In 2004, when Ted Koenig set out to establish Monroe Capital, the world was much different than it is today. Barack Obama was still an Illinois State Senator, Facebook was just beginning to shed its pet project status and the New England Patriots were the defending Super Bowl champions. Okay, so not all things have changed.
Still, Monroe Capital was born in a different environment than the one financial professionals inhabit now. Despite the tumultuous decade since its inception, Monroe has built itself from a start-up specialty finance company to one of the major players in the buyout and transactional finance space.
The Balance Shifts
“When we established Monroe Capital, my goal was to create a middle market specialty finance firm that was dependable, reliable, user-friendly and would stand the test of time, no matter what economic cycle we were in,” says Koenig, Monroe’s president and CEO.
In its first 10 years, Monroe navigated its way through a slew of economic cycles, some gentle and others tumultuous, allowing Koenig to test his new company’s ability to weather the calm of economic stability, the storm of economic downturn and the tepid climate of economic recovery.
From 2004 to 2007, competition was fierce from a financing perspective. Winning deals came down to one simple factor: capital. Whichever bank or hedge fund could provide the most was usually the one celebrating at the finish line. During this period Monroe entered the fray, feeling its way in an environment that, while competitive, presented many opportunities.
Then came 2008 and the Great Recession. The regulatory capital levels of banks dried up due to losses and mark downs in loan portfolios. Many hedge funds were essentially decimated due to miscalculations in making illiquid loans to private companies. The hedge funds that survived began to “gate” or block off their limited partners from redeeming their invested capital, effectively locking them out of new fundraising from the institutional investor community. Those funds and firms backed by faltering hedge funds had to sell their good, performing loan assets at whatever price they could get to create liquidity to meet redemption requests.
Similar results developed when funds had market-to-market credit facilities, usually in the form of what were called TRS (Total Return Swap) credit facilities. A previously efficient way to fund loan assets, TRS facilities became problematic when loan prices fell, as Koenig says, “like a ton of bricks.” Overnight, capital calls were made on these types of bank facilities, and since most hedge funds could not cover them, they were forced to sell their loan books at deeply discounted prices.
While hedge funds were brutalized in these exchanges, Monroe was able to benefit from the sale of such loans.
“We were an active buyer of these private illiquid loans at that time, usually in the 75% to 90% range on what would later prove out to be all par-level recoveries,” said Koenig. “Many of these hedge funds never recovered, and the finance firms that were backed by these hedge funds quickly folded.”
Of course, hedge funds weren’t the only ones affected by the economic crisis. Banks also had to contend with the changing environment to survive. Many did so through TARP funding, creating radically different business models, while others consolidated to avoid being completely wiped out. As they scrambled to keep their heads above water, banks also felt the crush of increased regulatory requirements with the passage of the Dodd-Frank legislation. Required regulatory capital levels were increased and certain types of on-balance sheet activities were cut out entirely by legislation. This essentially took regulated banks out of the on-balance sheet, middle market enterprise value and cash flow-based, deal lending business. Once again, Monroe was able to seize the opportunity and provide these services.
“That same enterprise value and cash flow-based lending was precisely the product that Monroe had developed during that period of time,” says Koenig. “We worked hard on creating a strong cash flow lending business post-Great Recession to both the private equity sponsor and non-sponsor community in the lower middle market.”
With competition largely gone, as banks and hedge funds became non-factors or, at the very least, restricted participants, Koenig saw an important need for the market and an opportunity for Monroe.
“The market needed this lending product, as that was the only way middle market buyout deals were getting financed as the asset-based lending market could not create enough availability to cover the purchase price multiples being paid for healthy businesses,” Koenig says.
The market has evolved from the immediate post-recession environment, and so has Monroe, as it continues to deliver products and capabilities to customers in the lower middle market, including private equity sponsors. Monroe’s reach has broadened considerably with nine offices across the U.S. and Canada and a portfolio of roughly $3.1 billion in loans across more than 200 borrowers.
“We have become much more of an asset manager with limited partner investors located throughout the U.S., Europe and the Middle East, consisting of many universities, endowments, state, county and city pension funds, foundations, hospitals, churches, sovereign wealth funds and high net worth families,” says Koenig. “We also have an active collateralized loan obligation business and a publicly traded, business development company in Monroe Capital Corporation (MRCC). However, we are still the same dependable, reliable, user-friendly business that we set out to create in 2004.”
