Carlyle Group LP (CG) is the biggest of at least half-a-dozen private-equity firms raising funds to lend to U.S. mid-sized businesses, as dwindling returns from traditional bonds have sent investors in search of income.
Carlyle GMS Finance Inc. is seeking $1 billion for a vehicle to lend money to mid-market companies, according to two people with knowledge of the plan. The firm is joining KKR & Co., Brevet Capital Management LLC, White Oak Global Advisors LLC, Monroe Capital and Cyan Partners LP, which are collectively raising more than $4 billion for first-time funds that would make senior loans to such companies, according to investors and marketing documents obtained by Bloomberg News.
Many of these private-equity firms are telling prospective clients they can generate more than 10 percent in returns, before fees, from the strategy, and touting their ability to distribute interest payments to risk-averse investors looking for income as bond yields have shrunk to historic lows. Carlyle, KKR and others are also seizing an opportunity to provide financing for buyouts in anticipation of a wave of deals as private-equity firms globally are sitting on $370.2 billion in unspent capital, according to Preqin Ltd., a London-based research firm.
“In today’s persistent low-interest rate environment, investors are searching for yield and a 10 percent net return is attractive given the risk-return characteristics of this asset class,” said James Gereghty, head of distressed investing at fund-of-funds manager Siguler Guff & Co.
Firms investing in senior loans are seeking to appeal to all types of investors including pension plans, which are struggling to achieve the 7 percent to 8 percent annual returns necessary to meet future liabilities. The yield on the 10-year (USGG10YR) note dropped to a record low of 1.379 percent on July 25, down from 5 percent in 2007 before the Federal Reserve cut its target rate to zero to 0.25 percent. The yield touched 1.81 percent on Oct. 17, the highest level since Sept. 19.
The New York State Common Retirement Fund committed money for the first time to middle-market lending funds from Brightwood Capital Advisors LLC and Monroe Capital, according to a February monthly transaction report.
The firms are pointing to opportunities to fill the void left by banks, which are turning away from smaller and mid-sized companies as they face higher capital costs under new financial regulations for loans made to riskier borrowers. Since the financial crisis four years ago, banks have been reducing risk and building capital buffers under the Dodd-Frank regulations and Basel III.
“This is a very long-term opportunity if you think about the structural problem banks are facing,” said Barbara McKee, co-founder of White Oak, whose firm is in the process of raising the first of its private debt funds that has a private equity structure. “Banks are attempting to balance their own book, exacerbated by more costly regulations.”
Non-bank lenders such as firms managing collateralized loan obligations and hedge funds, which had trouble selling stakes in loans and other illiquid investments during the height of the financial crisis in 2008, have also pulled back. That has squeezed middle-market companies, which are typically those with earnings before interest, taxes, depreciation and amortization, or Ebitda, of $50 million or less, and are considered riskier than their larger counterparts.
Loans to middle-market companies fell 41 percent to $7.8 billion this year as of Oct. 11 compared with $13.2 billion during the same period last year, according to a report by Standard & Poor’s Capital IQ Leveraged Commentary & Data. Mid-market loans yields averaged 7.46 percent as of August, compared with 6.67 percent on loans to larger companies.
Private-equity firms typically use debt to finance the purchase of companies that helps juice returns. Senior loans are considered the safest form of debt as they sit on top of the capital structure and take priority in the event of a default. Mezzanine is nestled between senior debt and equity, which is at the bottom of the capital structure.
Carlyle GMS Finance would be regulated as a business-development company and primarily make senior-secured and unitranche loans with floating rates, according to two people familiar with the matter. Unitranche loans combine senior and mezzanine debt.
The Carlyle fund will use leverage through a $500 million borrowing facility, and is seeking returns of 7 percent to 10 percent, according to the people. When capital is invested in new deals, investors will receive shares in the business development company, or BDC, the people said. The BDC is expected to go public within the first five years.
