Germany was previously a laggard in terms of developing its private debt market, but this appears to have changed. In a statement announcing the closing for the first of two funds, looking to lend to companies with EBITDA ranging from €4 million to €25 million in May, HF Debt’s managing director, Andreas Doerfert, simply said: “Private debt as a form of financing has now arrived in Germany and has reached a serious size.”

Doerfert’s bullishness is supported by the latest Mid Cap Monitor Report, published by investment advisor GCA Altium. The figures are clear; in 2016 private debt funds accounted for just 16 percent of fundraising in the German LBO market, with the remainder financed by banks. By 2017 this had more than doubled to 34 percent, with the numbers for the first half of 2018 hitting 48 percent for non-bank lenders.

And it’s not just deal numbers that are increasing. HF Debt, an offshoot of Germany private equity stalwart Hannover Finance, isn’t the only manager to launch funds targeting small and medium-sized enterprises in the country. Swiss outfit Vincenda, Frankfurt-based ESO, and Deutsche Credit Capital Partners are among several new entrants to the market over the last 18 months.

“The Landesbanks are out of the game. They are trying to keep existing clients but are not taking on new business”
Alexander Bode

This represents a significant change for a sector that had previously been an outlier in terms of relying on banks to fund the mid-market, with private debt activity seriously behind the UK and the US. And according to Daniel Heine, Zurich-based manager director at Patrimonium Asset Management, the private debt market in Germany is set to double in size in the next two years, potentially catching up with the UK in total volumes within five years.

This view is, in part, supported by Alexander Bode, Cologne-based managing partner at BB Alternative Partners.

“Will the German market be the same size as the UK in five years time? I totally agree with that. However, the UK private debt market is not at its ceiling. While the German private debt market will catch up with where the UK market is now, the UK will grow in the interim.”

Stuck in the middle

One reason for this rise, according to Bode, is that the Mittelstand – typically small, family owned firms – which form the bulk of the current market for private debt in the country, are a unique feature of the German economy, and differ from SMEs in other developed economies.

“The Mittelstand doesn’t correspond with the middle market in the international sense and are typically much smaller businesses with €2 million-€20 million EBITDA. Typical customers of a European private debt fund start at EBITDA of around €15 million, but penetration even below that mark into the Mittelstand increases,” says Bode.

It’s not just the Mittelstand that is unique to Germany, it also has a bespoke three-tiered banking system. At the base are the co-operatively owned savings banks, while above them are the Landesbanks – banks owned by the regional governments – and finally the private banks, such as Deutsche Bank and Commerzbank.

Basel III and IFRS 9, which have radically increased the cost of long-dated bank lending, particularly for firms with a weak credit history, are a global phenomena, but Germany’s banking system is adding to the attraction of private debt. The majority of SME lending was provided by the Landesbanks, but these are now no longer the force they were in providing credit to smaller entities, says Bode.

“The Landesbanks are out of the game. They are trying to keep existing clients but are not taking on new business. The global financial crisis hit the Landesbanks hard in terms of some poor investment in structured credits and given that these are government-owned institutions there is a strong political will for there not to be a repeat.”

“Private debt is becoming more normal; the traditional lenders have become more open to co-operation with private debt funds”
Daniel Heine

It is telling that a new entrant to the German private debt market, DCCP, is headed by Dr Nicolaus Loos, who formerly led banking and markets at mid-market lending specialist IKB. IKB made some disastrous investments into the US subprime market and was subsequently acquired by US private equity outfit Lone Star Funds.

The problems facing the Landesbanks have, according to Patrimonium’s Heine, transmuted into a fantastic opportunity for credit funds to fill the gap. However, he is keen to stress that the private debt providers are complementary to, rather than competition for, the banks in providing finance for the SME sector in Germany.

“Private debt is becoming more normal; the traditional lenders have become more open to co-operation with private debt funds. This is a fantastic synergy as debt funds are not direct competition to commercial banks because they can only offer lending but none of the other banking services that firms require. We recently reached an agreement with Credit Suisse – we do deals with them at the lower end of the borrower spectrum, those firms rated BB-B.”

Heine declined to go into specifics on how much lending had taken place so far and says that Credit Suisse is a large enough bank that Patrimonium would not require similar agreements with lenders, but he did expect the trend itself to magnify, saying he “assumed” more deals of this type are currently taking place.

The retreat of the Landesbanks from the smaller end of the Mittelstand market has also been accompanied by an increasing awareness of the value of private debt providers, according to Bode. He says that CFOs in the mid-market who were previously reluctant to use private debt funds, and now coming to value their different approach to issues such as repayment terms, and loan approval times, to banks.

“Private debt providers are flexible. For example, they don’t demand amortised loans, requiring both capital and interest to be repaid over the loan period. Likewise, timeframes, say a corporate wants to take over a firm, or set up a new factory in Portugal. Private debt funds can provide that financing in as little as four weeks, whereas a bank loan would take at least three months to agree.”

Corporate credit

According to Bode, a number of German corporates are turning to debt funds as an interim measure. Typical deals are three years rather than five, which is more common for a bank loan. The corporate then refinances once its acquisition, or investment, has become more cashflow positive.

Not everyone, however, is convinced by the inexorable march of private debt into the German market. Frank Dornseifer, managing director of the BVAI – the German alternative asset association – says the numbers being touted may not stack up. “As it is a private market you don’t have the clear, pure facts,” he says. “You attend industry conferences and always hear data about how many private debt asset managers there are and what their AUM is, but people don’t trust that information so much.”

In order to shed more light on the market, the BVAI has commissioned a survey of asset managers, investors and SMEs to get firm numbers on the level of private debt and future demand for it.

“There will be some increase in the private debt sector, but I am not sure it will grow rapidly and have a similar market share as the UK and US,” says Dornseifer. “But at the end of November we might have new conclusions when we finalise our survey.”