Direct Lending: Benefits, Risks and Opportunities (2022)

KEY POINTS


  • Direct lending may generate attractive returns with less downside risk and mark-to-market volatility than more liquid credit strategies like broadly syndicated loans.

  • Debt financing needs could grow in the coming years because middle-market companies face a significant maturity wall and private equity sponsors may drive deal activity with the sizable store of capital they have on hand.

  • Superior risk control may be achievable because direct lenders have better access to management than investors in more liquid strategies and the ability to design bespoke creditor-friendly structures.

  • Tax-efficient investment solutions are available for limited partners from many geographies.

  • Outperformance may require superior deal sourcing capabilities and underwriting skill as well as extensive experience crafting creative solutions in complex situations.

What Is Direct Lending?

Direct lenders are non-bank creditors that make loans to businesses without using an intermediary, such as an investment bank. Direct lending, a subset of private debt, most commonly refers to first lien loans made to middle-market companies (i.e., those that report between $50 million and $1 billion in annual revenue); however, Oaktree broadens the definition beyond first lien loans to encompass many additional forms of middle-market lending, including second lien debt, mezzanine debt and unitranche debt (i.e., hybrid loans combining junior and senior debt). There are over 200,000 middle-market companies in the United States alone: a vast market that accounts for one-third of U.S. private-sector GDP and employment – a sum that would make it the world’s fifth-largest economy.1 Middle-market companies also play a significant role in Europe, representing around a third of private-sector employment in the four largest economies.2 Loans made to middle-market businesses are normally used to finance leveraged buyouts (LBOs), mergers and acquisitions (M&A), growth investments, and recapitalizations.

Direct lending investments typically have:


  1. Floating-Rate Coupons: Interest rates are normally quoted as a spread above a reference rate, such as LIBOR3 or the Secured Overnight Financing Rate (SOFR).

  2. Short Terms to Maturity: The average term to maturity on these loans is between five and six years compared to over seven years for high yield bonds, and the loans’ average lifespan is between three and four years.

  3. Strong Covenants: Loan contracts usually include negative and affirmative covenants that limit the borrower’s ability to reduce the value of the loan. These include maintenance-based covenants, which are tested at regular intervals throughout the life of the loan. These lender protections require companies to meet certain financial conditions, such as keeping their ratio of debt to EBITDA below a specific level.

  4. Less Liquidity: Lenders can’t move in and out of these investments as easily as investors can normally buy and sell broadly syndicated loans (BSLs) and high yield bonds; however, lenders are typically compensated for this risk with the possibility of additional return – the so-called illiquidity premium.

  5. Low Correlation with Public Markets: Because of the bespoke nature of direct lending deals, returns are normally not highly correlated with those of public debt and equity markets.

Direct lending, like private debt in general, has grown significantly since the Global Financial Crisis of 2007-2008. In the U.S., direct lending assets under management jumped by over 800% in the decade following the GFC.4 By 2020, the total U.S. direct lending market had grown to around $800 billion, according to a Refinitiv estimate.5 This growth has been due in part to the declining presence of banks in middle-market lending – a trend that began in the 1990s (see Figure 1). At that time, regional U.S. banks that serviced middle-market companies began consolidating; the resulting larger banks focused less on lending to small- and medium-sized companies and more on fee-based business lines and financings for larger firms.

The GFC accelerated this consolidation trend, and the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed in 2010, introduced enhanced rules and regulatory requirements that intensified underwriting standards and mandated that banks hold additional capital against assets. These changes further decreased banks’ ability and willingness to issue and hold loans to middle-market companies, especially businesses with riskier credit profiles. The impact of these shifts is underscored in leveraged loan primary market statistics: U.S. banks were responsible for over 70% in 1994, but only around 10% by 2020 (see Figure 1).

Figure 1: Primary Market Corporate Loan Participation

Direct Lending: Benefits, Risks and Opportunities (1)

As of December 31, 2020
Source: S&P LCD

Figure 2: European Direct Lending Assets Under Management

Direct Lending: Benefits, Risks and Opportunities (2)

As of Septemer 30, 2020
Source: Preqin

In Europe, banks play a much larger role in funding corporations than banks do in the U.S., where businesses rely more on the capital markets. However, European banks’ control over middle-market financing was declining for much of the last decade. For example, European banks’ outstanding corporate loan volumes were relatively stagnant in the years leading up to 2020. During the same period, European direct lending assets under management skyrocketed from almost nothing in 2009 to over $150 billion in 2020 (see Figure 2).


Opportunities

Oaktree participates in four types of direct lending opportunities across many geographies:

(Video) Direct Lending and the Private Credit Craze | Private Capital


  1. Situational Lending: Loans to companies with nontraditional revenue or earnings histories, such as those that report high levels of revenue but no earnings. Traditional lenders like banks may be unable to properly value these companies’ assets.

    Example: A life sciences company with revenue-generating drugs and substantial hard assets seeking to commercialize a promising new product

  2. Stressed Sector / Rescue Lending: Loans to companies in sectors experiencing stress and reduced access to the capital markets.

