A lot has happened in the last couple of decades in banking since the mid 90’s when I was a junior analyst running around the trading floors of London, hoping that soon I would get to do something more than…
A lot has happened in the last couple of decades in banking since the mid 90’s when I was a junior analyst running around the trading floors of London, hoping that soon I would get to do something more than get my boss some coffee. Whether the Asian Financial Crisis, or the Dotcom boom (and bust) the banking world has picked up the pieces, adapted and moved on. What I feel however after the Global Financial Crisis, is that there is a recognition (perhaps forced in some cases given that many tax payers ended up owning the banks) that the system truly broke, and perhaps has been broken for a while. What this has led to is some truly dynamic moves in the market, from the creation of new solutions to old problems, to the acceptance in many cases that a re-think and re-group of key areas of an organization is required.
One such big change in the US debt market that in many ways represents some of this is GE’s recent decision to exit the acquisition finance market. For many years, General Electric Co. (GE) had been the dominant player in lending to private equity firms requiring financing to acquire mid-market companies in the U.S. But last month GE announced the sale of its private-equity lending business to the Canada Pension Plan Investment Board (CPPIB), the largest pension fund in Canada, in a deal valued at $12 billion dollars, marking an important turning point in the U.S. lending market.
Expanding its role to become a dominant lender for mid-market M&A transactions may seem like an odd choice for a pension fund, but CPPIB seems to be attracted by the promise of steady returns kicked off by the large loan portfolio, which at least in theory lines up well as a funding source for its longer-term pension liabilities. “We are buying an ice cube that will never melt,” CPPIB Chief Executive Mark Wiseman explained to reporters from The Wall Street Journal. Whether this proves to be a great sale by GE or a great buy by CPPIB only time will tell.
GE’s sale of the sponsor finance unit, which includes Antares Capital and its $3 billion bank loan portfolio, was reportedly driven by the current low interest rate environment, in which GE found it increasingly difficult to compete with larger financial institutions, which enjoyed access to capital at much lower rates than GE itself could borrow, since GE’s access to the commercial paper market had been curtailed in the wake of the 2008 financial crisis.
The real question facing the buyout market now is whether GE’s exit from the market will have any long term effect on access to capital for private equity dealmakers or the ability to finance mid-market transactions going forward. It’s hard to overstate just how large a role GE has played in the deal market for mid-market companies over the last 10-15 years. By one recent estimate, GE Capital’s middle market loan portfolio at its peak was nearly eight times the collective loan assets held by all Business Development Corps combined. In a sense, CPPIB appears to be a good buyer for purposes of providing continuity to the deal market inasmuch as CPPIB has been an active participant in the U.S. buyout market, both as investor in private equity funds and as a lender, at least since 2009 when it established its own lending unit to take advantage of the retreat from the market of traditional lenders. When this deal closes, CPPIB will vault from a relatively marginal role to become the dominant player. Will CPPIB try to expand their new found position in this market or just “bank” on steady yield?
While CPPIB’s purchase of the GE lending business no doubt offers stability and continuity to the mid-market deal market in the short to medium term, the longer-term outlook still remains uncertain. The combination of record low interest rates and regulatory pressures that drove GE to exit the market continues to create stresses on other firms and something of a red flag for future refunding needs. There may be many borrowers who rushed into cheap debt markets over the last few years who find themselves with far fewer and much more expensive options when they need to refinance in the next 3-4 years.
Herbert Stein, the former chairman of the Council of Economic Advisors under Richard Nixon, is credited with formulating his own economic law: “If something cannot go on forever, it will stop.” The current low-interest and low-default environment certainly seems to be no exception to Herbert Stein’s law. It remains to be seen when interest rates begin rise again, and credit starts to tighten, just what sort of support CPPIB extends to borrowers in the mid-market, where it now finds itself holding such a dominant position.
Romesh Jayawickrama is the CEO of Aurigin (formerly BankerBay). He can be reached at email@example.com.