The development company will be managed by Carlyle professionals including Mitch Petrick, who oversees the investment committee, and Linda Pace, head of U.S. structured credit for the firm’s global market strategies unit. Some members of a team from lender Churchill Financial, which Carlyle bought last year, will also make investments. The group invested $2.5 billion in 240 middle-market companies from 2006 to 2011, according to the people. Carlyle is the second-biggest private-equity firm by assets. It oversaw $156 billion in assets as of June 30.
KKR, the New York-based firm that managed $61.5 billion at the end of June, is seeking as much as $500 million for a fund that would make senior loans to middle-market companies, according a person familiar with the matter, who asked not to be identified because the fund is private. The fund, which will have modest leverage, will originate senior secured debt including first-and second-lien leveraged loans and bonds, the person said. It will target companies with $25 million to $100 million in Ebitda.
KKR also manages a $1 billion-plus mezzanine fund that will finance private-equity investments and corporate acquisitions.
“In a number of instances the way this starts is we’ll be out talking to mid-market businesses out of our mezzanine business, and they say that’s great, we’d love to talk to you about mezz but can you help us on the senior loan front?” said Scott Nuttall, head of KKR’s Global Capital and Asset Management Group, during an April conference call with analysts and investors. “The opportunity is clearly in the billions.”
Tennenbaum Capital Partners LLC, an alternative investment firm-based in Santa Monica, California, is offering investors the choice between separate accounts and pooled funds that make senior loans to middle-market companies, according to a person familiar with the matter.
“As a broad based alternative credit manager, Tennenbaum Capital Partners has seen recent increased interest in its senior loan strategy,” Raj Vig, managing partner at the firm, said in an e-mailed statement. “The firm has over a decade of experience in the middle-market originating, structuring and managing senior loan assets.”
Randall Whitestone, a spokesman for Washington-based Carlyle, and Kristi Huller, a spokeswoman for KKR, declined to comment, as did officials for the other private-equity firms.
Monroe Capital, a Chicago-based private investment firm, is seeking $400 million for a private-equity fund that provides senior secured loans to companies with $5 million to $25 million in Ebitda, according to an investor presentation obtained by Bloomberg. Monroe Capital provides senior and junior debt as well as equity co-investments to middle-market companies in the U.S. and Canada.
Monroe Capital is targeting returns of 14 percent to 16 percent or greater excluding fees and including leverage, according to the presentation. It will charge a 1.5 percent management fee.
Cyan Partners, founded by leveraged finance executives including Ashok Nayyar, who was formerly a co-head of global leveraged finance at Morgan Stanley, is seeking $750 million for Cyan Credit Fund I LP. Cyan Partners is targeting 12.5 percent to 15 percent returns excluding fees, it said in its presentation.
Kayne Anderson Capital Advisors LP, an alternative investment management firm based in Los Angeles, was gauging investor appetite in May for a senior loan fund that may seek $250 million, according to a client presentation. The fund would capitalize on growing demand for senior debt over the next five years. The firm cites more than $400 billion in leverage loan re-financings and about $80 billion of capital raised for buyouts of mid-sized companies that has yet to be invested.
The firms are also pointing to advantages of the private-equity structure compared with other types of funds. Private-equity firms have the flexibility to use more leverage to boost returns than business development companies, vehicles formed under the Investment Company Act of 1940 that lend to middle-market companies. These funds typically receive constant funding through the public markets.
BDCs also can present challenges as they are subject to the vagaries of the public markets, according to the Kayne Anderson presentation. In Carlyle’s case, the BDC will remain private as it builds a track record. TPG Capital similarly gathered $1.4 billion for a private business-development company that will eventually go public.
Unlike hedge funds, private-equity funds don’t have to worry about quarterly liquidity and redemption requests because they typically lock up investor money for as long as a decade.
“Investment managers have come to realize even if they are investing in a short-term debt situation of two to four years there is potential downside that may call for an extension of a loan, or in the worst case a company may end up in a restructuring,” said White Oak’s McKee, whose firm raised hedge funds to make direct loans. “A private equity-style structure gives you a lot more flexibility because you don’t have investors expecting quarterly liquidity.”
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