    Example: A business in an industry negatively affected by the Covid-19 pandemic, such as entertainment or travel

  3. Secondary Private Loans and Loan Portfolios: Direct loans or portfolios of loans sold by investors or leverage providers. Sellers might be forced to offload loans in response to near-term liquidity needs, leverage pressures, regulatory capital requirements, or performance concerns.

    Example: Loans sold by banks looking to reduce geographic or sector concentration

  4. Sponsor Financings: Loans related to LBOs, where the lender works with sponsors who have subject-matter expertise in more complex industries.

    Example: Loans to fund LBOs in partnership with a software-focused private equity firm

What Are the Benefits of Direct Lending?

Direct lending portfolios, if structured properly, have the potential to generate returns similar to or higher than those of other credit investments such as BSLs, but with less risk. Additionally, an allocation to direct lending enables investors to gain exposure to private-equity-sponsored deals without assuming the same level of risk as equity investors. The advantages versus many other types of debt investments include:


  1. Greater Protection From Rising Interest Rates: Loans have shorter duration (i.e., lessor sensitivity to interest rate changes) than fixed-rate debt. Unlike most debt instruments, many loans don’t decline in value as interest rates increase because they have floating-rate coupons that increase in line with the underlying reference rate. Duration is also shortened because loans usually feature all-cash coupons, while some high yield bonds include payment-in-kind, or PIK, coupons, which are paid with the principal at maturity. Middle-market loans may also include call protection, which reduces prepayment risk by restricting borrowers from retiring loans within a few years of issuance, and prepayment penalties. Additionally, floating-rate loans normally have contracted floors on the reference rate, offering some protection when rates decline.

  2. Higher Seniority and Security: Loans are first in line in the capital structure to be paid out in the event of a default. Senior loans have the initial claim on assets, such as cash, accounts receivable and equipment; junior loans have subordinated claims, but are still senior to bonds.

  3. Greater Lender Protections: These loans typically offer strong downside protection because they are collateralized and high in the capital structure. Additionally, the loan contracts normally include both incurrence covenants, which are applied when the company seeks to take an action like adding additional debt, and maintenance covenants, which restrict certain activities and require companies to maintain specific leverage and interest-coverage metrics that are measured at least quarterly. Meanwhile, BSLs are increasingly classified as covenant-lite because they rarely include maintenance covenants.

  4. Lower Potential Losses in a Default: The average recovery rate for U.S. middle-market senior loans between 1989 and 2018 was 75% – far higher than the 56% for senior secured bonds (see Figure 3). Additionally, around 59% of the average U.S. middle-market LBO purchase price was financed by equity in 2020, meaning that the company would have to lose more than 59% of its value before the loan would be impaired (see Figure 4). That’s far more than the 44% equity contribution reported for large-company LBOs.

Figure 3: Recovery Rates by Asset Class (1989-2018)

Direct Lending: Benefits, Risks and Opportunities (3)

As of December 31, 2018
Source: S&P CreditPro
Note: Recovery rates are calculated as the value received in settlement, discounted at the effective interest rate on the instrument, as a percentage of the principal default amount.

Figure 4: Total Equity Contribution For LBOs

Direct Lending: Benefits, Risks and Opportunities (4)

As of December 31, 2020
Source: Refinitiv LPC

  1. More Upside Potential: First lien middle-market loans have offered more yield spread per unit of leverage since late 2016 compared to first lien large-corporation LBO loans (see Figure 5). Middle-market loans also feature warrants and other sweeteners more frequently than other credit instruments, providing debt investors with the ability to enjoy equity upside potential along with downside protection.

Figure 5: Compensation Potential in Middle-Market and Large-Corporation Loans

Direct Lending: Benefits, Risks and Opportunities (5)

As of December 31, 2020
Source: Refinitiv LPC

  1. More Control: While direct lending normally requires greater due diligence than traditional debt investment strategies – more akin to the private equity norm – this relationship-based lending model gives the lender more access to the company before and after deal inception and greater control over terms and structure – which can be especially advantageous in adverse scenarios.

  2. Higher Illiquidity Premium: Direct lenders can often secure higher origination fees and coupon rates compared to investors in BSLs, which are more liquid. Middle-market companies with fewer borrowing options are often focused on the certainty of capital rather than just the cost of capital.

    (Video) Private Debt & Direct Lending Opportunities in 2021

  3. Lower Volatility: The marked-to-market valuations of direct lenders’ investments normally aren’t as volatile as those of high yield bonds or more liquid loans, and price volatility is commonly used to represent risk in risk-adjusted return calculations.

  4. Greater Diversification: Private loan performance is often not well correlated with that of other types of assets or with the business cycle in general. This is especially true in industries with highly specialized products; for example, in life sciences, individual companies are often focused on different diseases, reducing intra-sector-concentration risk. The large size of the universe also helps lenders create more diversified portfolios, as they can access opportunities unavailable to investors limited to the public markets.

What Are the Biggest Risks in Direct Lending?

