Loan Note: Lenders seeing value in real estate; ARR financing poses a challenge

Reflections on this week's PDI Germany Forum, including why there is optimism around real estate debt. Plus: the attractions and challenges of ARR financing and why regulation and impact may not be happy bedfellows. Here's today's brief for our valued subscribers only.

They said it

“A red wall of worry has built up across financial markets, with investors increasingly nervous that economies are set to career into recession”

Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown, a UK financial services company

First look

Looking up: Real estate debt offering good terms to lenders (Source: Getty)

Real estate’s solid foundations
“Back to a lender’s market,” is how Ralf Kind, head of real estate debt at Edmond de Rothschild Real Estate Investment Management, described the situation in the real estate debt market on the opening day of the PDI Germany Forum in Munich.He said that new loans in the space were able to boast higher margins, lower loan-to-values and better covenant packages. “It feels a bit like the covid period between 2020 and 2021,” added Kind. “From a new deal perspective, there are great opportunities.” He said whole loan pricing had increased by around 50 basis points while mezzanine had seen around a 1 percent increase in expected internal rate of return.An opportunity has arisen because of the reluctance of banks to finance real estate deals and projects. “The banks are focused on the safer credits, using lower leverage and targeting only certain types of assets,” said Jean-Baptiste Meyer, senior vice-president and portfolio manager at PIMCO. “Many projects are in need of finance but the banks are not comfortable with them.”Because of the bank pull-back, Trevor Castledine, senior director and head of private credit at consultancy bfinance, agreed that the demand for finance was greater than supply. He noted there was some new construction activity, especially in the residential sector, but added that there was also some uncertainty and nervousness around valuations.

The challenges of adopting ARR finance
There’s more than one way of supporting a growing company. This was the message from the PDI Germany Forum panel on the second day, which explored growth debt. The panel heard from those backing companies all the way through their growth life cycle, to those only jumping in at the early venture-stage end… and many shades in between.One of the interesting topics discussed was annual recurring revenue financing, a reasonably popular form of finance in the US that has begun to make its presence felt in Europe over the last three to four years, especially over the last 18 months. It’s a form of lending that focuses on subscription-based revenue streams.Unlike venture debt and growth debt, which tend to be the preserve of specialist fund managers, ARR financing is often an add-on to a direct lender’s existing activities. But this process of ‘adding on’ may not be straightforward. It involves borrowers that may not yet be breaking even and thus may be hard to reconcile with a direct lender’s typically cashflow-based approach.There are some strong attractions to ARR financing including high top-line growth, low churn and yields that are generally slightly higher than those offered by unitranche. But for direct lenders interested in adding it to their toolkit – and, from our conversations, we believe there are some considering doing precisely that – it may be a tough sell with investors worried about strategic drift. Regulating impact
Several conversations on the sidelines of the PDI Germany Forum revealed frustration with the regulation of ESG/impact investing and specifically having to take a lead from the  Sustainable Finance Disclosure Regulation.Some firms believe they are taking positive action in portfolio companies that is not necessarily defined as an action compliant with the regulations. The problem with this, say the critics, is that such investing becomes an exercise in ticking boxes and not necessarily delivering real change on the ground.Of course, it’s a difficult issue to reconcile. Is the subjective view of a fund manager that it is making a positive difference necessarily to be trusted? At least having rules and guidelines holds everyone to a uniform requirement. But it’s hard not to sympathise with the frustration of a manager trying to do the right thing but not necessarily being recognised for it.


Europe defaults set to climb
The European trailing 12-month speculative grade corporate default rate is expected to hit 3 percent by March next year, according to a report from S&P Global Ratings (login required). This compares with the extremely low rate of 0.7 percent seen in March this year.In its most optimistic scenario, S&P predicts a default rate of 1.25 percent and, in its most negative scenario, 5 percent. The rating agency said firms had been fairly successful at passing on higher input costs to consumers but that growing risks would pose challenges as the year progresses.S&P said interest rate sensitivity “seems lower” in Europe than the US but that inflationary and geopolitical risks were “arguably much higher”.

New Munich office for Pemberton
UK-based manager Pemberton has opened its second office in Germany. The new Munich office is headed by Adrian Grammerstorf, who joined Pemberton from Allianz Global Investors.

Grammerstorf has more than 18 years of experience in European private credit, leveraged finance and transaction services. Prior to joining Pemberton, he spent more than three years as a director at Allianz Global Investors, where he was responsible for deal origination and structuring of credit financing for private equity-driven acquisitions in Germany and across Europe.Nils Weber, who has been part of the company’s DACH business since 2015, will team up with Grammerstorf to lead sponsor coverage and deal origination in the DACH region, as well as supporting Pemberton’s growing business in the Nordics.

LP watch

Institution: Maine Public Employees Retirement SystemHeadquarters: Augusta, USAUM: $18.8 billionAllocation to alternatives: 39.2%

Maine Public Employees Retirement System has confirmed a $125 million commitment to Comvest Credit Partners VI, a contact at the pension informed Private Debt Investor.

Comvest Partners‘ latest fund launched in March and is targeting $1.7 billion. The fund will focus on corporate opportunities in North America with senior debt returns. Its predecessor, Fund V, closed on $1.3 billion in April 2021.

MainePERS has a 5.1 percent allocation to alternative credit and a 7.9 percent allocation to traditional credit. Its recent private debt commitments have tended to focus on North American corporate vehicles.

Today’s letter was prepared by Andy Thomson with John Bakie and Robin Blumenthal