capital available to private equity sponsors and borrowers, unitranche volume has soared and spreads have tightened considerably.

Issuance rocketed to US$8.67bn in the second quarter of 2018, up 178% from the first quarter. Sponsor and borrower demand for the product has pushed the cost of unitranche loans down, which typically come at a premium for borrowers. The average spread on unitranche facilities fell to only 605bp over Libor in the second quarter of this year, down from 633bp in the prior period and 661bp in 2017.

While lenders compete on structures and pricing, hold sizes represent another battlefield. Lenders can and must take down sizeable pieces of a given deal in order to win assets.

Previously, before the explosion in alternative capital and private credit strategies, the larger more established middle market lenders took US$75m tickets in a given deal, widely considered a significant hold. Today some of those same participants can commit US$200m-$300m hold sizes.

The ability to commit such large amounts of capital to one deal has transformed the competitive landscape, giving substantial advantage to credit managers with size and scale.

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