The relationship-based nature of direct lending and the bespoke nature of the loans involved mean one’s ability to properly source, underwrite, structure, and monitor an investment is even more important here than in traditional credit strategies. This is a demanding workload, which could overwhelm inexperienced investors. Problems may arise at any stage in the lending process:


  1. Failure to Establish a Robust Sourcing Pipeline: Increased competition for direct lending deals means established firms with large origination platforms and strong deal sourcing pipelines will have a significant advantage over newer, smaller funds.

  2. Failure to Manage Fund-Level Leverage: Direct lending funds may use leverage offered by commercial banks to amplify the returns on their investments. However, the term of the fund-level leverage is often shorter than that of the underlying assets, which creates leverage refinancing risk. Additionally, leverage providers may demand quick repayment when the assessed value of the direct lenders’ portfolio companies declines – even if this decrease is minimal – which can magnify liquidity problems in a downcycle.

  3. Failure to Complete Proper Due Diligence: Direct lending requires the type of extensive research normally associated with private equity transactions – far more than is often necessary or feasible with BSLs. Not only must lenders have the proper staff and resources, but investing in certain industries, like life sciences or software, also requires lenders to possess sector-specific expertise.

  4. Failure to Properly Structure the Investment: Firms without structuring expertise or with narrow investment mandates may lack the creativity and flexibility needed to adapt to borrowers’ needs and thus be unable to seize attractive opportunities or design financing structures that could maximize risk-adjusted return potential. Firms may also lack the resources to properly address the legal, tax and regulatory concerns that arise when setting up bespoke structures.

  5. Failure to Sustain Active Management: Successful direct lending requires continuous monitoring of investments. This demands discipline, resources and experience so that problems can be identified and addressed early.

  6. Failure to Properly Navigate a Restructuring: Firms with limited experience in distressed situations and challenging economic environments may lack the skills needed to identify early warning signs of distress, return a company to solid financial footing, or maximize the recovery value of an investment.

The past decade’s ultra-low interest rate environment increased investor appetite for the attractive risk-adjusted returns that can potentially be secured through direct lending. This competition has enabled companies with weaker balance sheets to borrow and to offer fewer investor protections when doing so. For example, leverage multiples of five to six times EBITDA have become more commonplace even for firms with EBITDA under $20 million. Lenders have also been agreeing to more generous earnings add-backs that inflate EBITDA, making leverage levels appear artificially low. Demand for private investments is also reducing illiquidity premiums and enabling some borrowers to dilute lenders’ call protection. This competition will likely only intensify in the near term if fear of rising interest rates increases demand for floating-rate products.

How Does Oaktree Seek to Address These Risks?

Oaktree believes many of the aforementioned risks can create opportunities for experienced contrarian investors who prioritize downside protection and patience over immediate capital deployment – those who never seek to do a deal “at any price.” With an 18-year track record in middle-market direct lending – representing over 300 transactions and $11 billion in financings in many geographies – Oaktree believes it has developed the skill set needed to control risk at every stage in the lending process.

Sourcing: Oaktree maintains relationships with over 200 sponsors as well as many advisors, commercial banks and capital markets teams, which we believe provides us with a comprehensive view of the investment universe. Our dedicated sourcing and origination platform has helped us maintain and expand these relationships; they are enhanced by our strong reputation for keeping our word and honoring our commitments. Also, when we work with sponsors, we prioritize invitation-only opportunities from private equity firms with which we already have relationships because: (1) we don’t face as much competition for these deals; (2) our familiarity with the sponsors normally speeds up the deal process and increases the probability of closure; and (3) our longstanding relationships help us gauge how sponsors will act during the investment’s life cycle, including in a possible restructuring.

Selectivity: Oaktree seeks to be highly selective when choosing partners and investments. Historically, actual investments have represented around 3% of the total financings our direct lending funds have considered, as potential opportunities must survive a rigorous screening process involving extensive due diligence. For example, Oaktree often engages its own third-party experts prior to making an investment in addition to fully reviewing the sponsor’s diligence analyses and all buy-side and sell-side commissioned third-party reports. This independent and comprehensive due diligence is highly valued by private equity sponsors, who repeatedly partner with Oaktree to benefit from the firm’s insights and vast resources. This advantage better enables us to demand attractive terms that can bolster downside protection.

Valuation: Oaktree employs a loan-to-value approach using what it considers to be conservative assumptions unlike many lenders who use a simplistic multiples-based approach or more aggressive assumptions. We believe beginning with an appropriate company valuation is key to securing downside protection.

Structuring: Oaktree’s extensive experience with complex financings enables us to more easily identify structural risks and develop creative solutions. This means deals are designed so that Oaktree can limit potential losses in negative scenarios, mitigate tax concerns, and navigate local regulatory regimes.

Monitoring: Oaktree continuously monitors portfolio companies and has extensive access to companies’ management teams and sponsors so that we can manage overall risk and begin risk-mitigating discussions with companies long before covenants are breached.

How Can an Investor Address Tax Concerns?

U.S. tax law considers loan origination to be engagement in a business or trade, so investors both inside and outside the U.S. may therefore have concerns about increased taxes stemming from direct lending. However, there are numerous tax-efficient strategies available to address these concerns.

