Here is Why Small-to-Medium Sized Businesses Are Turning to Direct Lenders

Author: Julie Jenkins | March 21, 2019

The term direct lending is used when an organization directly lends the money to the borrower without involving any bank. After the financial crises, the regulations became quite tough, which forced the regular banks to minimize business lending. These conditions became an opportunity for asset managers who emerged as the “savior” lenders for mid-to-large sized companies. The regulators, however, are concerned if the market could sustain and manage this type of growth without getting into trouble.
To understand the process more clearly let’s answer some of the most frequently asked questions:
What exactly is direct lending?
Initially, asset managers such as private-equity and hedge funds became direct lenders. Now, other investors such as insurance firms are also collecting funds from different investors to become high-yielding lenders. These direct lenders mostly do their own research work before investing their money in long-term loans. In addition to lending, direct lenders also, at times, offer support to the borrower and assist with growth planning.
Who are the borrowers?
Most of the borrowers are mid-to-small range businesses that usually fail to get loan approvals from the banks. Since these businesses do not have enough options, therefore, direct lenders mostly loan them the much-needed funds at higher than usual interest rates.
Why is direct lending, despite higher interest rates, becoming popular?
Direct lenders have continuous cash flowing into their loan pool and they are constantly on the lookout for different deals. According to Preqin, a research firm, almost a third of the total investors may prefer to invest their money more in private debts this year as compared to 2018. Half of these investors intend to enter long-term deals.
Preqin’s report further stated that $129 billion in 2017 and $110 billion in 2018 went into private debt capital. Direct lending funds constituted 41 percent of this capital. As of June 2009, the industry has assets worth $770 billion under management. The biggest center for direct lending, so far, is North America and it holds about 61 percent of the total market share, says Deloitte.
How do these deals work now?
Both in Europe and the United States, the competition in the direct lending market is quite fierce. More and more borrowers are turning away from traditional banks and going to direct lenders for their loans. As a result, lenders, in some cases, do not have the kind of protection they would like.
With more funds in direct lenders’ vault and the growing competition, the checks for deals are getting bigger. Some of the lending funds are even joining forces to offer packages with large finances to the borrowers. In February we saw one of the largest transactions in Europe’s private debt sector when Ares Capital gave 1 billion pounds to Daisy Group of U.K. Telecom Services. These bigger checks are one of the main contributors to a very impressive growth rate in the sector.
Is direct lending a risk?
Most of the direct lenders prefer to invest in companies that are too small in size to secure loans from conventional banks but promise growth. However, recently, a few lenders have also started to lend money to companies that do not have bright prospects, which increases the risk factor for the lenders. This is probably a direct consequence of the increasing competition in the market.
Even though the competition is high, the companies that go to direct lenders are the ones that fail to get loans from regular banks. This gives lenders a great window to draw up contracts that promise higher returns and profits for their investors.
What is the biggest con of direct lending?
The idea of investing in companies that are “desperate” for loans at higher interest rates may seem very attractive. However, the loan recovery from these companies in the times of economic recession may not be that easy. According to JPMorgan’s CEO Jamie Dimon, direct lenders could find themselves in a position where they may not survive a downturn as they offer lower-quality loans. How does it impact the borrower? If, during the time of recession, direct lenders disappeared then many borrowers may find themselves “stranded”.

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