Despite substantial growth, Koenig does not view the increased size of the company as the only barometer of its ability to thrive over the last decade.
“I am a big believer that growth for growth’s sake should not be the defining measurement of success. In our business, there are lots of ways to measure growth. Mostly, it is in assets under management, or AUMs, as it is referred to in our industry. However, all AUMs are not created equal,” says Koenig, noting that Monroe is on its 10th investment fund vehicle and has provided capital to more than 550 different borrowers over the last decade, while growing at an approximate 30% CAGR since the Great Recession. “Those are the growth metrics that I am most proud of.”
Koenig says that Monroe currently has multiple borrowers in each of the 30 or so Moody’s industry classifications. To service such a diverse customer base, Monroe puts an emphasis on careful borrower selection, thoughtful credit/underwriting decisions and meticulous portfolio monitoring and management.
“While we may not win every deal, although that is clearly my goal, I want to make sure we are in a position to ‘see’ every deal,” says Koenig, who notes that Monroe sees about 2,000 deals per year but funds only 50 to 60 on average. “We provide private equity sponsors and company borrowers with quick and honest feedback. We close on what we propose, and we do not re-trade our deals. We have achieved a market reputation as being a go-to provider for transactional finance over the last 10 years. That is critical in our business.
“In a competitive market for buyouts among financial sponsors and others alike, the strength, honesty, reliability and longevity of a financing partner can often be the difference between winning a deal for a sponsor or not being included in the final bidding group,” says Koenig.
Monroe’s strategy worked in 2015. Its funds added over $1 billion of new loans for its borrowers in 2015. On the public side of the business, in its Q3/15 financial report for YTD/15, Monroe showed investment in new portfolio activity of $125.3 million, up 38% from the $90.6 million logged during the same period in 2014. Additionally, it had a Q3/15 end portfolio of $329.7 million, up 41% from YE/2014.
“Our BDC, like many others, is experiencing growth in loan assets due to the general lack of aggressive bank players in the market today for transactional finance. The really neat thing about our BDC, MRCC, is that it has consistently been one of the top performing BDCs in the space, it pays a current cash dividend of around 10%, and has yet to incur a realized loan loss since its IPO in 2012,” says Koenig. “MRCC is growing its loan portfolio with good quality loan assets and is completely covering its dividend with core investment earnings. That is the type of BDC that I would want my friends and family to invest in.”
Monroe has also had great success in small business investment. It launched its first Small Business Investment Company (SBIC) fund in 2012 and has risen to prominence in the industry since, winning the Small Business Administration’s 2015 award for SBIC of the Year.
“It’s always nice to receive awards, as they are a reflection of what others think about your work and your firm. We have been blessed to receive many lending and investing awards since 2008,” says Koenig, adding that Monroe currently has three SBIC fund licenses. “The common thread underlying these awards is having best in class people in our organization. We are one of the very few asset management and finance firms that are 100% owned by management. We have a complete alignment of interests with our investor limited partners and our shareholders. That is a huge selling point for our firm.”
A big move made by Monroe in 2015 was the launch of its newest vertical, which will provide asset-based lending to the retail and consumer products industry. It is a return to a familiar space for Monroe, which has its roots in doing second lien asset-based term loans for retailers such as FAO Schwartz, Family Toy, Payless Cashways, MC Sports, Natural Wonders and others.
Though Monroe has been predominately focused on being a first lien, senior secured cash flow and enterprise value based lender since its inception in 2004, Koenig says the company has kept its eye on the retail and consumer goods industry and recently decided it was the right time to enter the space.
“We see an opportunity to capitalize on our deep, long-term dated and permanent capital base, together with a history of best in class underwriting and credit, to be a ‘solutions oriented’ lender in this space,” says Koenig. “There has been, and will continue to be, dislocation in the retail lending space, with what has been happening to regulated financial institutions courtesy of the Fed, OCC, Comptroller and so forth, combined with the recent consolidation in the overall asset-based lending market and to the retailers themselves, as many have been and will be increasingly challenged by the internet and companies like Amazon. We have the ability to provide a clean and elegant solution to middle-market companies operating in this space that the banks today simply cannot match in terms of availability, liquidity and flexibility of structure. As it has been the case with our other verticals, my guess is that we will become preferred partners to companies and to other banks in this space, rather than being viewed as competitors.”
