“There has been a philosophical change, a seminal change in the way banks operate, especially in the middle market space,” Grunewald told Buyouts in an interview. “We think it’s a permanent change.”
Global regulators are likely to put pressure on banks through the international regulatory framework known as Basel III, and U.S. regulators may put even more stringent regulations in place restricting bank lending, Grunewald said. As a result, he argued, “Middle market companies are going to need more capital than banks are going to be able to provide.”
Therein lies the opportunity for business development companies, closed-end investment funds that have a pass-through investment structure similar to real estate investment trusts. BDCs, which can invest in both equity and debt, have emerged as a growing force in leveraged finance since the financial crisis of 2008 and 2009.
Although the vehicles were authorized in 1980 as a way for small businesses to find inexpensive financing, the industry only has taken off in the wake of the financial crisis. The St. Louis-based investment bank Stifel Nicolaus & Co. had only 16 BDCs in its coverage universe in 2010; today the number of BDCs exceeds 40, according to the Chicago investment bank Lincoln International.
The number of non-traded BDCs also has surged since Franklin Square Capital Partners launched the industry’s first non-traded BDC in January 2009. Today, the firm’s three funds, sub-advised by GSO / Blackstone, the credit management arm of The Blackstone Group, makes Franklin Square Capital Partners the non-traded industry’s largest player, with $7.9 billion of assets under management collectively.
Other buyout shops, including Kohlberg Kravis Roberts & Co and Apollo Global Management LP, have struck similar arrangements to provide advisory services and fund management to non-traded BDCs, as well.
BDCA, which launched in August 2011, in the middle of the non-traded BDC surge, caused a bit of a ripple in the market in August, when it announced that it was raising the price on its latest public offering, to $11.10 per share from $11, with an eye toward sustaining a 7.75 percent annualized distribution rate on the dividends that it returns to its investors.
“Our assets continue to perform extremely well,” with no borrowers past due or in default, Grunewald said. BDCA has a mid-market focus, seeking borrowers with less than $1 billion in revenues, and Grunewald said “the vast majority” of its investments are with sponsor-backed businesses. The company has a hold size of $20 million to $50 million of debt per transaction, though it may syndicate larger deals, he said.
With backing from the REIT American Realty Capital rather than an entity affiliated with a buyout firm, BDCA can be “sponsor agnostic,” Grunewald said. And as for competition with other non-traded BDCs, he said, “We hardly see those other BDCs in our transactions.”