Conference Presentation, Panel
Filling the Mid-Market Financing Gap
Milken InstituteStaci Warden, Michael Arougheti, André Bourbonnais, Bilal Rashid, Brian Reynolds, Steven Sugarman, Stacey Worden, Mike Arrigetti
- Mid-market employment growth is expected to continue, building on 4.5% growth since the crisis compared to 2% for large-cap firms, with the sector viewed as the economic vanguard and bellwether.
- A permanent shift of lending from large banks to the private credit market is anticipated due to regulatory frameworks forcing de-leveraging, with capital flows from pension funds and insurers seeking yield in a low-interest-rate world.
- Demand for leverage loans is projected to persist across company sizes driven by private equity fundraising cycles, refinancing needs, and corporate development activities, while BDC legislation is expected to pass to support this trend.
- The private debt asset class is increasingly viewed as cycle infrastructure with expected return thresholds stabilizing between 8% and 10%, despite a compression from historical 20%+ rates to the current 12% to 13% range.
- Market conditions over the next one to two years are forecasted to be a "risk-on, risk-off" environment where capital is valuable for solution providers, though pricing is currently described as aggressive due to massive institutional involvement.
- Risks include a potential "O8 scenario with a slow recovery" most harmful to the mid-market, rising defaults likely to tick up at least by 2018, and a 5 to 6 basis point return compression as the market matures.
- Specific credit concerns arise if debt-to-EBITDA ratios exceed 4.5 times, with larger syndicated deals and companies above this leverage level expected to face difficulties or correction.
- Opportunities for higher risk-adjusted returns are identified in the lower middle market, specifically non-sponsored companies, and in emerging market areas like transitional commercial real estate and European private credit.
- The industry faces a risk of terms softening and risk misanalysis if capital supply increases excessively, potentially creating a "co-investment" dynamic similar to private equity where pricing pressures reduce lender negotiating leverage.
- Regional banks are expected to act as the engine for filling the void left by systemically important institutions, potentially collaborating with private capital partners or evolving into liquidity providers through structured credit.
- Deal flow is expected to remain strong across the credit spectrum due to market inefficiencies, even as capital flows increase, with the mid-market continuing to outperform large-cap firms in economic growth metrics.