Changing the game

The institutional loan market has grown meaningfully in recent years to include a diverse group of investors whose appetite for risk rises and falls faster than it ever has before, writes John Martin.

The nature of the lending relationship between large bank groups and private equity firms has changed quite significantly within the past couple of years. As a private equity firm, you aren’t just dealing with a small stable of commercial bank lenders or commercial finance lenders. Now you’re dealing in an arena where you have a lot of institutional investors in your credit facility who are driven by the returns they can earn by lending to portfolio companies. They aren’t driven by developing and expanding relationships. They’re looking for the returns. That’s fine, but it has definitely changed the relationship.

Today’s universe of lenders is extremely diverse. They range anywhere from prime rate funds to CLOs to diversified money managers. The number is meaningfully in excess of 200 different investors, which may not seem huge, but when you have a lot of these parties buying into institutionally distributed loans in $1 million, $2 million and $3 million pieces, you get an idea of how widely distributed these loans can get.

The institutional loan market also reacts much quicker to world events today than it ever used to, which results in it being very choppy from time to time. In the first quarter of 2011 there was a tremendous amount of liquidity coming into the institutional loan marketplace. A lot of transactions could get done in a relatively smooth, seamless way for issuers. Then when everything was perceived to be blowing up in Europe it immediately impacted that marketplace. Institutional investors in loans immediately pivoted to requiring higher returns. It was just a risk-reward reaction. The view was risk was higher so those investors wanted to get paid more.

In 2012, the same dynamic happened again, and again it was driven largely by events in Europe. What was different in 2012 was, the market pulled back for about a six- to eight-week period, but then those investors basically decided the world wasn’t going to end and very quickly came back into what they viewed as an attractive asset class. So spreads widened for six to eight weeks, but now they have come back to what I would argue is a normal, steady stream in the marketplace.

However, US private equity firms are now facing a different challenge that has nothing to do with the lending environment: strategic buyers. There’s been a lot written about the cash balances that corporates are building up on their balance sheets because when you’re operating in a 1.5 percent GDP growth environment, the only way companies can grow is by buying other companies. Strategics have been very aggressive in making acquisitions these days and they’re creating some unique challenges for the private equity world.

John Martin is chief executive officer of GE Antares Capital.