The growth of private credit funds in Europe has already transformed the lending landscape in some markets, with others evolving rapidly as the regulatory environment in countries such as Italy, Spain and Germany became more accommodating to alternative debt finance options.

Alternative lending was up 9 percent by number of deals across Europe in 2018 versus the previous year, according to Deloitte’s latest Alternative Lender Deal Tracker. European private credit firms have also grown in scale as they have raised larger funds, inviting some comparisons with the larger, more mature US market, where direct lending has long been an established alternative to the bank loans more traditionally employed by European companies.

Indeed, the arrival of US-based private credit firms on European soil has created a degree of consistency between the two regions. “We don’t approach the two markets differently,” says Daniel Pietrzak, KKR member and portfolio manager for the firm’s private credit funds. “We have dedicated coverage of financial sponsors and intermediaries in both the US and across Europe to ensure our sourcing funnel is as large as possible.”

While, in some respects, the two regions are converging when it comes to the use of private credit, there are key distinctions. Part of this is because of the variety in European states that doesn’t exist in the US. “The US market can at times be easier to cover than the European market, even though the former is much larger, as the different jurisdictions and languages across Europe mean we have to sculpt our teams with a great deal of care,” adds Pietrzak.

Yet the differences between the US and European credit markets also extend to the type of structure on offer to borrowers. In the US, around one-third of direct lending deals are unitranche, according to Proskauer’s 2018 Private Credit Insights report, which analyses terms and features across the transactions the firms have worked on during the year. By contrast, 82 percent of private credit deals in Europe were unitranche in 2018.

Lost in translation

Part of this divergence can be explained by a difference in terminology. “When talking about unitranche loans in the US and European markets, we should define what we mean,” says Peter Antoszyk, partner in Proskauer’s Private Credit Group.

“The term unitranche in Europe generally means a stretched senior loan with a super senior revolver, all governed by a single document; in the US, the term unitranche can mean any number of structures, including the European style unitranche. However, it is most often used to refer to a bifurcated or first out-last out structure.”

Bifurcated unitranche is a structure that synthetically recreates, in a single document, a first-lien/second-lien structure.

“It’s very different doing a credit deal in southern Europe from one in the UK … But that’s one of the key attractions of private credit”

Daniel Pietrzak

The US market tends to feature more bespoke credit deals, adds Pietrzak. “We can do more highly structured unitranche in the US, with between 2.5 and 10 percent mandatory amortisation rather than just using cash sweeps, for example, plus a term loan with covenants for when the capital is allowed to be drawn. You wouldn’t see this kind of structuring in Europe.”

Some of this is due to the difference in maturity between the two markets and the higher prevalence of bank lending in Europe. “In our view, Europe is two to three years behind the US in terms of development,” says Fenton Burgin, head of Deloitte’s UK advisory corporate finance team. “In the US, it’s an accepted feature that direct lenders provide working capital in a deal, rather than the banks, while in Europe, the banks still largely provide the working capital lines in private capital transactions.”

Pietrzak agrees. “The US market is more mature,” he says. “You also have quite a few companies in continental Europe that are lower levered and have banks as an alternative. This can make for simpler unitranche deal structures than you’d see in the US.”

However, part of the reason the two regions show a divergence is the type of documentation used. Bifurcation is a case in point. Once prevalent in the US market (in 2014, 61 percent of US unitranche deals were bifurcated, according to the Proskauer report), it never took off in Europe.

“As a market, Europe hasn’t generally adopted bifurcation – it’s very rare to see this outside of the US,” explains Antoszyk. “One of the reasons for this is the fact that the market uses standard LMA documentation, which doesn’t include bifurcated unitranche. The banks have also been resistant to moving away from traditional first-lien/second-lien structures. In addition, the demand hasn’t been there from sponsors and their debt advisors.”

By contrast, in the US, lenders rely less on standard documentation. “That allows for more flexibility and tailored structuring,” says Antoszyk.

So what of the future? As the European market continues to grow will we see structures converge with those of the US? Burgin points to the ongoing implementation of Basel III, which will increase the cost to banks of providing working capital, enabling funds to expand further into this space in Europe. Yet there will always be distinctions between what’s on offer between the two regions, according to Pietrzak.

“It’s very different doing a credit deal in southern Europe from doing one in the UK or the Nordics and all are different again from the US,” he says. “But that’s one of the key attractions of private credit. Each deal is slightly different and so while we always have consistency across underwriting and documentation, we can tailor loans to each unique situation.”

Going straight
Once a dominant feature of the US deal market bifurcated unitranche is becoming increasingly rare

Bifurcated unitranche – a structure that synthetically recreates first- and second-lien debt to provide what looks like a single credit facility – used to be a prevalent type of unitranche debt in the US. Yet over the past few years, the market has swung in favour of traditional first-lien/second-lien structures. “It was perceived in the past that bifurcated unitranche allowed lenders to offer better terms with less execution time and cost and fewer points of friction as the facility was governed by one document,” says Proskauer’s Antoszyk. “However, there is now much less of a distinction between unitranche and traditional first-lien/second-lien structures. These more traditional document structures are tried and tested.”

The move towards straight deals is also a result of the greater amount of capital held by private credit funds today. “We are seeing fewer bifurcated unitranche deals in the US mainly for practical reasons,” says KKR’s Pietrzak. “Funds are now more sophisticated and have deeper pools of capital – they can provide funding at shorter notice than previously and more frequently.”