Next wave of distressed funds target opportunities born from middle-market primary explosion - Middle Market Memo

14 September 2017

One of the latest trends on the hedge fund capital-raising circuit has been to design vehicles aimed at targeting middle-market capital structures, said five industry sources.

 

The funds are being pitched as traditional hedge funds that will, among other options, invest in the potential fallout from the recent excess of lending to the middle market. One new fund already up and running under such a mandate is the Monroe Capital Special Situations Fund, which recruited Cesar Gueikian from Melody Capital and UBS earlier this summer.

 

“These funds are either taking a loan-to-own approach or looking at non-control distress,” said Sean Hill, a partner in the funds practice at Kirkland & Ellis, adding that there has “definitely been an uptick in the market.”

 

Still, the bonanza of secondary opportunities middle market distressed investors may be banking on has yet to arrive. And when or if it does, playing a workout scenario could come with unique challenges.

 

Direct-lending stalwarts such as Antares CapitalAres, and Golub Capital have large hold positions, particularly in illiquid club loans and unitranches. And so the decision for those funds to offload individual positions at a discount below par can make for tangled negotiations. The dynamic runs through both private funds answering to limited partners with a short-term investment window and vehicles such as publicly-traded BDCs who have permanent capital as a result of raising capital in the equity markets.

 

An additional catalyst new hedge fund vehicles are citing, is that some direct lending funds are not equipped to own equity, said one of the sources. Still, some of the larger lenders in the space, like NXT Capital, do have workout groups, while Garrison Capital in the past has taken equity in its investments such as Speed Commerce and then recapitalized it .

 

Still, the wider bet that today’s middle market primary action will headline tomorrow’s restructuring has its naysayers, even with interest rates rising this year. And so the party continues.

 

As reported by our sister news service Creditflux, the Teachers Retirement System of Illinois agreed to USD 225m in new commitments, of which USD 125m went to NXT’s senior loan fund. Amongst BDCs, Owl Rock increased the size of its mid-market debt fund to USD 4.6bn while Carlyle’s BDC TCG BDC went public in the second quarter.

 

This comes even as pricing continues to gradually tighten amongst new loans from both the BDCs, despite a slight retrenchment in 2Q17, and amongst private credit lenders, according to the BDC Quarterly Data & Analysis Report and Private Credit Report, respectively.

“Private equity funds are continuing to raise credit funds as their LPs have access to the market and access to other companies (from a relationship standpoint),” said one private equity funds consultant.

 

Monroe, Ares and Antares did not return calls as of press time.

 

by Jon Berke