Ex-U.S. Investors

  • For U.S. income tax purposes, all income a foreign person realizes from a trade or business in the U.S. is considered effectively connected income (ECI) and is therefore subject to taxation. As stated above, this often includes income related to direct lending.

  • For large investors domiciled in countries with favorable tax treaties, such as Canada, Japan, the United Kingdom and many EU countries, this tax concern may be addressed with a bespoke fund-of-one solution. The investor would still be subject to state income taxes and be required to file U.S. tax returns.

  • Ex-U.S. clients may invest through a levered blocker corporation, which blocks ECI and eliminates the need for U.S. tax filings. However, regular corporate tax and withholding tax may still be imposed on dividends and interest income. The effective tax rate is generally expected to be between 10–35%, depending on whether the investor holds less than 10% of the blocker, the amount of debt in the structure, the cash distribution profile, and the tax treaty of the country in which the investor is domiciled. If a sovereign wealth fund owns less than half of the blocker, then its interest income and dividends won’t be subject to U.S. taxation.

  • Some investors may gain exposure to direct lending without being subject to ECI tax by investing through a Business Development Company (BDC). However, this tax-efficient structure may be inappropriate in some situations. Please see the BDC overview for more details.

  • Ex-U.S. investors are generally not subject to the ECI tax if the loans in the direct lending fund are to non-U.S. companies and structured properly.

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U.S. Investors

  • Tax-exempt U.S. investors – including corporate pension plans, foundations and endowments – may be subject to tax on unrelated business taxable income (UBTI) related to leverage used by a direct lending fund.

  • Tax-exempt investors with UBTI sensitivity can normally mitigate this tax concern by gaining exposure to direct lending through a U.S. blocker corporation vehicle, which is similar to the levered blocker described above for non-U.S. investors.

  • U.S. tax-exempt investors can also generally avoid being subject to UBTI by investing through a BDC. Please see the BDC overview for more details.

  • So-called super tax-exempt investors like public pension plans are normally not subject to U.S. taxation, including income related to direct lending.

  • All other taxable U.S. investors will be taxed on income realized through direct lending, but these taxes may be reduced by investing through a BDC. Again, please see the BDC overview for more details.

In addition to U.S. taxes, investors may also be concerned about local withholding taxes on interest from the borrowing company’s jurisdiction. These concerns can often be addressed with specific investment structures: for example, investing through a Luxembourg corporation for loans to European companies. Oaktree has well-established regional investment platforms that can help clients mitigate the impact of taxes on returns.

What Might the Post-Pandemic-Era Opportunity Set Look Like?

Middle-market companies in many regions will likely require significant refinancing capital moving forward. First, U.S. companies face an impending maturity wall: over $550 billion in middle-market debt is scheduled to mature through 2027 (see Figure 6). Also, European banks may have limited lending capacity, so European firms that have faced extended Covid-19 lockdowns may struggle to refinance upcoming maturities. Additionally, some U.S. firms’ BDCs have struggled during the pandemic: the non-accrual rate (i.e., the percentage of loans with payments over 90 days late) hit 5.1% in the third quarter of 2020, topping the record 4.5% middle-market loan default rate experienced in 2009. This stress could increase the need for refinancings and generate forced asset sales, creating attractive buying opportunities for patient investors.

Figure 6: Middle-Market Loan Amounts Maturing Through 2027

Direct Lending: Benefits, Risks and Opportunities (6)

As of December 31, 2020
Source: Refinitiv LPC

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We believe that the best opportunities may be found in either beaten-down industries, such as travel and leisure, or industries requiring more subject-matter expertise, like healthcare or information technology:


  • “Unloved” Sectors: Many creditors eschew all companies in a troubled sector, potentially increasing the interest rates willing lenders can secure. Locating bargains requires portfolio managers to have both skill and discipline, as they must conduct rigorous issuer-by-issuer analysis to identify strong companies whose fundamentals belie their stressed-sector discount. Additionally, significant structuring expertise is needed to ensure investments offer sufficient downside protection.

  • Complex Sectors: Successful investment in sectors with highly technical products and assets, such as life sciences and software, requires specialized expertise. Many traditional lenders often won’t lend to these types of companies because the businesses’ lack of stable earnings makes simple multiples-based valuation techniques unworkable.

The demand for capital from direct lenders is already rebounding from the Covid-19-induced pullback in the second and third quarters of 2020. M&A and LBO activity declined during this period because financial market participants were unwilling to transact given the uncertainty created by the pandemic. However, by the fourth quarter, worst-case scenarios in many sectors had failed to materialize, and deal flow not only bounced back, it reached record levels, and activity has remained robust thus far in 2021. Moving forward, demand for debt financing could increase because private equity funds focused on middle-market companies have over $80 billion in dry powder available to drive LBO activity.6

This historical moment is characterized by a lack of clarity, so it’s more important than ever that direct lenders possess an uncommon skillset: capital discipline, sector-specific expertise, strong sourcing relationships, knowledge of tax-efficient strategies, and structuring experience. The pandemic has accelerated some trends – such as the shift to e-commerce and interest in advanced healthcare solutions – but it has also introduced new anxieties, like those over rising inflation. Lending into such uncertainty demands consideration of downside protection as well as upside potential. As our co-founder Howard Marks has long said, “we can’t predict, but we can prepare.”


