Ted Koenig, how is Monroe Capital positioned in the personal lending business?
Ted Koenig: Monroe is positioned as a provider to U.S. mid-market companies with revenues of between $50 million and $250 million and EBITDA of $5 million to $40 million. Given the inefficiencies of this market, we have the opportunity to achieve a higher interest margin behind our debt, along with key protections for lenders – loan arrangements, pledging of assets and shares, reduced debt and larger equity buffers. This market segment helps us generate „alpha“ for our investors, as opposed to lenders who focus on larger companies that can look for financing solutions in both public and private markets. We are one of the largest asset managers in this segment, managing approximately $20 billion in assets under management (AUM). Our portfolio includes over 450 companies and invests in approximately 110 transactions per year. In the debt market, we have grown by 25 percent per year (CAGR) over the past 15 years.
How has the private credit asset class changed and how have the associated market opportunities developed?
Ted Koenig: The growth of personal loans has increased significantly since the global financial crisis of 2008/2009. Previously, banks dominated the corporate lending business, also in the European market. However, due to the new strict regulations for banks, they have now become much more limited in their ability to lend to medium-sized companies. Asset managers like Monroe fill the gap that banks leave in the financing market. Twenty years ago, we started with U.S. pension funds and insurance companies. At that time, the European market was still completely dominated by banks. After the financial crisis, private lenders gradually entered the European market. It started in Germany, followed by Great Britain and France. In Germany, banks, especially the Landesbanken, continued to have a strong market position in the corporate lending business. Therefore, the US market was much easier for managers like us and we were able to grow significantly. Today, regulators in Europe have tightened capital rules and regulations for all banks, similar to those in the US. This has created a significant demand for personal loans, and demand will continue to grow in the coming years.
What factors are driving the growing interest of pension funds in the private credit asset class?
Ted Koenig: Pension funds traditionally invest mainly in fixed-income securities such as government and corporate bonds. Their motivation lies primarily in the security and preservation of assets. During the financial crisis, pension fund investors lost a lot of capital by investing in equities and alternative investments. Then came the low interest rate environment and its effects. This created a very large financing gap for pension funds. At that time, they needed a return of 6 to 7 percent in the US and Europe to cover their costs and obligations such as health insurance, welfare, retirement provision, etc. When interest rates fell to 2 to 3 percent, the big pension funds faced a cash flow shortage because their assets were invested primarily in fixed-income securities. This led to a wrong situation for the pension funds. Five or six years ago, they started investing in private loans because it allowed them to achieve stable, predictable and safe returns of 8 to 10 percent with significantly lower volatility compared to public credit markets. As a result, the private credit asset class has grown significantly due to demand from pension funds and insurance companies.
In the meantime, the interest rate situation has changed.
Ted Koenig: With the rise in interest rates over the past two years, traditional fixed income securities have become more attractive to investors again, as they are liquid and well-valued. Personal loans, on the other hand, are illiquid and have no rating. However, investors can only achieve prime returns of 5 or 6 percent with fixed-income securities. In contrast, direct lending can generate returns of 10 or 12 percent. Pension funds and insurance companies have become accustomed to higher returns and want to continue to achieve them.
What is the outlook for the private credit market?
Ted Koenig: We have been observing the same trend for years in the USA and now also in Europe: banks are confronted with ever stricter regulations. The stricter regulations are aimed at better protecting shareholders. They may be good for banks and shareholders, but bad for borrowers, medium-sized companies, and business deals. If a bank has to hold more capital due to regulatory requirements, it needs more capital to lend. This capital dilutes the bank’s returns to its shareholders. As a result, banks in the US and Europe avoid business activities that require them to provide more balance sheet capital for loans. They prefer to engage in fee-based businesses that do not require large capital commitments. This opens up new business opportunities for private loan investors and provides more opportunities to gain market share. This trend will continue in leveraged financing outside banks. The demand for financing on the market is high and will continue to grow.
Is Monroe Capital particularly strong in certain industries and new technologies?
Ted Koenig: Our business is growing in all industries. Since we are not regulated like traditional banks, we can be creative and focus on areas of new technologies. Our particular focus is on business services, technology and software, as well as the healthcare services segments, which tend to have a high barrier to entry and an economic barrier around their products or services. These are usually also transactions with higher margins. A good asset manager should always strive to generate „alpha“ for his clients. Liquid loans are a beta business. Investors can first grow with liquid loans and then slip into the beta market. In my view, loans should generate alpha. Therefore, it is our job to identify the sectors that offer above-average returns. From the point of view of diversification, we are active in all areas and are looking at where we can achieve the returns that our clients need.
The buyout market has stalled internationally in recent years. What are the reasons for this?
Ted Koenig: In today’s buyout market, there is a mismatch between the expectations of buyers and sellers. All sellers still believe that we are in 2021. The buyers, on the other hand, live in 2024. The multiples were different in 2021, and sellers have not yet come to terms with the fact that they have changed today. Back then, markets were good for them, and in 2022, 2023, and 2024, they waited for cheap stock valuations and purchase price multiples like in 2019 and 2021. Today, private equity firms sit next to them: they stay longer with their portfolio companies and wait for their sales value to increase. Soon, however, the GPs will have no choice but to sell because the LPs want their capital back. GPs must therefore pay out the capital to the LPs. I expect to see an increase in deal flow in the fourth quarter and then further acceleration in 2025 as interest rates continue to fall. In 2024, private equity firms are currently waiting for falling interest rates and rising purchase price multiples.
What market developments do you expect in the medium term?
Ted Koenig: I don’t expect any major changes in the markets in the short to medium term. Regulations will continue to make life difficult and complicated for banks. As a result, more and more financing transactions are being shifted to personal loans. This has shaped the US market over the last 12 to 13 years, and I expect a similar development in Europe. Personal loans remain the fastest-growing alternative asset class, with strong managers offering attractive risk-adjusted returns to their investors.
Dr. Guido Birkner ist Chefredakteur von dpn – Deutsche Pensions- und Investmentnachrichten. Seit dem Jahr 2000 ist er für die F.A.Z.-Gruppe tätig. Zunächst schrieb er für das Magazin „FINANCE“, wechselte dann als Studienautor 2002 innerhalb des F.A.Z.-Instituts zu den Branchen- und Managementdiensten, später zu Studien und Marktforschung. Von 2014 bis 2020 verantwortete er redaktionell den Bereich Human Resources in der F.A.Z. BUSINESS MEDIA GmbH. Seit Juli 2019 gehört er der dpn-Redaktion an.