Competition for commercial loans is so steep that even business development companies, known for taking risks that banks won't, are feeling pressure to make concessions on terms to borrowers.
BDCs have expanded their presence in middle-market lending as banks have retrenched. But there is no shortage of capital chasing deals. A record 95-week period of consecutive fund inflows ending in April inflated leveraged corporate lending by $66.7 billion. Some of the asset yield compression that has torn into lenders, including BDCs, may finally begin to let up as loan fund outflows help stabilize the market, analysts say.
Despite the pressures in this field, Raj Vig, managing partner at TCP Capital Corp., says there is still significant room for BDCs to increase their market share. TCP has $959 million in assets and a $712 million market capitalization; its external advisor, Tennenbaum Capital Partners, boasts $5 billion in assets under management. Vig recently sat down with American Banker and discussed how BDCs can coexist with bank lenders, how TCP is responding to market pressures and compressed yields, and how higher rates will affect the market. An edited transcript follows.
Capital constraints and regulation have forced banks to retrench. What are BDCs offering that banks can't?
We are conscious and careful to say we are not displacing banks. I don't think that we are. But it is a challenge for them to do what we do, and that has exacerbated since the crisis.
The big picture point is that for middle market entities, in the very best times, they have always had lower access to capital than larger counterparts, which are usually household names. Whether that is because these companies are not as well known, or if capital markets are not the right place for them, access for traditional capital has simply weakened since the financial crisis. Many of these companies will have elements of a traditional bank structure, like a revolver or working capital facility that is not our business but we can round that out and complement it in a way that provides a solution to a business.
The big picture is, for an economy to grow, companies need access to credit. Not all credit is the necessarily the same product.
In April cash for bank loan funds finally reversed course after 95 consecutive weeks of inflows, followed by a reverse surge of cash outflows. How is the market responding?
We see a lot of opportunity with companies not as directly affected by the inflows and outflows in high-yield bonds or ETFs or more liquid instruments. What happens there impacts us, and those guys have seen some spread tightening and there's been some nervousness there, but we try to make the point that those movements and those capital flows are going to different companies than what we target.
The Fed has repeatedly sent warning shots to the leveraged loan market. Are lenders backing down? Are you feeling pressured to make concessions to attract deals?
Things have gotten competitive, there is no question. There are many ways to compete. Price is one. We don't necessarily need to be a high volume business, though that has been good. We try to distinguish ourselves by being a better capital provider than just price. We know the businesses, we are flexible, and if best price wins but it doesn't work for us, that's OK.
We are seeing a lot of opportunities, but we are also saying 'no' a lot maybe a lot more often, mostly because of some of the influences of the large cap market [where bigger companies borrow] to structures and pricing that others are comfortable doing.
Our philosophy is no single quarter needs to have a single amount deployed. Discipline is the best strategy.
So how do you play against those pressures, and what kind of weaker terms are you seeing?
When we underwrite, we don't underwrite to unreasonable growth.... Where some people have made less than conservative protections either in the terms of covenants or documents or terms not reflective of the risk logically that would play itself out at a weaker environment.
How about higher rates?
We think about that. Our structures are typically senior secured and floating rate instruments. Those are good hedges for a rate rise and we originate with an experienced team. We think about buffer and downside protection in some form.
What does the market opportunity look like for BDCs, and how do traditional lenders fit into the picture?
Regulatory challenges have made it very tough for banks. The capital rules against these instruments have a high if not full weighting. And the recent Fed comments on leveraged lending are very telling of their current concerns. Banks are just focused on a different business, a different instrument.
We interact with banks in several ways. If it is financing for an acquisition, or for business expansion, banks still get a fee for that.
Clearly there are some banks taking deals and doing things that they haven't done since the crisis, but today, we find most banks to be valuable partners. And we don't do revolvers.
Earnings are right around the corner. If yields grind tighter, will dividends take a hit?
Dividends are a function of returns we underwrite to and the cost of the entity. We think about our cost of capital. The yield on our portfolio is less than 100 basis points off than what we were two years ago. The cost side is also quite good. We have one of the lowest cost operating structures in the industry, in large part because of the leverage facilities bank debt, and now a convertible bond that we issued last quarter. We expanded one bank facility recently with Deutsche Bank, and we also have done four equity raises since we went public.
How does the rest of the year look for TCP?
Through last reported quarter we originated $575 million for the BDC over four quarters. We went public with a portfolio of $440 million, and we doubled that to $895 million through last reported quarter and that is without excessive spread compression. Last quarter we originated $169 million and the pipeline is robust.