During the height of the credit crisis in 2008, Walter Owens, then-president of corporate banking at CIT Group at the time, talked to other bank leaders about how to find liquidity on the balance sheet. He reached out to Denis Nayden and Doug Kaden at private equity firm Oak Hill Capital Partners about launching a new asset management vehicle that would invest in loans on behalf of middle market investors, in partnership with CIT. While the crisis kept the effort stuck in neutral, Owens patiently waited and watched the markets slowly repair themselves over time.
Four years later, as EVP at TD Bank Group’s Commercial Banking, he observed growing investor confidence in the leverage loan market. This new era in lending also brought with it increasing governmental oversight. “I realized that the alternative credit space had a huge opportunity to play a very meaningful role in commercial finance,” Owens says.
The magnitude of that realization led him to engage in more serious conversations with Nayden and Kaden in 2012. The group enlisted AIG and secured a $1.5 billion investment commitment. All parties “agreed that they were much more powerful together in creating a new middle market leveraged lender,” Owens says. On June 11, 2014, Varagon Capital Partners was born as an asset manager, with Owens taking the helm as CEO, and Oak Hill Capital and AIG as joint equity owners.
An Evolving Niche
Historically, large banks used deposits, or finance companies borrowed money from Wall Street to fund commercial and leveraged loans, making it difficult for middle market investors to access this particular asset class. In the ’90s and early 2000s, the market began opening up with a structured product known as CLOs, or collateralized loan obligations — securities backed by pools of debt, often low-rated corporate loans1 — and non-traditional investors could buy weighted tranches of loans. “As alternative credit players came into the space, they were actually working in partnership with banks and finance companies by offering the bottom part of a debt capital structure,” Owens explains.
Owens wanted to take things a step further with Varagon. Not only did he believe the leverage loan market’s solid performance and relative stability had lured investors back to the market after the credit crisis, he was convinced investors were drawn to the power of an asset manager to provide a full product offering, a “set of solutions” or a series of debt structures. So Varagon set forth a broad investment mandate to provide first lien, unitranche and second lien loans, as well as mezzanine financing, to companies with $10 million to $75 million of EBITDA. This one-stop financing offers competitive solutions up and down the capital structure, although the traditional middle market does not typically include broadly syndicated loans.
“We allow investors to invest directly in quality middle market loans, and tailor the types of loans and the exposure they’re looking for while availing themselves of the asset manager’s best-in-class risk management,” Owens says. “We provide investors with a high level of transparency. They understand what’s being originated and how it’s performing, and we’ll also provide them with advanced risk analytics.”
Varagon targets leveraged finance opportunities of up to $350 million with typical hold size of $20 million to $100 million. Owens and partners were attracted to the middle market’s pricing premium, which he says has yielded an additional 125 basis points on average over time, compared to the larger, more liquid market.
“What investors have come to see is that even though middle market companies are somewhat smaller, the overall credit performance, the default rates are similar to large leveraged companies,” he explains. “So you can earn a premium price for the same amount of risk.”
Owens believes the Varagon model is safer for an investor than purchasing a pool of rated CLOs since financing comes directly from investors. “The investors Varagon is working with truly want to own the loans over the long haul, and are looking for long-term returns, he explains. “That’s exactly the type of money that a private equity sponsor and its borrowers want. They want to be involved with people who understand cycles, and will be there in both good and bad times.”
The challenge of the middle market, Owens says, is to unearth the loans, since they are not part of the widely syndicated loan space. “You need an origination team,” he says. “Many alternative providers talk about ‘direct origination,’ and that’s traditionally what banks and finance companies have done. They hire large teams of sales people to go out and find the loans. An alternative credit provider has to do the same thing.”
PE Sponsor Channel
Varagon is focused on the private equity sponsor channel, particularly firms that emphasize due diligence, have experience in investment subsectors and bring a high level of professionalism, to originate credit. The team also hopes to service a large number of industries, including certain specialized areas such as healthcare and energy, and to enable large hold sizes.
Lastly, the team wants to be seen as a dependable. “[Private equity] sponsors are always looking for partners that have a good decision making process,” Owens says. “You’re able to say ‘yes’ or ‘no’ quickly, and if you say yes, you shouldn’t change the deal terms over time. We feel quite good with the way Varagon’s been created. We can meet that criteria.”
Past to Present
Owens considers his past leadership posts at GE Capital, CIT and TD Bank to be foundational blocks on which to build Varagon. GE Capital, where he was responsible for providing loans under $25 million, offered exposure to the credit dynamics of microenterprises. At CIT, Owens managed corporate finance businesses centered on the private equity and middle market leveraged finance space. TD Bank, where he oversaw U.S. corporate lending and specialty banking, provided an initiation into regulatory compliance and its ongoing hurdles.
Owens reunited several prior colleagues with the launch of Varagon. Nayden formerly served as chairman/CEO of GE Capital, and Varagon board member Michael Gaudino had been CEO/president of GE Corporate Financial Services. “The opportunity to harness their knowledge and experience in running large organizations is one I’m quite excited about,” the Varagon CEO says.
Cementing a Team
Owens is energized by the addition of other key team members, as well: Morris W. Offit, chairman of Offit Capital, serves on Varagon’s board of directors. His past affiliation with AIG, success in building financial franchises and grasp of the investment world adds another great dynamic to the board, Owens says.
On the Oak Hill Capital partners, Owens says, “It’s a team I always wanted to work with. Steven B. Gruber, one of the founding partners, Denis Nayden, Doug Kaden and John Monsky, general counsel, really struck me as a team that knew how to, not only envision a great opportunity, but to carry it through to completion.”
In acquainting himself with AIG, Owens was impressed by Brian Schreiber, EVP/deputy chief investment officer, and the private placements group (i.e., Ted Etlinger and Lorri White) that understood not only the overall strategic opportunity, but also execution. “So when you rolled it together — great people, the ability to build a new business and a huge market opportunity — it was pretty clear that Varagon was really something I’d love to do,” he says.
Solidifying its Reputation
In a crowded landscape, Owens hopes to create a name for Varagon through a proven track record, presence in various verticals and long-standing relationships, which is why leaders are packing the board with individuals who bring well-established connections and roots in the industry. The main obstacle Owens sees for Varagon is earning acceptance by sponsors and investors. “We spent a great deal of time in the design and creation of Varagon, and we feel good that we can meet that challenge,” he says.
Owens can’t portend the future, but he hopes the team will be seen as “very strong on quality origination, with a strong risk record,” so investors feel confident in increasing volumes and growing with Varagon. He concludes, “I think we’re not looking to be number one, we’re looking to be a leading player, and that really speaks to high confidence from both sponsors as well as investors.”
Jill Hoffman is editor of ABF Journal.
1. Investopedia US: Collateralized Loan Obligation – CLO. Available at: http://www.investopedia.com/terms/c/clo.asp (Last accessed October 8, 2014).