Direct lending is seeing a surge of fundraising appetite across various emerging markets.

A recent report from the Emerging Markets Private Equity Association (EMPEA) showed that fundraising for direct lending in 2018 topped 2017’s numbers by more than $1 billion. This spike has the strategy’s numbers switching places with the mezzanine debt strategy, which has been more traditional in emerging markets.

Direct lending jumped from $1.67 billion raised in 2017 to $2.85 billion in 2018, whereas mezzanine raised $3.24 billion in 2017 and $1.05 billion in 2018.

These direct lending numbers have experienced significant growth. Funds closed on less than $300 million per year for direct lending between 2010 and 2015, with some years seeing $0 raised. More than $1 billion of the direct lending capital raised in 2018 is focused on Asia, with Latin America close behind at $987 million.

“I think what is driving that [is] there has just been a pretty big pullback from traditional lending sources into these markets,” a source who works across all emerging markets told Private Debt Investor. “This is really driven by the same drivers in the US: balance sheet constraints and lack of appetite in emerging markets [by banks].”

The source added that because of this, private lenders are seeing more opportunities in those markets now than previously, and an increase in activity and fundraising seems like the next logical step.

Multiple market sources also told PDI that the growing popularity of the strategy makes sense, as the opportunities for private lenders continue expanding in that sector because of a noticeable shift in supply and demand.

These market players attribute some of this supply-and-demand shift to be the result of banks starting to pull back in emerging markets. While not as drastic as US banks after the financial crisis, the impact is substantial because there are already fewer bank options in emerging markets and some international banks are pulling back as well.

“I think [banks] have pulled back so far now you are seeing large corporations finding difficulty financing their requirements,” Diego Caicedo, chief executive at OmniBnk, told PDI. “More and more they have become more restrictive.”

Latin America-focused fundraising made up more than a third of those direct lending dollars, and the opportunities are on track to rise in that region. Caicedo said that OmniBnk, Latin America’s first neobank, has already noticed changes in demand since it started lending just three years ago.

“The top end of our loan book is around $1 million a piece,” Caicedo said. “Now we are seeing opportunities pop up in the $5 million to $10 million range.”

OmniBnk has originated just shy of $200 million in loans since its founding in 2016.

Caicedo said that, in addition to banks pulling back, there are legal changes in the works, specifically in Mexico and Colombia, that will make the markets more transparent and attractive for potential private lenders. Other emerging markets may be in the pipeline.

This spike in the direct lending numbers doesn’t appear to represent a one-off either. According to PDI data, emerging markets funds have collected more than $664 million so far in 2019.

In-market funds are targeting more than $22 billion for all credit strategies in emerging markets. Asia-focused funds are targeting $20.33 billion, followed by Latin America vehicles coming in at $1.79 billion, Sub-Saharan Africa at $670 million and Middle East and North Africa at $200 million.

“As the first generation of investors and people start understanding the underlying market, they will stop looking at this through the distressed lens, and instead through the long-term income lens,” Caicedo said.