Given the massive layoffs, default spike and deal-making dearth, the term “distressed” doesn’t begin to describe middle-market lending. At this point it’s more like “freefall.”
No one’s experienced that firsthand like Ian Fowler and Chad Blakeman of CastleGuard Partners, a new debt provider based in Chicago. The pair previously co-founded Freeport Financial five years ago with backing from hedge fund Start Investments. After spending months out of the market in 2008, in February Freeport laid off all but around four of its employees, who stayed on board to manage existing investments.
In April, Fowler and Blakely joined forces with Victor Viner, former co-founder and CEO of Volaris, an option strategy firm which sold to Credit Suisse in 2003. The three founded CastleGuard Partners with the goal of helping to turn the tide in middle market financing. The firm foresees $100 billion or more of middle market debt reaching maturity in next two years, and hopes to get a piece of their refinancings while their competitors lick wounds from legacy investments on the sidelines. I spoke with them earlier today about the firm’s source of capital, differentiating factors, and outlook for deal origination in the second half of the year.
What is the firm’s source of capital? Will you raise an institutional fund or are you speaking with backers?
Victor Viner: We are in the process of talking to a variety of institutional investors. We started the firm with capital from ourselves. We’ve been evaluating opportunities to purchase existing portfolios and in the origination and refinancing of loans coming due in the next three years. We need an equity partner and have been talking to some. We hope to have one lined up in the next 60 to 90 days.
How advanced are the discussions?
Victor Viner: We’ve signed some NDAs (nondisclosure agreements). Right now we’re just trying to optimize our structure for the needs of the market.
Is there a size you’re targeting?
Ian Fowler: There’s no clear answer to that. What we’re trying to achieve is getting the right investor. A lot of entities from the past cycle were built around a one year warehouse facility that exited to the CLO market. We don’t want that. We want to make sure our investors have a longer term horizon.
It will be more than a few hundred million but don’t want to pigeon-hole ourselves until we have the right investor. We’re also talking to investors about providing leverage.
What has the reception been like from institutions?
Ian Fowler: Over the last few months we’ve noticed a chance with investors but people are now focusing on the opportunities that are out there. This is a pretty easy opportunity to see when you look at all the refinancing that’s required. For us in particular, we don’t have any legacy issues. That’s been the issue that investors on the sidelines have had difficulty jumping in.
What will differentiate the firm from the few other players that are still active in the market?
Chad Blakeman: Well, really, there aren’t a lot of folks out there making loans. There are a few. By far most of the players have legacy issues that they’re trying to digest. Whether its problem loans or highly leveraged situations or low pricing situations, they’re trying to manage sizable portfolios, so there’s a reluctance to make new loans. It is a key determining factor. A lot of folks have virtually just ground to a halt.
Ian Fowler: We’re getting a lot of emails from PE firms that are rooting for us for lack of a better term. We’re trying to create some buzz in the space and with the way we’ve positioned ourselves. We’re hoping we can help create some momentum for the middle market.
Victor Viner: There are a number of new groups starting now as people are leaving other places of employment. One differentiator we have from them is my background in capital markets and trading, which brings a different perspective and experience. I’m implementing significant technology that I developed that enables us to look at loans for what may come in the future, instead of just servicing them. We’re also starting to generate some original content to provide to the middle market space and position ourselves as thought leaders in the industry.
Will CastleGuard look at unwinding distressed legacy assets on other firms’ balance sheets? What is the target mix between that, refinancing, and origination?
Victor Viner: We’re opportunistic and looking at some portfolios, and we even circled capital for those, but ultimately we didn’t see anything we liked. But we are looking.
Chad Blakeman: Our primary focus is on refinancing. It’s such a huge opportunity and will require a lot of capital given the dislocation that’s out there.
Ian Fowler: For the right situations, we will acquire the right assets. But we’re not a distressed fund. We want to position ourselves as more of a specialty finance shop, if you want to call it that.
Where in the capital structure do you plan to focus? Is mezzanine or sub debt of interest to CastleGuard?
Chad Blakeley: We’re sticking with bank loans, specifically senior debt. It produces attractive returns to the investor but is also the safest place to be in the capital structure at this time. You have collateral, covenants, things that are more protective of the asset class. There are not a lot of players out there so the opportunity to get enhanced returns is far better than it was in the past.
Do you think there’s a chance new deals will begin to spring up more in the back half of the year, or is 2009 destined to be a total dud?
Chad Blakeman: It’s possible [that 2009 could be a dud]. Without that new capital available it’s just tough to get things done this year. The LCD reports we’ve seen showed only 1 or 2 transactions closed in the beginning of the year. Nothing’s really getting done. A lot of it is trying to manage the portfolios that people have right now. Amendments are up something like 3.5x what they were at this time last year.
Earlier: Freeport Financial Empties Ship