(Bloomberg) -- Redwood Capital Management is preparing to start a business development company as the firm seeks to expand its reach in the hot direct-lending market. 

Redwood’s BDC will focus on loans to stressed and distressed middle-market companies, according to marketing materials seen by Bloomberg. The firm is raising up to $500 million for the vehicle, which will launch in early 2022 and remain private.

A representative for the New York-based firm, which is known for its distressed debt investments, declined to comment. 

Redwood’s BDC will contain a mix of senior loans the firm originates, and loans and bonds the firm purchases on the secondary market, according to the documents. It plans to hold 30 to 50 positions, focusing on companies with earnings between $50 million and $300 million. Redwood’s co-Chief Investment Officers Ruben Kliksberg and Sean Sauler will oversee the new vehicle. 

Growing Market

The market for private, direct loans by non-bank lenders has been growing for years and accelerated during the pandemic as traditional lenders tightened credit. The average size of loans in the so-called “shadow banking” sector has also increased, and is now a major source of credit for corporate America. 

Redwood’s expansion into dedicated private credit instruments comes as more investors seek out higher-yielding debt investments. At a time when the average speculative-grade bond yields less than 4%, Redwood is targeting investments that pay 4 percentage points to 9 percentage points above the London Interbank Offered Rate, according to the documents. 

The firm’s flagship fund gained 15.2% this year through August and its opportunity fund has returned 10.5% in the same period, according to a person with knowledge of the performance. Its second drawdown fund posted an internal rate of return 31% from its 2017 inception, and a 51% net return so far this year. The firm launched the third iteration of its drawdown fund in July.

Redwood is run by Kliksberg and was founded Jonathan Kolatch in 2000. It manages about $8 billion, including the $4.8 billion master fund, a $1.8 billion drawdown fund, and the $1.6 billion Redwood Opportunity Fund. 

(Updates to add BDC managers in third paragraph.)

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