Middle Market Lending -BDC's/Specialty Finco's and MM Banks

Im currently working in the "Lev Fin" group at a MM .commercial bank (think US Bank, Capital One, Citizens Bank). To avoid any confusion, we don't have an IB division so our version of Lev Fin refers to the specific lending team that specialize in financing deals backed by PE firms (LBOs, Dividend recaps, growth financings etc.) It's typically higher risk than vanilla commercial lending and its all centered around M&A, so the underwriting process can be pretty interesting. However it feels like banks are being pushed out of the space by regulation and I'm having second thoughts about staying the course and just climbing the ladder to a RM position as I had hoped when I joined. In my bank specifically most groups are regionally based with a focus on ancillary products, so our group is kind of an outlier which I think might amplify some of the regulatory constraints we face.

I'm currently a second year analyst making ~105k (80k base, 25k bonus) working about 50-60 hours a week. At age 23 I'm very happy with this balance but am concerned about pay progression moving forward and would be curious to hear about any differences in skill set/comp/culture for those who moved to BDCs, specialty finance companies or credit funds focused on the upper end of the capital stack. Id be interested to hear any sort of general insight or conversation about the leveraged loan market as well as it's sort of a niche corner that doesn't really get much light.

 

Curious why you feel banks are getting pushed out of this space. Thought I heard the OCC loosened standards and capital regulations on leveraged lending and banks saw this as a growth area on a risk adjusted basis in this low rate environment

 
Best Response

This might be the case for larger banks who haven't historically had much presence in the space and don't have much in terms of an existing leveraged loan portfolio, but I know in my experience they have literally crushed our business. Until January we were actually banned from doing anything where senior leverage exceeded 3.00x, which is considered the regulatory hurdle for a leveraged loan and pretty much put our whole group on standby. We've come back in slowly, but it's been very difficult to stay competitive as most quality deals are being bid up to senior leverage>4.00x which is virtually impossible for us to do due to our leverage limits. The catch 22 is that the lower leverage deals that we can pursue are generally weaker companies that are difficult to get approved internally because our credit offices know that they'll have the OCC down their back the second the economy hits a bump. That's really the conundrum in dealing with the OCC, they frame the conversation on their terms and refuse to have a conversation about the broader market. Even if they continue to loosen up on banks, I think most of the traditional players have probably seen their relationships take a serious hit over the last year or so. From a PE firms perspective why even bother putting up with the bureaucracy and accept a tighter covenant package from an OCC regulated bank when there are so many other, more reliable options out there?

 

Probably is to a degree but we are in somewhat of a unique situation. Not to give it away but we didn't really start lending to this market until right before the crisis and it still sometimes feels out of touch with the banks broader strategy. It's odd because we are routinely the most profitable group but we also are the first to blame wheneve something goes wrong. I'm sure some of the restrictions are self-imposed as I know the MD and the RMs in my group constantly butt heads with the higher-ups, but the credit risk people and senior management are so concerned with covering their own asses that they choose to just ignore the market and try to shift volume towards our ABL or regional corporate banking groups while we wither away. Trust me, it's quite frustrating for everyone hence why I'm considering other options. By the time the OCC approves our portfolio I have a feeling we will have lost a lot of key RMs and it will be difficult to reclaim our place in the market even if we get some more flexibility.

I will say though I shouldn't assume every bank is going through this. We just have seen ourselves get beat out more by non-bank lenders more so than other banks so I'd assumed we weren't alone. We're also more LMM though which I know attracts those types of entities.

 

The actual legality of the leveraged lending guidelines is being challenged right now which could be a significant benefit to regulated institutions and that should play out in the next month or so. But, who knows whether that will change the views of your senior managers... There are plenty of deals getting done in the market by regulated institutions that are at 5.0x+ senior and 7x+ total, though.

 

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