Fitch Ratings is raising concerns that as middle-market collateralized loan obligations become more popular and traditional high-yield CDO asset managers invest in the sector, not enough attention is being paid to the nuances of the asset class. The stable performance history that is now becoming available is a big driver to the growing acceptance, according to Alla Zaydman, a director with Fitch's credit ratings group. "There is also an abundance of lenders looking to lend and securitize and borrowers wanting to lower spreads," she said. But what worries Fitch is that playing in the middle market requires a skill set different than that needed to buy syndicated loans.
Middle-market lending firms such as American Capital Strategies and MCG Capital Corp. are growing and firms that invest in mid-market deals and more broadly syndicated loans are increasingly lending to middle market companies. From 2000-03 Fitch rated $2.65 billion of liabilities funding middle-market CLOs, while in 2004, $2.8 billion of liabilities were rated.
But there has also been an influx of institutional buyers in the space. "What is driving them is technicals," said one banker at a firm with a strong franchise in middle-market lending. An abundance of cash and a search for yield is the predominant reason why institutions are now buying these deals, he said. Zaydman is cautioning investors to look at whether the managers of CLOs with buckets for middle-market loans have the necessary expertise. "We hope they go out and find the necessary expertise and hire a team to complement their other skills," she said.
"When you are dealing with widely syndicated loans, there is public information and the arranger has generally done a good deal of due diligence," Zaydman noted. When you are talking about middle-market you need to do your own due diligence," she noted. The banker said middle-market deals are generally not rated and the credit quality is usually a little lower than the larger deals. But he said the level of due diligence and underwriting quality depends on the arranger and increasingly, middle-market deals are being rated at the request of the bank. Also, there is a more liquid secondary market developing, with the lenders generally axed in their names and the allocations more broadly syndicated.
