New Lenders Pounce In Fragmented Mid-Market

A handful of new mid-market financing shops are looking to fill the gap created by firms sidelined since the credit contraction began last summer. In almost every case, these new shops are backed by buyout firms and managed by professionals formerly employed by the finance companies they’re now trying to replace.

The two biggest names to have emerged are Tygris Commercial Finance Group, led by the former vice chairman of CIT Group and backed by an A-list group of sponsors including Aquiline Capital, New Mountain Capital and TPG Capital; and Maranon Capital, a new outfit backed by insurance giant Prudential Financial and steered by former executives of business development company American Capital Strategies. Unlike many of the firms that have gone quiet since the market for debt buyers froze last summer, these new shops are focused on holding debt rather than arranging loans and syndicating them to a group of willing buyers.

There’s no question a vacuum has opened up in mid-market finance since August 2007. A crowded field of arrangers and debt syndicators has dwindled to a few firms capable of holding significant chunks of senior leverage on their balance sheets. By the end of the first quarter of 2008, GE Capital Corp., through its mid-market specialist GE Antares, and Madison Capital Funding had separated themselves from the competition in sponsor finance, according to Reuters Loan Pricing Corp.

“There aren’t many people who are active right now,” a source familiar with one of the start-ups told Buyouts. “There’s Madison Capital and GE and on any given day a few other people.”

Still, despite the overwhelming sense that there’s opportunity to be had, would-be managers of start-up firms are having difficulty gathering the capital they need to start viable businesses. Obtaining equity backing isn’t the problem, sources told Buyouts. Rather, the evaporation of money in the capital markets has made new debt issuances—typically in the form of collateralized loan obligations—nearly impossible to complete, and without leverage these new firms would struggle to generate an attractive return on equity. This has kept many new firms from opening their doors.

LBO firms that have backed new finance companies all said they courted offers from several management teams before settling on the eventual winners. “Our investors analyzed a lot of different management teams and commercial finance strategies, and ultimately the investors in our group decided that Tygris was their best investment,” Frederick E. “Rick” Wolfert, CEO of Tygris Commercial Finance Group, said. “The general feedback was that investors [understood] the historic proportions of the market change. But our sponsors really got the strategy. They understand the importance of scale and the strategic approach we’re taking.”

The obvious implication is that some management teams haven’t been so lucky. Executives who formerly led mid-market lender Merrill Lynch Capital, for instance, have encountered little trouble lining up equity to form a new shop, but they haven’t been able to secure the debt required to make the venture work. Consequently, their efforts to get off the ground have stalled, sources told Buyouts.

“The market really wants [the Merrill Lynch executives] to come back,” a source familiar with their efforts said. “Merrill was a class act.”

One reason that Tygris Commercial Finance was able to get going is that, for now, it remains thinly levered. Its sponsors, a group that also includes DLJ Merchant Banking Partners, Diamond Castle Holdings and Hamilton Lane, have contributed more than $2 billion in equity to the firm, but its only debt comes from the existing portfolio of its first two acquisitions, U.S. Express Leasing, which provides equipment financing for small companies, and MarCap LLC, a health care leasing business. The plan for Tygris Commercial Finance is to build scale through acquisitions and within about five years lever the firm up to 6x or 7x equity, which Wolfert said is average for the industry.

“This business is not being designed for two or three years,” said an executive at one of the firms backing Tygris Commercial Finance. To that end, Wolfert has assembled an impressive group of finance pros, including veterans of GE and CIT.

When Tygris Commercial Finance announced its formation earlier this year, it had already signed up its deals for U.S. Express Leasing and MarCap, and more deals are on the way, Wolfert said. The firm intends to focus about 50 percent of its operations on equipment leasing and finance for small and mid-market companies. The other 50 percent will be devoted to mid-market commercial finance, focusing on providing senior secured financing to commercial customers and to financial sponsors.

Maranon Capital, for its part, took a slightly more conventional route with its organization. Like GE Antares, which started up with backing from insurer MassMutual before being sold to GE, and Madison Capital, which has backing from New York Life, Maranon Capital relies on Prudential Financial for senior debt. (Prudential and Maranon are not affiliated, however). Maranon Capital is led by Tom Gregory and Ian Larkin, both former executives in the Chicago office of American Capital Strategies, who left that firm in June 2006 and launched Maranon Capital in early 2008.

The core business of Maranon Capital is mezzanine finance, according to a source familiar with the firm. Because of its ties to Prudential, however, the shop can also provide senior loans, and it can combine the two into one-stop credit facilities. Maranon Capital will have the capacity to hold $50 million slugs of senior debt on its books.

Earlier this month, Maranon Capital announced the completion of its first deal, committing $27 million in senior and subordinated debt to Lake Capital’s acquisition of an information security software company. Maranon Capital’s executives declined to comment for this article because it’s still raising its first mezzanine fund.

The firm’s leaders sought backing from an insurance company and intentionally bypassed LBO firms, according to our source familiar with Maranon Capital. The fear was that a buyout firm would keep one eye on the exit, and that it would set Maranon Capital up for an eventual public offering, something the firm’s executives had no interest in. The executives “fundamentally didn’t want to go down the private equity path,” our source said.

Dan Marzalek, who led Merrill Lynch Capital’s financial sponsor group, meanwhile, is similarly interested in starting up a new firm with backing from an insurance company and was reportedly close to inking a deal before it fell apart in the last month, according to a source familiar with the effort. He, too, is leery of sponsorship from an equity firm, preferring more patient money from an insurance company, according to our source. “For him to do a New York Life-Madison Capital type of deal would be like dying and going to heaven,” our source said.

Note of Clarification: An earlier version of this story referred to Maranon Capital as an affiliate of Prudential.