Direct Lending: Filling a Void where Banks Once StoodDirectLending:FillingaVoidwhereBanksOnceStood

The global financial meltdown helped change the face of leveraged middle-market lending from one driven largely by banks to one now dominated by non-bank, institutional lenders. Indeed, the direct lending market has become a structurally permanent source of debt capital for leveraged loan borrowers, principally an LBO-driven, sponsor-led market, but which relies on fundamental credit underwriting.

“Banks have largely gotten out of middle-market lending as a result of further regulation,” said Harvey. “That helped open up the prospect of institutional firms offering nonbank capital in the marketplace in a way, quite frankly, that is better suited to what our borrowers want anyway, which is longer-dated and more flexible financing.”

The direct lending strategy focuses on five key elements:

• Middle-market companies with EBITDA of $10 million to $50 million
• Borrowers with resilient cashflow dynamics, and/or meaningful collateral, with a key focus on loss-avoidance through cycles
• Sponsored and non-sponsored transactions
• Generalist industry approach with an emphasis on business services, consumer products and services, distribution and logistics, food and beverage, energy, packaging, chemicals, and manufacturing companies
• Experienced management teams and owners with an economic stake in the company’s success

With more than $90 billion in assets under management, PGIM Private Capital is one of the largest global managers in the asset class. The firm leverages its global origination network to find deals that don’t necessarily fit the traditional bill of transactions such as broad auctions and leveraged-buyout financing, which make up the vast majority of the direct lending market. Instead, it looks to produce a more diverse portfolio between both private-equity-backed deals and also non-sponsored deals found through its network comprising privately held, often management or family-owned, companies.

“Ultimately, in private credit, origination is the biggest scarce asset, and we have origination capacity as deep as anyone in the world,” Harvey said. “When you think about selectivity of investments, you accomplish that by not being a price taker, but by finding your own deals through your relationships. And keep in mind it’s important to be selective not only when markets are fallow, but also when they’re flush.”

Deep, Local Coverage

Unique to PGIM Private Capital’s direct lending model is the business’s regional office network, with nearly 200 investment professionals in local markets around the world. It’s a setup that allows the firm to take a macro-economic perspective on global trends that underlie its structuring and underwriting, and also provides the flexibility to offer cross-border financing structures, as well as transactions in any one domestic market.

“This is extremely important from our perspective,” Harvey said. “Many other direct lenders typically sit in New York or London and they’re usually calling on a finite set of transactional people. They’re not going into northern Iowa or eastern Washington state and calling on family-owned companies over a long period of time. We want to get close to local markets and close to companies that issue capital across the risk spectrum, which enables us to capture a broader part of the market. And because of our scale we can do it over a long period of time; it’s hard for others to replicate that.”

Of course, it’s not an overnight phenomenon. Harvey calls it the “everyday blocking and tackling” at the regional office level, as opposed to a one-time push for business.

“What I get most excited about is creating a differentiated portfolio of scale for our investors,” he said. “I think our model allows us to provide a lower risk return than what the broader market is offering right now. But you can’t just flip a switch – it takes time.”

Learn more about PGIM Private Capital