When AIG (NYSE: AIG ) starts straying from its core businesses, it might be time to start asking questions.
Earlier this week, AIG announced a new venture to take part in middle market lending. The company put up $1.5 billion to lend to middle market companies that generate $10-75 million in annual EBITDA.
A frothy market?
AIG is entering the middle market lending landscape at a time when yields are dropping, and risks are rising. In recent months, covenant-lite loans, which require sparse financial requirements from the borrower, are making up a greater percentage of middle-market volume.
AIG said only that it would make loans of up to $350 million, and hold as much as $20-100 million of each loan. The rest will be syndicated to other investors.
Syndicating part of the loan is interesting. It implies AIG plans to hold loans in a specific part of the capital structure. Typically, lenders underwrite a full loan, syndicate out of the first-lien position, then hold the riskier, second-lien or mezzanine loan. This strategy can help create income from origination and syndication fees, but adds to the remaining portfolio's risk level.
Reading between the lines
At $75 million in annual EBITDA, and $350 million in loan sizes, AIG is implying that, on the upper-end of its transaction sizes, it would hold loans at a debt-to-EBITDA ratio of roughly 4.6. That's consistent with recent deals in the middle market, where loans are typically made as a multiple of EBITA.
AIG certainly isn't the first insurance company to look toward the middle market for greater yields. Trinity Universal Insurance Company, a subsidiary of the ex-Teledyne business, Kemper Corporation (NYSE: KMPR ) , recently partnered with Fifth Street Finance on a senior loan fund. Golub Capital BDC has a similar arrangement with a subsidiary of Torchmark Corporation (NYSE: TMK ) .
In those joint ventures, the middle market loan portfolio uses additional, third-party leverage to boost returns. There's no way to know if AIG plans to further leverage its middle-market lending venture.
While AIG's commitment to middle-market lending is small relative to its total balance sheet, these platforms can be ramped up quickly. It's something to watch carefully, especially from an insurance company that, historically, hasn't done all that well when it strays from its core business of property & casualty insurance.
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