Business Development Companies (BDCs)

What are BDCs?

Business Development Companies are closed-end investment vehicles that were created by the U.S. Congress in the 1980s to invest in and provide managerial support to small- and medium-sized enterprises. They are regulated like an investment company but have filing demands similar to those of an operating company.

BDCs are characterized by a unique set of requirements:

  • Seventy percent of the BDC’s total assets must be invested in “eligible portfolio companies” (i.e., U.S. private businesses or U.S. public companies with a market capitalization under $250 million).

  • The BDC must offer significant managerial assistance to its eligible portfolio companies.

  • No single investment may account for more than one-quarter of total assets, and over half of all investments must each represent under 5% of total assets.

    (Video) Credit Risk Considerations for Direct Lending and Private Debt

  • The BDC’s debt-to-equity ratio may not exceed two to one.

  • Annual shareholder meetings must be held to elect a Board of Directors, depending on the jurisdiction and corporate structure.

  • The BDC must file quarterly financial reports (10-Qs) and annual financial reports (10-Ks), including valuation disclosures of all investments.

BDCs can either be publicly listed on exchanges and offer daily liquidity or be structured as unlisted vehicles with defined investment and wind-down periods. Investors own shares in a BDC.

What are the tax benefits of BDCs?

Most BDCs elect to be formed as a Regulated Investment Company (RIC), an entity that isn’t subject to federal corporate income tax provided all of its taxable income is distributed to investors and the BDC meets certain source-of-income and asset-diversification requirements. A BDC will also block ECI and UBTI from flowing through to the investors. Most of the dividends paid to non-U.S. investors aren’t subject to U.S. withholding taxes because the BDC’s income is primarily derived from interest income. Additionally, BDC tax reporting is relatively simple and similar to the process used when investing in mutual funds (i.e., a 1099 form is submitted). Investors aren’t required to file federal or state returns around a liquidity event.

What are the other benefits of BDCs?

Federal regulations mandate:

  • dividend distributions,

  • greater transparency through quarterly reporting, and

  • limitations on the use of leverage.

What are some of the drawbacks of BDCs?

  • Federal regulations restrict BDCs’ potential investment opportunities.

  • Operational expenses are much higher than those of a non-BDC-structured fund because they include the cost of a Board of Directors, public filing fees, and other regulatory/compliance costs.

  • BDCs may not be the best option for investors from some European countries.

What differentiates Oaktree’s approach to BDCs?

Oaktree’s extensive firm-wide credit platform gives us access to higher quality deal flow compared to the typical BDC, meaning we can be more selective and potentially secure better terms – the foundation of risk control in direct lending. Oaktree also believes it can keep its expenses low because we have a well-established, scalable operations platform.

EndNotes

1 The National Center for the Middle Market
2 Invest Europe
3 LIBOR was formerly an acronym for the London Interbank Offered Rate; its official name is now LIBOR ICE. It’s being phased out and replaced by rates like SOFR and SONIA (Sterling Overnight Index Average). The ICE Benchmark Administration will stop publishing LIBOR for most settings after December 31, 2021.
4 Preqin
5 Refinitiv’s estimate is based on the middle-market loan amounts maturing through 2026.
6 Preqin

Notes and Disclaimers

This document and the information contained herein are for educational and informational purposes only and do not constitute, and should not be construed as, an offer to sell, or a solicitation of an offer to buy, any securities, or an offer, invitation or solicitation of any specific funds or the fund management services of Oaktree (as defined below), or an offer or invitation to enter into any portfolio management mandate with Oaktree. Any offer of securities or funds may only be made pursuant to a confidential private placement memorandum, subscription documents and constituent documents in their final form.

The term “Oaktree®” used herein refers to Oaktree Capital Management, L.P.™ or its affiliates, individually or collectively, as the context requires.

This document is being provided on a confidential basis solely for the information of those persons to whom it is given. The materials, including the information contained herein, may not be copied, reproduced, republished, posted, transmitted, distributed, disseminated or disclosed, in whole or in part, to any other person in any way without the prior written consent of Oaktree. By accepting this document, you agree that you will comply with these confidentiality restrictions and acknowledge that your compliance is a material inducement to Oaktree providing this document to you.

Responses to any inquiry that may involve the rendering of personalized investment advice or effecting or attempting to effect transactions in securities will not be made absent compliance with applicable laws or regulations (including broker dealer, investment adviser, or applicable agent or representative registration requirements), or applicable exemptions or exclusions therefrom.

This document contains information and views as of the date indicated and such information and views are subject to change without notice. Oaktree has no duty or obligation to update the information contained herein. Further, Oaktree makes no representation, and it should not be assumed, that past investment performance is an indication of future results. Moreover, wherever there is the potential for profit there is also the possibility of loss.

Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Oaktree believes that such information is accurate and that the sources from which is has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Moreover, independent third-party sources cited in these materials are not making any representations or warranties regarding any information attributed to them and shall have no liability in connection with the use of such information in these materials.

