Lower Middle Market Lending in 2025: Outlook from TPG Twin Brook’s Managing Partner Trevor Clark

In our latest edition of The TPG Take, we sit down with TPG Twin Brook’s Managing Partner Trevor Clark who shares his perspective on the environment for direct lending in the lower middle market. Clark discusses how new lending structures, a modulating market, and growing interest from investors have created tailwinds for experienced lower middle market lenders within a segment traditionally more sensitive to shifting market dynamics.

Macroeconomic Lower Middle Market Direct Lending Dynamics

"It's been an interesting time for direct lending in general, specifically in the lower middle market. What you've seen in a period of higher interest rates and inflation is additional stress get brought to these companies.

There's this perception that certain market forces – economic contraction or instability in the broader global economic environment – are going to have a bigger impact on a lower middle market company than on an upper middle market company. That's a fair assumption.

The result of that when you think about broader economic impacts and lending to a highly-underwritten, highly-managed basket of lower middle market companies, is that you pick companies that have the cash flow dynamic of the very best large company. You put less debt on those companies, and you have better lender protections such that you have the ability to take action when there is a broader economic contraction or a pandemic or other unforeseen events. We can take the type of actions, in concert with our private equity owners, that allow these small companies to pivot and make sure they can continue to grow.

We understand that there is a value proposition in this lower middle market. It's going to take more work because we have to look at more small companies to find those really attractive cash flow producing companies. But if we can do that, we can have an experience much different than what you see in other parts of the lending universe."

The LMM Direct Lending Marketplace

"We're sitting in this position of strength, meaning direct lending is producing returns. And by returns, I'm talking about first lien, senior-secured, low-levered companies that have a long-term performance history. So, you're seeing increasing allocations into the world of direct lending because there's always that story about relative value.

The average investor who is going to look at the lower middle market is going to want to understand: 'I see the premium, but am I taking more risk for that premium?' I think it helps when lenders are experienced in the lower middle market. For 23 years, we've targeted this part of the marketplace."

New Direct Lending Structures and Interest

"Ten plus years ago, the institutional investor was really the first mover into this asset class. Retail had a smaller piece; insurance a smaller piece. But the institutional investors really dominated the sector. What's taken place is as direct lenders like TPG Twin Brook and others have scaled, we've come to this recognition that it wasn't an asset problem. It wasn't that we couldn't attract those type of investors. It was a structuring problem. So, in the case of retail, with the advent and growth of the BDC structure, you've seen those really come to the forefront. Then you look at the insurance investors. This all comes down to: what are the capital charges an insurance company gets in different parts of the investor universe? For direct lending, there is the advent of something like structured notes, which is the same pool of assets, but structured in a way that the insurance companies got better capital treatment. So, their interest in expanding their exposure to direct lending went up."

Market Modulations & the Future of the Lending Environment

"While inflation and interest rates aren't going to magically turn on their head this next year, we do feel like the market's modulating from the perspective of where interest rates are going to go, and inflation seems to be more under control. What that will lead to is more transaction volume, which means more lending opportunities. Then you add the fact today that with roughly $20 billion of assets under management and over 260 borrowers, the existing base of our business continues to grow through add on acquisitions and other activities. Our existing portfolio continues to grow. We're very excited to be able to deploy capital, and we feel very good that we have the backing of this world-class company, TPG, to allow us to do that."

In Other News & Views...

As usual, we also want to "circle back" to share other recent insights from our ecosystem, senior leaders, and investing professionals that you might have missed.

In our series Partnerships in Focus, we hear directly from leaders across the TPG portfolio and ecosystem. In this episode, we hear from Tim Schantz, President and CEO of Troon. Tim shares his excitement about the future of the golf industry and how TPG has partnered with Troon to continue to grow its business and find unique ways to serve its customers.

Our TPG Capital team spends years building conviction around interesting and enduring investment themes and seeks to partner with companies in those areas of the market to enable long-term growth. We have followed Surescripts for nearly a decade and were excited to close on our investment earlier this year. We look forward to partnering with the Surescripts team to support and scale innovative technologies that enhance patient safety, lower costs, and enable quality care. Hear more about the partnership from TPG Partners Katherine Wood, Art Heidrich, and John Schilling in our latest episode of Investment Insights.

Thank you to all of our followers and readers for joining us for another edition of The TPG Take. Please share the newsletter with anyone you think would be interested and we look forward to being back in your inboxes in the new year. See you in 2025!