Dayna Kleinman, Head of Business Development, Wealth Management Solutions at Monroe Capital, joined Julie Cooling, Founder and CEO of RIA Channel, at the CAIS Alternative Investment Summit to discuss direct lending in the lower middle market.
Monroe Capital was founded in 2004 before private credit was an asset class of its own, and the firm has grown to nearly $18 billion in AUM. Before the global financial crisis of 2008, approximately half of loans were originated by traditional banks. With the reforms to the banking system following the GFC, middle-market lending by banks declined due to increased regulations and risk-based capital charges. In 2022, the share of middle-market loans originated by banks had fallen to just 25%. Regional bank failures, such as Silicon Valley Bank, lead to a risk-off environment and tighter lending terms at banks. This makes the access to credit offered by private lenders even more attractive for borrowers.
Monroe Capital specializes in direct lending to lower middle-market firms with EBITDA below $35 million. For example, the firm might lend four times EBITDA, or $100 million, to a company with $25 million EBITDA. In the lower middle market, lenders are able to originate loans with strong covenants, which are designed to reduce the frequency and severity of defaults.
Kleinman notes that today’s interest rate environment is normal but follows an abnormal decade of no interest rates. As the Fed has tightened interest rates over the last year, floating-rate loans are now earning higher interest rates. Loans where borrowers were previously paying 8% interest rates have now reset to rates of 12%. While this increased income is good for investors, it can put stress on the ability of borrowers to service the loans. Defaults are likely to rise and may be higher in covenant-lite loans and for borrowers whose businesses depend on the health of consumers who are being squeezed by inflation.