(Video) BEHIND THE STORY: Developer-Lending: Risks vs Benefits

© 2021 Oaktree Capital Management, L.P.

FAQs

What is direct lending risk? ›

The primary risks associated with direct lending strategies are credit, interest rate, illiquidity, and regulatory risk. Credit risk references the likelihood that a borrower will default in the payment of principal and/or interest.

What are the advantages of direct lending? ›

The growth of direct lending has enabled mid-sized businesses and lenders to prosper from favorable terms, greater term flexibility, high yields and negotiable risk. Middle market businesses are far more likely to secure a sizable loan from a direct lender than from a traditional financing institution.

What are the risks associated with lending? ›

What are the risks of lending?
  • RISK FACTORS.
  • AN INVESTMENT IN LOANS ON ANY PEER LENDING PLATFORM IS SPECULATIVE AND INVOLVES RISK. ...
  • RISKS RELATED TO FINANCIAL INFORMATION. ...
  • RISKS RELATED TO THE RELATIONSHIP WITH ABLRATE AND AGENTS/SPONSORS ON THE PLATFORM. ...
  • RISK RELATING TO TRADING LOANS ON THE LOAN EXCHANGE.

What is an example of direct lending? ›

Direct lending involves the transfer of funds from the ultimate lender to the ultimate borrower, most often through a third party. An example is a private party purchasing the securities issued by a firm.

What is direct lending strategy? ›

Direct lending is a form of corporate debt provision in which lenders other than banks make loans to companies without intermediaries such as an investment bank, a broker or a private equity firm.

How does direct lending make money? ›

Investors fuel the direct lending process by issuing capital to third-party fund managers or platforms, helping to finance private loans. Direct lending funds may also draw capital from business development companies and asset management firms.

Who are the biggest direct lenders? ›

The Top Direct Lending Funds

In the first category are firms like Ares, Goldman Sachs Merchant Banking, Apollo, Bain Capital, KKR, Blackstone (GSO), Cerberus, Fortress, and Centerbridge.

Who is considered a direct lender? ›

Direct lenders are non-bank creditors that make loans to businesses without using an intermediary, such as an investment bank.

How big is the direct lending market? ›

Companies borrowing in the $1.2 trillion direct lending market are looking for financing they are confident will happen, even if it costs a little more.

What are the three types of risk in lending? ›

The major risks faced by banks include credit, operational, market, and liquidity risks.

What are the 4 types of risk? ›

The main four types of risk are:
  • strategic risk - eg a competitor coming on to the market.
  • compliance and regulatory risk - eg introduction of new rules or legislation.
  • financial risk - eg interest rate rise on your business loan or a non-paying customer.
  • operational risk - eg the breakdown or theft of key equipment.

What are the 3 types of risk in principle of lending? ›

  • What is Credit Risk? The default risk on a debt that arises from a borrower who fails to make the required payments is called Credit Risk. ...
  • Credit risk assessment. ...
  • Types of Risks.
  • 1) Credit Default Risk. ...
  • 2) Concentration Risk. ...
  • 3) Country Risk. ...
  • Mitigation of Risks. ...
  • Calculating Credit Risk.
14 Mar 2020

Is direct lending considered buy side? ›

Direct Lending as an Asset Class

Direct lending has become attractive for buy side participants because of the high absolute returns as well as risk adjusted returns.

What is the difference between direct lending and private credit? ›

Private credit is an asset defined by non-bank lending where the debt is not issued or traded on the public markets. Private credit can also be referred to as "direct lending" or "private lending". It is a subset of "alternative credit". Private Credit has been one of the fastest-growing asset classes.

What is direct lending asset class? ›

Direct lending is an asset class that has historically generated attractive, risk-adjusted returns through a variety of business cycles. Despite growing interest in direct lending, the asset class continues to provide opportunities to generate alpha.

How is direct lending and dealer financing similar? ›

There's direct lending, which means you're borrowing money from a bank, finance company or credit union. Then there's dealership financing, where you apply for a car loan through your car dealer. With direct lending, you pay the financed amount plus a finance charge which is interest and/or fees imposed on the loan.

What is the difference between direct and indirect lending? ›

Indirect vs Direct and What You Need to Know

Direct loans are loans that are originated directly from your credit union to your member or future member, the consumer. Indirect loans come through a car dealership or other venue that has your credit union as one of their network lender options.

What is direct credit investment? ›

The direct credit investment strategy is focused on the opportunity set within more senior components of a company's capital structure, and with characteristics including contractual yield, shorter duration and capital preservation.

Why direct lending is a booming part of private debt? ›

Direct lending is a big part of the private debt market because it can provide lenders with the cash they need to fuel their expansion. However, direct lending comes with its own set of risks and rewards. On the one hand, lenders like CashnetUSA can offer borrowers lower interest rates and longer terms.

What is a direct lender finance? ›

A direct lending fund is essentially a professionally managed fund in which a number of investors combine their capital. The fund is then used to provide debt finance to businesses.

