Beyond the gaze of the banks

Hidden behind the fiercely competitive sponsored market, Spain is beginning to wake up to the opportunity offered by sponsorless deals. Ignacio Díez of Trea Direct Lending assesses progress to date and future potential.

This article was sponsored by Trea Direct Lending and appeared in the May 2019 issue of Private Debt Investor magazine.

Trea Direct Lending is a Spain-based manager with offices in Barcelona and Madrid, currently raising its second fund, targeting €150 million-€200 million. The fund focuses on providing senior secured loans to family-owned companies, mostly in Spain, and is part of Trea Asset Management, a €4.6 billion asset management company.

TDL’s typical portfolio company is a family-owned SME with a history of 30 to 60 years whose owners want to stay in the business for another 30 years. These companies have strong market positions and are moderately exposed to the economic cycle. In terms of size, EBITDA tends to be between €3 million and €20 million. The firm provides four- to six-year senior secured loans through tickets of €5 million to €25 million. Moderate leverage, collateral and strong covenants are required, targeting 8 percent gross returns.

Ignacio Díez, head of TDL, talks about the Spanish opportunity in the sponsorless private credit market and its evolution, which offers a huge investment universe for investors to access.

Targeting 8 percent for senior secured, with moderate leverage and strong collateral: what is it about the Spanish market that enables this kind of approach?

Ignacio Diez

The Spanish private credit market is polarised. Banks have gone through massive consolidation (from 150 to 15 in a few years), have considerably cleaned up their balance sheets, and are now lending aggressively to large companies in deals over €50 million. In that segment, banks analyse and structure credit well, through syndicated loans and leveraged loans, so it is very complex to compete with them there.

In LBOs you see strong competition among private debt managers and banks. Funds are competitive, though, taking much more risk in unitranche structures, outside the senior space, as with term loan Bs it is very challenging to get to 7-8 percent returns. For SMEs the dynamics are different, banks struggle to finance these companies due to higher Basel III capital consumption, but particularly because they struggle to analyse and structure credit, as these companies are financed by the regional branches and not by the corporate credit departments. This is where we find our opportunity. We do not compete with banks or with pan-European PD managers, and that is why we can generate this attractive alpha.
Most of the companies we invest in are already financed by banks, and we are comfortable being with them in the capital structure. However, there are a number of factors that lead companies to look for alternative financing: flexibility, speed of execution and the quantum (banks sometimes prefer to keep exposure to a single name below certain pre-defined thresholds).

What is your view of the Spanish market looking ahead?

The prospects are very good for our segment in Spain. The economy is doing reasonably well, coping with internal and external political uncertainty.

Banking consolidation is expected to continue, opening a large opportunity. Every merger increases the credit concentration in the banks’ balance sheets and there is no clear alternative if they want to reduce risk, as the private placement market in Spain is non-existent and the debt capital market for SMEs – MARF – is really small.

On the demand side, we are seeing more and more acceptance of direct lenders among SMEs. A few years ago, cost was the only variable, but now they are more open to pay for flexibility and speed, and find it healthy to diversify their financing sources.

There are also challenges ahead, such as a deteriorating economic cycle and a slowdown in Europe. We are cautious on that front, preferring companies with limited exposure to the cycle and with good collateral.

There is a perception in the market that sponsorless deals are riskier than sponsored ones. What would you say about that? Why should LPs look at them?

Sponsorless deals have significantly less financial risk. They are less levered as families do not want excessive leverage, as opposed to sponsors. There is a much bigger alignment of interest with shareholders in that respect.

There are multiple studies that prove that family-owned companies outperform through the cycle, with better margins, higher growth and lower leverage than others.

In addition, LPs de-correlate their portfolios in the sponsorless market. This is a very interesting part of the economy that otherwise is not possible to get access to, as these companies are private without traded bonds or shares.

In the sponsored market, LPs end up increasing correlation, as many double-up their exposure through the same LBOs, both in equity and in debt, as those are the same deals in which their PE managers invest.

If the market is so interesting, why are few managers focusing on it? What will it take for it to fully develop?

Because it is a different market and you need a radically different structure to play in it. In sponsored deals, origination is much more simple, as there is a small number of PE managers and negotiation is more straightforward.

When it comes to family-owned SMEs, there are other factors besides purely financial ones, such as origination, structuring and negotiation that can sometimes take several months. Most large managers are not willing to invest the time and resources, but that is what generates an important part of the alpha.

You need local teams in each major country or region, and to build local credibility with at least two to three deals per year, making it a three- to four-year investment in each of the five to six European regions.

That is why you do not yet see a pan-European sponsorless fund. That could turn out to be the holy grail of private debt.

This market has not fully developed yet, as all managers are still small and country-specific, with very few with a proven track record. They still need some time to deliver. At the same time, most institutional investors just focus on large manager names, even though they know the sponsor market is saturated. Investing in smaller firms could be a career risk. Most would love to invest in pan-European sponsorless funds, but that does not exist yet.

What types of investors are supporting your funds?

Our investor base is mostly institutional, mainly insurance companies and family offices. We are expanding now into private banking, which is asking for this asset class.

The Spanish government FoF is our anchor investor in Fund I. We do not have the EIF as an investor, but we have them as guarantors in some of our deals in both funds, which is much better for our investors. The EIF guarantees 50 percent of the losses in those deals, which constitutes a great arbitrage for our investors, as part of the portfolio is AAA risk. This works very well for insurance companies, which reduce significantly their capital consumption.

Finally, an important aspect of our second fund is the participation of international investors. We already have two. One of them is our main/anchor investor, and we currently are in due diligence processes with two other foreign investors. The Spanish institutional market is still very small compared with other European markets, but we are seeing a considerable increase in appetite for this asset class as time goes by.