Panel, Conference Presentation
Financing the Missing Middle Market
Milken InstituteJonathan Bach, Lawrence Golub, Rick Miller, Jim Moglia, Adam Sokoloff, Barry Volpert
- Market trading dynamics are expected to continue balancing covenants against liquidity, with a prevailing risk that covenant-light structures in the conventional area could lead to severe underperformance if credit markets implode similarly to late 2008.
- Adherence to strict underwriting disciplines and documentation is viewed as the primary survival mechanism for middle market lenders, whereas capitulating to value lending or relying on desk buyers may result in "beta producer" status and poor returns.
- Investors lacking natural asset class understanding or acting as non-liquidity providers face the risk of price disconnection from underlying value, particularly if central bank monetary inflows lead to unforeseen intermediate or long-term consequences.
- A modest rise in inflation and interest rates is predicted to benefit the middle market by increasing levered earnings and nominal returns, though a return to deflation or an economic seizing up comparable to the fourth quarter of 2008 remains a significant downside risk.
- Institutional capital allocation is shifting due to record distribution levels and a lower numerator of deployed capital against a higher denominator, creating a "flavor du jour" environment where fundraising is exceptionally easy for semi-established managers.
- Private equity exit strategies are evolving with IPOs moving from a secondary option to the primary strategic alternative, characterized by smaller deals of $100 million to $150 million, early lockup lift-offs, and accelerated deleveraging.
- A migration of capital is anticipated where conventional players exit while non-conventional investors enter, driven by "cheap access to capital" and the need for sponsors to diversify exits by selling both pre- and post-Lehman portfolio companies.
- Commercial banks are expected to reinvent themselves as intermediaries responsible for deal quality and collaborate with direct lenders to assume risks they would otherwise avoid, while regulators' contradictory policies continue to shape market behaviors.
- The middle market's competitive advantage relies on origination expertise and a "close to the ground" understanding of deals, differentiating successful direct lenders from marginalized entities that outsource diligence or rely on large balance sheets.
- Private equity firms are predicted to generate higher returns than other asset classes by purchasing at lower multiples, adding value through management recruitment and international expansion, and exploiting the illiquidity premium in a fragmented, rural-like terrain.
- Verification of investment theses is becoming more robust through the financial sponsor community, which crowds out traditional deal sources and creates accountability through portfolios of smaller deals that are difficult for outsiders to assess.