How much do you make in private credit? ›

The salaries of Managing Director - Private Credit Investments in the US range from $240,000 to $360,000 , with a median salary of $300,000 . The middle 67% of Managing Director - Private Credit Investments makes $300,000, with the top 67% making $360,000.

What is private credit example? ›

Notable examples of private credit include specialty lending, residential lending, and direct corporate lending.

What is private credit fund? ›

Private credit funds are pools of actively managed capital that invest primarily in loans to private companies, seeking to generate income by investing in loans of private companies.

What is indirect borrowing? ›

An indirect loan is a loan where the borrower doesn't have a direct relationship with the lender. An intermediary facilitates the lending process. Auto loans are one of the most common examples of indirect lending, with the dealership facilitating car loans through its network of third-party lenders.

Is it better to use a direct lender? ›

Consumers cut out the middleman by going to a direct lender. Doing so may also make the loan process faster. Since the lender deals directly with the consumer, the two can communicate effectively with one another rather than having to rely on someone else to relay messages back and forth.

What are the three types of lenders? ›

The three main types of lenders are mortgage brokers (sometimes called "mortgage bankers"), direct lenders (typically banks and credit unions), and secondary market lenders (which include Fannie Mae and Freddie Mac).

What is the difference between a lender and broker? ›

A lender is a financial institution that makes loans directly to you. A broker does not lend money. A broker finds a lender. A broker may work with many lenders.

Who invests BDC? ›

Qualifying as a BDC

The BDC must invest at least 70% of its assets in private or public U.S. firms with market values of less than US$250 million. These companies are often young businesses seeking financing or firms suffering or emerging from financial difficulties.

What is private credit BDC? ›

A BDC is a closed-end fund that is required to invest at least 70% of its assets in private or thinly traded public companies in the form of long-term debt and/or equity capital, with the goal of generating current income and/or capital gains.

Is CLO private debt? ›

The portfolio of loans is selected by a collateral or CLO manager, who actively buys and sells loans based on their overall attractiveness and diversification. The CLO finances this pool of loans with privately placed rated debt and equity, providing investors with market levels of return.

What are 5 financial risks? ›

Credit risk, liquidity risk, asset-backed risk, foreign investment risk, equity risk, and currency risk are all common forms of financial risk.

What are the 5 main risk types that face businesses? ›

Here are five types of business risk that every company should address as part of their strategy and planning process.
  • Security and fraud risk. ...
  • Compliance risk. ...
  • Operational risk. ...
  • Financial or economic risk. ...
  • Reputational risk.
16 Jun 2021

What is risk types of risk? ›

Types of Risk

Broadly speaking, there are two main categories of risk: systematic and unsystematic. Systematic risk is the market uncertainty of an investment, meaning that it represents external factors that impact all (or many) companies in an industry or group.

What are 3 examples of risk? ›

Examples of uncertainty-based risks include:
  • damage by fire, flood or other natural disasters.
  • unexpected financial loss due to an economic downturn, or bankruptcy of other businesses that owe you money.
  • loss of important suppliers or customers.
  • decrease in market share because new competitors or products enter the market.
1 Feb 2021

How do you manage risk? ›

Develop a plan to treat risks, so you can:
  1. identify each risk type and the level of risk to your business.
  2. suggest strategies to treat each risk.
  3. create timeframes for each strategy.
  4. decide who's responsible for specific parts of the plan.
  5. work out resources required such as money, staff and external help.
10 Aug 2021

What is risk explain? ›

Definition: Risk implies future uncertainty about deviation from expected earnings or expected outcome. Risk measures the uncertainty that an investor is willing to take to realize a gain from an investment.

What are the basic principles of lending? ›

  • The lending process in any banking institutions is based on some core principles such as safety, liquidity, diversity, stability and profitability. ...
  • While giving out loans, the lender, i.e, banks look at the capacity of the borrower to repay the loan.

Do you know the 3 types of risk ratings are given for customers? ›

Classification of the customers is done under three risk categories viz. low, medium, and high.

Which is the most important principle of lending? ›

1. Safety. "Safety first" is the most important principle of good lending. When a banker lends, he must feel certain that the advance is safe; that is, the money will definitely come back.

How much do sell side analysts make? ›

Salary Ranges for Sell Side Research Analysts

The salaries of Sell Side Research Analysts in the US range from $250,000 to $300,000 , with a median salary of $300,000 .

How do sell side analysts make money? ›

Sell side equity research makes money indirectly, primarily through commissions generated when the buy side trades through the sell side trading desks. You see, research is one (very important, I might add) part of a three-part team that also includes sales and trading.

How do you get into buy-side? ›

Associates on the buy side are recruited from MBA programs around the world, as well as from sell side equity research pools. An associate typically spends three to four years in that position until they become an associate-analyst, and, finally, an analyst.

What are the different types of credits available to a customer? ›

What Are the Different Types of Credit? There are three main types of credit: installment credit, revolving credit, and open credit. Each of these is borrowed and repaid with a different structure.

