THL Credit Seeks Piece Of Senior Loan Action

Earlier in July, the Boston buyout shop’s lending affiliate, THL Credit Advisors, completed its acquisition of the Alternative Credit Strategies group from McDonnell Investment Management, a Chicago area money manager.

At a stroke, the transaction multiplies THL Credit Advisors’s assets under management six-fold to $2.8 billion, while the addition of the Alternative Credit Strategies team doubles the size of the THL Credit staff. The new group is to become known as the Senior Loan Strategies team at THL Credit Advisors, which until now has focused exclusively on junior debt.

James K. Hunt, CEO and CIO of THL Credit Advisors, said his firm is positioning itself to be a player in a market that is still being transformed in the wake of the financial crisis. “We have the capability to be a capital provider in a world that is going to have a diminished role for banks and an increased role for alternative financial institutions,” Hunt told Buyouts.

Two years after the Dodd-Frank financial reform was signed into law, banks and other providers of financing face continued uncertainty and incremental increases in regulation, which are likely to limit their participation in highly leveraged cash-flow financing for years to come. Hunt said the emerging trend, now only in its second or third inning, will determine who capital providers will be in the future.

To be sure, LBO lending strategies have long been a feature of the buyout industry; The Blackstone Group, for one, brought on board a credit team in 2008, hiring a group of credit investors from Credit Suisse First Boston’s alternative capital arm who had formed GSO Capital Partners in 2005. But other prominent buyout shops also have stepped up their search for opportunities in lending, using a variety of approaches. Apollo Global Management LLC and The Carlyle Group have acquired credit operations in the last year, while Kohlberg Kravis Roberts & Co. closed a $1 billion mezzanine fund, its first, last fall. Blackstone/GSO, Apollo Global Management, KKR and others also have launched initiatives advising unlisted business development companies, which provide senior loan and mezzanine capital to smaller borrowers.

Thomas H. Lee Partners also has been in the credit space for a while; it established its own BDC, THL Credit Inc., in September 2007 and took it public in April 2010 as the financial crisis ebbed. The BDC focuses on mid-market junior debt, in four main flavors: mezzanine, second lien, unitranche and some special situation senior debt, Hunt said.

The acquisition of the McDonnell Investment unit was undertaken not by THL Credit Inc., the BDC, but rather by the BDC’s external manager THL Credit Advisors, the credit affiliate of Thomas H. Lee Partners. The transaction was in the works for a year and a half, Hunt said. The agreement was announced in May; it closed in July. THL Credit acquired the unit’s $2.5 billion portfolio and hired its team to lead THL Credit Senior Loan Strategies LLC: James R. Fellows, Brian W. Good, Robert J. Hickey and Michael A. Herzig.

“The four senior horsemen who have been running the business will continue to do so,” Hunt said. As THL Credit Senior Loan Strategies, the group manages $2.5 billion in collateralized loan obligations, one of which is still in its reinvestment period; a loan opportunity fund, a leveraged vehicle; a similar unleveraged fund; and a variety of separate accounts.

McDonnell Investment Management, based in the Chicago area, focuses on municipal and investment grade bonds, and has a practice in insurance asset management. “While it is a very good platform, we are now able to have some compelling synergies to take the investment portfolios to a higher level,” Hunt said.

Synergies

Key to that is the industry expertise at Thomas H. Lee Partners. While the buyout shop focuses on a handful of specific sectors—business and financial services; consumer and health care; and media and information services—“we’ve found tremendous synergies in industry knowledge and industry coverage,” Hunt said.

Both as a matter of firm policy and as a matter of compliance, the BDC does not provide financing for deals that the buyout shop undertakes. Nor, because of their differing missions and markets, does Hunt contemplate that the BDC would find itself alongside the Senior Loan Strategies team in a financing, he said. Instead, the cross-pollination of expertise is the key, even though the business units pursue their strategies individually.

“The people side we knew was going to work because the deal was incubating for so long. But now that we’re formally under one roof and we have the compliance working, it’s proving to be a fantastic connection,” Hunt said.

THL Credit Advisors already is looking to leverage the Chicago location of the Senior Loans Strategies team. THL Credit Advisors, which has BDC offices in Boston, Houston and Los Angeles, is looking for an expert in junior mid-market debt to sit alongside the Senior Loan Strategies team in Chicago. Hunt said he wanted to develop a BDC team of three or more in Chicago. “We’re working for the right senior person, and we’ll build around that.”

The BDC serves both sponsored and unsponsored borrowers in the mid-market with junior capital; it works with 700 sponsors, primarily in 17 focus cities, often backing change of control, recap, and refinancing transactions, and is more of a direct business than intermediated, Hunt said. It also has 300 unsponsored clients throughout the United States, mostly entrepreneurs and small cap public companies; those transactions typically are intermediated, usually by an investment bank or other trusted adviser.

In managing the BDC, THL Credit Advisors employs a “top down” origination approach, Hunt said. “A senior person gets involved right at the outset to predict [whether]this a transaction we will pursue.” It uses a screening process to greenlight decisions, with decisions made by a five-person investment committee. The goal is to respond promptly to borrowers, Hunt said. “The market values certainty and predictability. They don’t mind a no, but they want a quick no.”

The BDC made 12 investments in 2011, probably a typical pace, and although it has the capacity to do more, the greater concern is finding worthwhile transactions, Hunt said. “This is a business where the fish have to be biting. If the fish aren’t biting, we’re not shy about going back to the dock.”

Surveying market conditions now for the BDC, Hunt sees “a good market,” he said. Because the cost of capital is low, “these are the best risk adjusted spreads I have seen in my career right now.”

Because it launched after the mid-decade credit peak, THL Credit Advisors holds “exclusively a new era portfolio,” Hunt said, with no legacy BDC investments from the credit bubble, only since the summer of 2009. “What a phenomenal time to be building a debt portfolio. We can see exactly how companies performed during the recession.”

Given today’s slow economy, the firm is seeing compelling opportunities for cost-saving businesses, in fields such as business process outsourcing or for successful companies buying failed competitors, Hunt said. “Dislocation is creating both opportunities and problems.”

THL Credit Advisors has had to coach its public-company constituents to understand that this is a lumpy business, with some active quarters and others with no appropriate opportunities, Hunt said. “We winnow many opportunities to make the investments we make” and is comfortable being patient. “We’re seeing good opportunities, but the backdrop is not easy.”