With a number of successful verticals in its stable, Koenig and Monroe have a clear experience-based strategy when it comes to entering an underserved industry. That strategy centers on having the right talent to lead.
“The reason we establish verticals in our business is that we have identified the best athletes available to play a position, much like drafting players for a professional sports team,” says Koenig. “We want the best players at each position that are as knowledgeable about their borrowers’ businesses as their own borrowers. In my view, that philosophy leads to long-term success.”
While there was not the same pomp and circumstance of the NFL draft when Monroe brought in Andy Moser and Marc Price to lead its retail and consumer products division, it was still major news for the industry. The duo not only has strong ties to Koenig and Monroe but also boasts immense industry experience, making them the “best athletes available” as well as the perfect fit for Monroe’s roster.
“Throughout my career I have admired Ted’s longevity and passion in respect to the evolution of middle-market lending. Over the years, Ted, Andy and I have always made time to discuss successes and challenges in respect to our lending platforms,” says Price, who was an executive vice president at Salus Capital Partners and who has also worked with EMCC and State Street Global Advisors. “Timing is everything as it relates to one’s professional career, and when the opportunity presented itself to co-head a Retail & Consumer Products ABL Group within the well-established Monroe Capital platform, I felt it was a great match culturally where we could all be successful for a long period of time.”
Moser, the former president and CEO of Salus who has led the asset-based lending units at First Niagara Bank and NewAlliance Bank, echoes Price’s sentiments.
“The opportunity to collaborate with Ted on a new industry platform has been years in the making, and in many ways, I’ve considered him a mentor whom I’ve always respected. We’ve shared each other’s successes, missteps and collaborated on industry best practices with an eye toward building a great platform and anticipating the needs of the market,” says Moser. “So when I was approached to co-lead a new industry vertical with Marc Price and join Monroe, the timing was right. It’s an opportunity that I’ve always wanted to see come to fruition.”
Talent alone doesn’t make for strong business performance. Luckily for Monroe, Moser, Price and Koenig see a great deal of opportunity for the new vertical, which will further enhance Monroe’s standing in the financial services industry.
“Monroe is poised to continue leading the way as an alternative, non-bank provider of capital solutions, and entering the retail and consumer products sector is a natural extension of their business,” says Moser. “Trends in our sector together with the overall economy point to many opportunities for Monroe, and maintaining a disciplined and selective approach to lending money will be critical. As far as retail, trends and change itself are faster than ever before and the gap between winners and losers is widening further.”
What Comes Next?
With a new division, substantial growth and a number of accolades in tow, Monroe is set to tackle the challenges of 2016 and beyond. In the near term, continuing the same levels of success should not be overly difficult, as Koenig expects 2016 to be much like 2015, with money readily available and plenty of deals to go around.
Nonetheless, there are still some areas of concern. Koenig thinks the private equity business will become more difficult as there is currently more than $500 billion of PE dry power, or funds raised and not yet invested, while purchase price multiples remain elevated.
“The days of buying a company for a low multiple, doing some financial engineering, growing EBITDA and then selling the company for a high multiple are in the past,” says Koenig, who also notes that banks will continue to be less active in the middle market buyout financing market due to increased regulation. “Today, PE firms will need to add some real and ongoing value in terms of management, customers, markets, margin, etc. if they are going to succeed in generating acceptable investment returns.”
Koenig also thinks that the search for yield will continue, but that 2016 will be the year that individuals figure this all out, following in the footsteps of insurance companies, pension funds and universities.
“Many post baby boomers, those 50 years old and older, now need to think about a current return strategy for their own personal investment portfolios,” says Koenig. “The days of counting on social security or funded IRAs for retirement benefits are over as most of us will live much longer and the costs to support our future health care needs will be far greater than any actuarial assumptions could ever have been imagined 20 to 30 years ago. Investments in companies like MRCC will become a necessary part of personal retirement planning because of the stable long term dividend yields.”
Finally, Koenig warns of both traditional risk — unemployment, labor costs, taxes and government regulation — and global risks such
as cyber-crime and terrorism.
While future challenges may be different, over the course of a decade, Koenig has proven he can navigate Monroe through both tumultuous and flourishing times. Now he’ll set out to do it all over again.