What does a private credit analyst do? ›

A credit analyst is responsible for assessing a loan applicant's ability to repay the loan and recommending that it be approved or denied. Credit analysts are employed by commercial and investment banks, credit card companies, credit rating agencies, and investment companies.

What is considered fixed income? ›

Fixed income is an investment approach focused on preservation of capital and income. It typically includes investments like government and corporate bonds, CDs and money market funds. Fixed income can offer a steady stream of income with less risk than stocks. Are you a financial advisor?

What are the advantages of direct lending? ›

The growth of direct lending has enabled mid-sized businesses and lenders to prosper from favorable terms, greater term flexibility, high yields and negotiable risk. Middle market businesses are far more likely to secure a sizable loan from a direct lender than from a traditional financing institution.

What are the advantages of dealership financing? ›

Financing a new vehicle through a dealership can offer incentives such as cash back, lower interest rates, and even trade assistance cash when you use their subsidiary lender.

What is alternative credit? ›

Alternative credit is a type of financing provided to corporate borrowers or against real estate assets that may be otherwise hard to secure in traditional, public credit markets.

What is the difference between direct and indirect lending? ›

Indirect vs Direct and What You Need to Know

Direct loans are loans that are originated directly from your credit union to your member or future member, the consumer. Indirect loans come through a car dealership or other venue that has your credit union as one of their network lender options.

Who is considered a direct lender? ›

Direct lenders are non-bank creditors that make loans to businesses without using an intermediary, such as an investment bank.

What is the difference between direct lending and private credit? ›

Private credit is an asset defined by non-bank lending where the debt is not issued or traded on the public markets. Private credit can also be referred to as "direct lending" or "private lending". It is a subset of "alternative credit". Private Credit has been one of the fastest-growing asset classes.

Do banks do direct lending? ›

Credit-related groups at the large banks work well if you want to break into direct lending. Think: Leveraged Finance, Restructuring, and M&A and industry teams with solid deal flow and debt-related deals.

What means are used in direct financing in direct financing? ›

Direct Finance: Direct finance occurs when you apply for a loan through the same lender, which is usually a bank or other financial company. With direct finance, you'll receive your personal loan or interest rate, and then you'll know how much you'll have to spend at the dealership.

Who provides TILA disclosures in direct lending? ›

The purchaser or assignee that acquires the loan must provide the required disclosures no later than 30 days after the date on which it acquired the loan.

What is direct to consumer lending? ›

Consumer-direct lenders provide lending options to a higher volume of borrowers using mortgage CRM software and other apps to provide a web-based lending experience, while traditional retail lenders use loan officers to work directly with the borrower on their loan.

Is it better to use a direct lender? ›

Consumers cut out the middleman by going to a direct lender. Doing so may also make the loan process faster. Since the lender deals directly with the consumer, the two can communicate effectively with one another rather than having to rely on someone else to relay messages back and forth.

How big is the direct lending market? ›

Companies borrowing in the $1.2 trillion direct lending market are looking for financing they are confident will happen, even if it costs a little more.

What are the three types of lenders? ›

The three main types of lenders are mortgage brokers (sometimes called "mortgage bankers"), direct lenders (typically banks and credit unions), and secondary market lenders (which include Fannie Mae and Freddie Mac).

Is direct lending considered buy side? ›

Direct Lending as an Asset Class

Direct lending has become attractive for buy side participants because of the high absolute returns as well as risk adjusted returns.

How is direct lending and dealer financing similar? ›

There's direct lending, which means you're borrowing money from a bank, finance company or credit union. Then there's dealership financing, where you apply for a car loan through your car dealer. With direct lending, you pay the financed amount plus a finance charge which is interest and/or fees imposed on the loan.

How do you explain a private credit score? ›

Private credit is a way for businesses to raise capital (money). In private equity, an investor owns all or part of the company. In private credit, the investor lends money to the company in exchange for interest payments and can impose covenants and/or collateralization that secures the loan.

What is direct lending asset class? ›

Direct lending is an asset class that has historically generated attractive, risk-adjusted returns through a variety of business cycles. Despite growing interest in direct lending, the asset class continues to provide opportunities to generate alpha.

Why direct lending is a booming part of private debt? ›

Direct lending is a big part of the private debt market because it can provide lenders with the cash they need to fuel their expansion. However, direct lending comes with its own set of risks and rewards. On the one hand, lenders like CashnetUSA can offer borrowers lower interest rates and longer terms.

What is direct credit investment? ›

The direct credit investment strategy is focused on the opportunity set within more senior components of a company's capital structure, and with characteristics including contractual yield, shorter duration and capital preservation.

Videos

1. Webinar | Direct Lending - The Benefits of Scale and Differentiated Sourcing
(TEXPERS)
2. In conversation with Richard Miller: The state of the US direct lending market in 2022
(SuperReturnTV)
3. New Horizons: The Evolution of Direct Lending and Illiquid Credit
(Milken Institute)
4. Direct Lending to Small Businesses
(Beyond Wall Street)
5. Private Debt & Direct Lending Capturing Opportunities in New Issues or the Playing the Secondary Ma
(FLAIA)
6. A New Benchmark for Direct Lending
(The Lead Left)

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