Looking for top gear

Italy’s direct lending market looks set to see more private debt issuance in 2018 than ever before, as funds carve out a niche and begin to compete with the dominance of the banks.

A total of €641 million in private debt was issued in Italy in 2017, a 35 percent increase on the €474 million figure for 2016, according to a report by Deloitte in collaboration with AIFI, the Italian private equity and venture capital association.

In all, 19 private debt providers were active in the geography, either fundraising, investing, or both, including funds with teams on the ground as well as pan-European firms based elsewhere.

Daniele Candiani is a partner in debt advisory and corporate finance at Deloitte, based in Milan. He says: “Private debt funds continue to grow in the Italian market throughout 2017 and in the first months of 2018. Given the existing pipeline, the next six months are now expected to exceed the volumes and values of deal activity seen in the same period last year.”

One of the biggest challenges for direct lenders in Italy is the historic dominance of the banks, which had the credit markets to themselves until only a few years ago. While the banks were more reluctant lenders in the wake of the credit crisis, they are now extremely competitive, according to Carlo Massini, a banking and finance partner with law firm Hogan Lovells in Milan.

“Banks are very aggressively back in the market now,” says Massini. “They are pursuing opportunities fairly actively and not leaving a lot of room in the mainstream loans market for debt funds. There is certainly space for debt funds, but we see them looking at situations that are not interesting for banks for one reason or another, or looking at pursuing particular types of assets.”

While the funds can rarely compete on price, coming in two or three times more expensive than the banks according to some estimates, they can still pick up deals where borrowers are looking for either more flexibility, or higher leverage, than the banks can offer.

Examples of recent deals include the April 2017 €130 million unitranche deal that saw GSO Capital Partners, part of the Blackstone Group, as the sole investor in Fintyre’s unitranche bonds when the business was bought by Bain Capital Private Equity. Then earlier this year, Deloitte acted as debt advisor to Quarantacinque raising €30 million acquisition financing ahead of a bid for a majority stake in Italian IT group CAD IT by Magnetar Capital, which has offices in the US and London.

Muzinich & Co is a corporate credit fund based in Italy that has a €286 million fund investing solely in the Italian domestic mid-market. One of its flagship direct lending deals involves Eco Eridania, one of Italy’s leading medical and hazardous waste companies, which it began working with in 2014. Muzinich has supported that company’s growth from an EBITDA of €8 million in 2014 to €33 million today.

‘Extremely competitive’

Paulo Mancini, co-head of private debt for Muzinich in Italy, says his firm looks at all opportunities that are cashflow generative, and does both sponsored and sponsorless transactions. “Over the last two years, the credit market in Italy has become extremely competitive on the lender side,” he says. “The banks have gone back to lending in a very aggressive way, which has clearly put private debt providers under pressure. We have to focus on our niches, create a bit of a story, and we don’t do the plain vanilla transactions.”

Mancini says there are several ways the funds can appeal to borrowers. “Our niches are small to medium-sized deals, for creditors with complex timing issues where we can be more competitive than the banks, or where there are confidentiality issues, because we tend to have capacity to keep deals within the group, which is very small.” Competing on price is a non-starter, he says.

Candiani adds: “Private debt funds are more flexible than the banks, and so are able to provide more flexible structures, and often more leverage. Plus, they are able to move quickly whereas the bank approval processes can take some time.”

It is here that the opportunity looks to be expanding, as more borrowers become aware of the versatility of the direct lending model. While there are not particular sectors that necessarily stand out for private debt funds in Italy, there are parts of the market that look ripe for more activity.

“Banks tend to prefer the companies and sectors where there are hard assets that lend themselves well to a traditional credit analysis,” says Candiani. “I see the main area for development by the debt funds to be in industries where the assets are intangibles, such as services, IT, tourism, logistics, and so on.”

Mancini adds: “Probably the most appealing part of the market for private debt funds is the mid-sized deals, because you have situations where a deal is too big for a single bank, and not big enough to be syndicated. So rather than call in three banks, it can make sense to go to a fund and see if they can do everything in one place.”

He points to sectors such as shipping, where there are turnaround and special situation deals to be done, as further markets ripe for more private debt.

According to the Deloitte/AIFI report, a total of 82 corporates received some form of direct lending in Italy last year, across 102 transactions. In terms of the debt instruments used, 65 percent were bonds, 32 percent loans and 3 percent hybrid instruments. One in four issuers was private equity-backed, and the most popular sectors were industrial goods and services, food and manufacturing, and IT.

There are some legal hurdles that stand in the way of more pan-European funds operating in Italy. In December 2016, the Bank of Italy published new rules to enable alternative lenders to provide direct lending, but to lend in Italy, EU debt funds must be authorised in their home jurisdiction to carry out lending. While the new rules have been generally welcomed, there is an implication that EU-authorised alternative investment funds must be expressly licensed in their home markets, rather than just generally permitted, which is not always the case.

Massini says: “There is this regulatory conundrum, whereby you are permitted as a non-bank if you are licensed in your home jurisdiction, and in the UK debt funds are permitted but not formally licensed.”

He adds there are ways to overcome these hurdles, and regulation is complicating but not prohibiting the growth of Italy’s private debt funds. “I can’t give you a forecast in terms of timing, but I’m firmly convinced we are about to see a big change in this market.”

Whether a rise in interest rates will kickstart activity, or the impact of regulatory change will dampen banks’ appetite for lending, it is hard to predict where the magic bullet will come from. But the borrower appetite for private debt funds strengthens with each deal that closes, and so most market participants predict more work to come.

“Italy shows good investment opportunities and still enjoys more protective structures for lenders, including relatively lower leverage ratios, compared with the UK, Germany and France,” says Candiani.