When Tim Clifford first worked up his business plan for a team that would finance mergers and acquisitions of smaller companies, he didn't think of shopping the idea to a regional bank, much less one in New York that was founded by a labor union in the 1920s.

Headquartered near Manhattan's once-bustling garment district on Seventh Avenue, Amalgamated Bank wants to stake money for mergers and buyouts of small and midmarket companies. This week it helped finance a private-equity firm's investment in a medical device company.

Amalgamated joins a growing number of small banks looking to finance transactions for a market long dominated by giants like Bank of America Merrill Lynch and Wells Fargo. The funding is welcome among private-equity investors, whose traditional sources of financing have dried up during the credit crisis. Longtime participants are licking their wounds and cleaning up balance sheets, so they are lending less while a major source of money for the buyout world — collateralized loan and debt obligations — has been running on fumes.

For the newcomers, leveraged finance can be a healthy source of fees.

"Initially, I'd targeted larger, midtier institutions on a national level," recalls Clifford, who was a managing director at Churchill Financial, a specialty finance company in New York, before he sketched out and sold his idea to senior executives at Amalgamated.

Amalgamated, which calls itself "America's Labor Bank," hired Clifford in September. His new lending team of three professionals, known as Amalgamated Capital, will lend $5 million to $60 million to buyers of companies valued at up to $150 million.

Clifford's team aims to generate 8% to 10% in risk-adjusted returns through loans to businesses in several industries, including consumer, distribution, education and health care. The poor liquidity in the market presents "a wonderful opportunity to take advantage of a market in need," Clifford says.

That need became more acute recently with the bankruptcy of CIT Group Inc., a specialist in financing a wide range of midcap businesses.

Besides Amalgamated, other newcomers offering leveraged finance for small and midsize company buyouts include regional banks in California, New York and Pennsylvania.

"Some of the regional banks see an opportunity to get very attractive pricing on conservative financing structures," says Jack Glover, a partner at PNC Equity Partners, the private-equity arm of PNC Financial Services Group Inc. of Pittsburgh. PNC Equity focuses on companies valued at $25 million to $150 million.

Glover should know. After all, he turned to Manufacturers and Traders Trust Co., a regional bank in Buffalo, to recapitalize its portfolio company, Griffith Energy Inc., a propane and heating oil distributor in Rochester, N.Y. Griffith's owners used $80 million in new debt to pay down an older loan used to buy the company. The financing was also used to pay a special dividend to PNC Equity, which earned back 1.5 times its investment in the company.

"You don't find many $5 billion commercial banks that have the attributes that are applicable to run a successful leveraged finance business," Clifford says.

The Opportunity

Financial sponsors' sources for new financing have dwindled as banks and specialty lenders that had long supplied cash-flow loans back have stepped back from lending to focus on stabilizing their own businesses.

In addition to CIT, business development companies like Allied Capital Corp. also stumbled in the credit crunch (the Los Angeles specialty finance company Ares Capital Corp. recently acquired Allied for $648 million). And GE Capital Corp. was said to have slowed down its lending because it was burdened with a large commercial real estate portfolio.

For regional banks, the cash-flow loan business is an attractive one. Credit market conditions are improving, and with the Federal Reserve's Fed Funds rate hovering at 0% to 0.25%, there is great potential to generate attractive returns.

Middle-market senior loans, for example, generally command around 500 to 600 basis points above Libor, bankers say, whereas the amount of senior debt private-equity firms can borrow for acquisitions has increased to 2.5 times to three times cash flow.

During the private-equity industry's heyday, 2005 to 2007, larger banks like Bank of America and JPMorgan Chase, for example, held sway in midmarket LBO lending. They were joined by a number of specialty lenders that jockeyed to arrange syndications for midsize buyouts. The more well-known players included CapitalSource Finance LLC, GE Capital and Madison Capital Funding.

