Do you see more German-based investors becoming interested in private debt?
There’s a very clear answer to that: Yes, the German LP base is looking hard at private debt investment and beginning to create private debt allocations within overall asset allocations. Private debt is new for the German investor base but more and more allocations have been created and they are now trying to fill those. They are in the process of getting to know the sector, the service providers and fund managers and the individual investment approaches.
I would say German investors are 10 years behind those in the US, maybe three years behind the Nordics and probably also two to three years behind the UK – but maybe two to three years ahead of Southern Europe. At Patrimonium, we already have German institutional investors but they originally committed to us out of their alternatives buckets which meant we competed with private equity, hedge funds and the like. Now we come across different investors wanting to make new private debt allocations, and that means we are competing for the capital only with other private debt funds.
Pensions and insurance companies account for the bulk of German investor interest but more and more family offices are becoming interested as private debt increases in popularity and they read about it in the media. German family offices made their first private equity commitments around 10 years ago, and it makes sense that they are now looking at private debt because its development is about 10 years behind private equity.
Paradoxically, the German market is seen as both a big opportunity because of the Mittelstand but also a very difficult market to operate in successfully. What do you make of this view of Germany?
I think both of these aspects are true. On the one hand, it’s true that Germany offers an extremely attractive market. It’s the fourth-largest economy in the world and has the deepest volume of opportunity in Europe at the corporate level thanks to the Mittelstand. Moreover, Germany has a very strong credit culture, is lender friendly and the legal system is well defined.
But the German lending landscape is over-banked, over-leveraged and tier one capital is extremely restricted. The likes of Deutsche Bank, HSH Nordbank and the Landebanks are very leveraged and many banks had to be rescued following the crisis. Lending under the Basel rules is becoming more and more difficult, and that’s opening a gap for alternative lenders like us.
However, the German market is not easy, it’s difficult. You need to create and build a sourcing network and that takes time. The more investments you do, the better you get to know sourcing partners and build trust. To create a credible network, you need at least two years to do it. You can’t just come to Germany from abroad and send a letter to the usual suspects. Developing trust in Germany takes time.
If your universe of potential deals is the Mittelstand, it’s tremendously helpful if you speak the language. These businesses are used to getting their credit from local providers who speak German, so you need a German-speaking team. If you don’t have one, you need to hire one.
Also, there is a specific legal environment that you need to be in full command of. Loans come under German law and there is specific German loan documentation. If you’re a US fund manager which has not worked within German law, then that’s a barrier to entry.
Furthermore, you have to overcome a trust issue at the company level. Dealing with direct lenders rather than the local Landesbanks is something new and you need to develop a track record of doing investments and be able to provide references. The companies need to see what you are about and how you behave. It’s difficult for a new provider to go there and be successful.
How do you view current market conditions? Are you optimistic or pessimistic?
We’ve been around some time and lived through 2008/09, so we’ve been through a full credit cycle. At the moment things are very positive, there’s a very low default rate. If you’re new to the market, you probably take that as normal. We are aware that the current cycle will come to an end and you will see default rates increase very quickly. The only question is the level of defaults – we know the current period will come to an end, we just don’t know when.
In today’s lending environment, you have to be prepared to survive when the cycle comes to an end. It’s always in the back of your mind if you have been through the experience of 2008/09. A key question is whether, in good times, you loosen your underwriting standards or not. If you survived 2008/09, the chances are you will not be prepared to loosen your standards. You don’t want to find yourself back in the same situation. If you’ve not been through a full cycle, you’re more likely to be optimistic and possibly naïve.
What would you expect some of the main talking points to be at the Germany Forum?
I would assume that one question will be whether disintermediation is really happening in Germany. From the outside Germany is attractive, but it’s perceived to have a lot of banks and other providers.
Also, if you look at the inflow of capital, most of it is going into funds targeting sponsored deals. I think another question will be what do those managers which have received large inflows do with their dry powder? Do they further loosen their underwriting standards?
I am also keen to hear from German investors: What is their point of view? How attractive do they perceive the market to be? How much are they likely to invest and where?