The volume of lending by asset managers to companies and to private equity firms buying companies is growing, as increased regulation pushes banks out of the lending business and income investors seek decent yields in an environment of record-low interest rates.
In particular, increased capital requirements and restrictions on whom they can lend to have made banks reluctant lenders. “The banking industry in the U.S. has been nationalized,” says Dick Bové, Florida-based equity research analyst at Rafferty Capital Markets. “Banks are being told how much assets they can hold and where they should go.”
Meanwhile, the Fed is increasing the money supply. As it forces that money outside the banking system, asset managers take up the slack. “Investors have to find a place to put their money,” Bové says. Plain-vanilla fixed-income securities offer inadequate returns: The ten-year Treasury yields just 1.54 percent. So investors and asset managers “have to go out on the risk spectrum,” he says. And that pushes them to corporate lending. “The lending is all driven by macro elements,” Bové says.
Corporate lending by asset managers began in earnest after the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 and has intensified over time. There are no official statistics for the size of the market for corporate lending by asset managers, because many of the loans don’t have to be reported publicly. Market participants estimate the amount of loans outstanding totals $200 billion to $400 billion. And individual loans have now crossed the $1 billion mark. The middle market — corporations with $10 million to $1 billion of annual revenue — provides the sweet spot for lending, asset managers say.
“Banks have to some extent abandoned lending to middle-market companies in favor of bigger ones with higher credit ratings,” says Kipp deVeer, co-head of the credit group at Los Angeles–headquartered Ares Management and CEO of Ares Capital Corp., which manages approximately $30 billion in direct lending.
At the same time, middle-market loans have a solid risk profile and offer an attractive yield, says Brent Humphries, head of AB Private Credit Investors in New York, which has more than $1 billion of corporate loans outstanding and targets returns for its investors ranging from 9 to 13 percent, after fees and expenses. AB-PCI generally lends from $20 million to $75 million per investment.
Ares Capital Corp. generally makes loans of $100 million to $400 million. It recently led what it says is the first $1 billion unitranche loan by a direct lender to private equity firm Thoma Bravo for its $3 billion purchase of data software company Qlik Technologies. “The loans are getting bigger as the opportunities have grown, and the companies are bigger,” deVeer says.
Other companies that have borrowed from Ares include American Seafoods Group, an Alaskan fishing company ($800 million), and North American Partners in Anesthesia ($150 million).
AB-PCI has lent to discount retailer Bargain Hunt, in connection with its sale to private equity firm Thomas H. Lee Partners (amount undisclosed), as well as to NeoGenomics Laboratories ($55 million), a cancer genetics tester, for its acquisition of cancer-testing company Clarient. “We have the ability to supply capital for growth initiatives, including the financing of finance buyouts,” Humphries says.
Other major players in the market include KKR, Neuberger Berman, Oaktree Capital Management, Prudential Capital Group and Centerbridge Partners.
And more want to get in. Adams Street Partners, a $27 billion asset management company in Chicago, is about to take the plunge. “Our private equity clients said they would like to get into debt capital too,” says Bill Sacher, New York–based head of private credit for the firm. “The market opportunity created by banks exiting the middle market is still in its early stages.”
So, what are the risks? Obviously, there’s a credit risk each time a loan is made. In macro terms, “the credit cycle is the biggest risk,” Sacher says. “It will be interesting to see how all the loans perform when the credit cycle turns, and that may not be too far off.” When the market shakes out, we will learn whether the asset managers are more stable lenders than banks, notes Stephen Ellis, director of financial services equity research at Morningstar.
Bové is worried that things won’t turn out well. The growth in corporate lending by asset managers “is a very bad thing,” he says. “There should be regular audits of bank lending, so there should be regular audits of lending by nonbanks. But there’s none.”
With lenders moving out on the risk spectrum, the probability of making weak loans is high, Bové says. He predicts bankruptcies will increase. “This creates a lot of disruption in the lending system, reduces protection and almost promises a deeper recession the next time we run into one.”
To be sure, with a market size of several hundred billion dollars, the asset manager corporate loan market pales in comparison to the $9 trillion of bank loans outstanding. So, says Bové, the asset managers are not a significant threat to the financial system.
Tony Ressler, co-founder, chairman and CEO of Ares Management, is a panelist at this year’s Delivering Alpha conference, jointly held September 13 by Institutional Investor and CNBC.