As the credit crunch took hold, however, most banks and financing companies retreated from the debt markets. Loan issuance is still largely moribund. New issuance in leveraged loans, for example, was down 40% for the first nine months of 2009 versus the first nine months of 2008, according to Fitch Ratings.

The chance for regional banks to launch additional business lines and add market share from traditional cash-flow lenders became more apparent in recent weeks after CIT's bankruptcy. The backbone of the finance company's business was arranging debt for small and midsize businesses, including billions of dollars in cash-flow loans for private-equity firms. For instance, it financed Castle Harlan's $250 million acquisition of Anchor Drilling Fluids Inc. in May 2008. CIT served as co-syndication agent for $119.5 million senior bank debt, including a $20 million revolving and term loan facility in the transaction.

CIT was the No. 3 middle-market lender in number of deals for 2009, just ahead of PNC and Wells Fargo, which rounded out the top five, according to Seattle private-equity data provider PitchBook.

CIT, though, hasn't been active in arranging new debt since July. It isn't expected to engage in new origination activity until it emerges from bankruptcy.

The company filed for court protection on Nov. 1, with the goal of completing the workout in 30 to 40 days.

"The amount of refinancing that is coming due in the middle market over the next several years is quite significant. We remain committed to this sector and believe this presents an opportunity for CIT in the future," says James Hudak, co-head of corporate finance at CIT.

Hudak estimates that $470 billion worth of middle-market loans will come due in 2014.

CIT's bankruptcy is timely for regional banks stepping into middle-market LBO finance business, according to Jeff Kilrea, a managing director in the commercial finance group at CapitalSource, which has financed $400 million worth of midmarket loans this year.

"In the short term it creates a liquidity hole. They can step in and fill that liquidity hole that CIT may be giving up," Kilrea says. "Some of those institutions are not saddled with an existing credit book that they have to worry about. They appear to be entering at the right time of the cycle."

Also new to the deal market are Susquehanna Bank and TriState Capital Bank.

When ICV Capital Partners LLC of New York acquired a majority stake in PFM Group in May, it tapped the two Pennsylvania banks for senior debt financing.

By using the community banks, ICV was able to secure funding for the purchase of the investment advisory firm at about 525 basis points above Libor, compared with higher pricing from traditional middle-market finance providers, according to ICV managing director Tarrus Richardson.

The deal had a conservative capital structure — 70% of the purchase consisted of equity and the remainder consisted of debt.

Another new player, Fifth Third Bancorp, announced its first foray into the middle-market finance business just days before CIT filed Chapter 11. The $111 billion-asset Cincinnati company's private-equity lending platform will provide senior debt for companies generating $10 million to $50 million in cash flow. It hired former CapitalSource banker Brian Crabb and Josh VanManen, who previously worked in Fifth Third's structured finance group, to spearhead the effort.

Fifth Third officials weren't available for comment.

One problem for the deal-finance newcomers, despite the overall lack of leverage, is that so many banks and financing sources are champing at the bit to finance new deals.

Industry observers don't expect the existing players to give up significant ground to the new market participants.

It would also be a bit of stretch to suggest that the new crop will trump well-established lenders that have long plied the backwaters in midsize company lending, including Bank of America Merrill Lynch, Wells Fargo, JPMorgan, Citigroup Inc. and BNP Paribas.

Private-equity shops have also sought to break into middle-market lending over the past year.

In June, MidOcean Partners hired Steve Shenfeld to head the New York firm's MidOcean Credit Partners unit, which will focus on financing middle-market deals.

Genstar Capital of San Francisco launched MidCap Financial LLC in October 2008 to provide loans for health care companies valued at $10 million to $200 million.

One middle-market financing veteran said he isn't worried about the new competition.

Hugh Wade, senior managing director of Madison Capital of Chicago, says it may be hard for new players to get into the business at this point given the lack of transaction volume to support new origination activity. After all, activity for mergers and acquisitions of all sizes is markedly off from recent years.

Nonetheless, Wade concedes, "They help create more liquidity for transactions."

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