An outbreak of conviviality

The relationship between banks and funds has moved into more positive territory, according to panellists at Private Debt Investor’s one-year anniversary, underlined somewhat by Royal Bank of Scotland’s support of the event as hosts.

Fund managers on the panel indicated banks have warmed to the concept of private debt funds, comments that reflect a growing number of tie-ups between the two groups. Notably, GE Capital and Ares Management have operated a joint venture focusing on senior secured loans for several years, and Barclays and Bluebay Asset Management cemented a partnership in January.

William Nicoll, head of non-bank lending operations at M&G Investments, said his firm had many discussions with UK banks in 2008, offering them the opportunity to put to work their institutional investors’ capital. But from 2009 to the final quarter of 2013, the banks went from being interested and helpful to actively unhelpful, though he did note that they faced mounting regulatory pressure, particularly to lend, during that time.

Nicoll said the banks’ suspicions were rooted in the belief that the funds would ultimately steal their customers, even though fund manager do not offer many of the ancillary services typically provided by banks.

Attitudes have changed since the last quarter of 2013, Nicoll said. Banks have expressed more interest and have been more helpful.

Those comments were echoed by Alcentra managing director Pascal Meysson, who said that the “relationship [has] become warmer in the last six months”, though he questioned whether banks’ attitude adjustment was a “defensive move” in response to the threat of unitranche financing, which has proved popular with sponsors.

The product has become increasingly popular in the UK, where “bank and institutional investors [are combining] with one tranche, but subsequently separating into two parts, or the bank and institutional investor will come with two parts but with pre-agreed inter-creditor [documents],” Meysson said. The structure allows banks to keep their customer while offering a product it wouldn’t normally be able to provide. It also reduces cost of capital for the borrower while protecting attractive risk characteristics for the first loss piece, he said.

When asked whether this was just another form of senior and mezz lending offered by banks and institutions before the credit crisis, Meysson indicated the situation was not very different but that the dynamics had changed somewhat. Prior to the crisis, there were two types of mezzanine financing – one with the syndicated market, where the banks would sell down, and a second where a sponsor would contact the fund manager to match up with a bank to provide financing. The difference since 2008 is that fund managers are now offering the senior debt also.

One audience member questioned whether arrangements between banks and funds constituted arranged marriages prompted by debt advisory firms.

Malcolm Hassan, head of UK funds sector at RBS, agreed with the assertion, saying that most modern borrowers consider both banks and non-bank lenders when assessing lending package, and that 84 percent of deals RBS had looked at so far this year involved a debt fund, up from 43 percent last year.

“Banks are taking more control of who to marry with,” he said, in relation to senior and unitranche deals.

REGIONAL GROWTH

Patrick Marshall, head of credit at Tikehau Capital, said his firm has a cooperative relationship with banks, adding that Tikehau worked with them to reduce their holds in certain transactions, while competing with them on others. Tikehau established a joint venture with Macquarie in 2012 and has previously partnered with Italian bank Unicredit.

The panellists cited both Italy and France as areas of opportunity for future business and partnerships, as evidenced by a recent surge in direct lending in France and the signing of a memorandum of understanding for a loan vehicle organised by Kohlberg Kravis Roberts, Alvarez & Marsal, Unicredit and Intesa Sanpaolo last month.

ROOM FOR GROWTH

Although relationships between banks and fund managers have warmed, there are still many areas in need of progress. For instance, discussions between bank and non-bank lenders have been limited in Scandinavia and Germany, where domestic banks are more entrenched.

Corporates’ need for direct lending solutions also has yet to be fully addressed, said Nicoll. Very few non-bank lenders are capable of direct lending, as it is “not a scalable market for fund managers”, he said.

The lack of scale also hinders fund managers’ ability to move into new geographies.

“If you want to be in Italy, you need a team there,” Nicoll said. Without stronger ties to the banks and their networks, fund managers need to source and originate deals themselves, which typically requires a lot of manpower.

The market also faces challenges with regard to pricing risk, an area where Marshall said maintaining discipline is essential.

“We don’t accept that lending to SMEs is more risky. It’s about the ability to source. It’s about being a credit picker rather than a market buyer,” he said.

Relationships were even progressing to the stage where banks are providing leverage to funds as managers strive to enhance returns. Leverage is something investors have been asking about in the last few months, panellists said. Some suggested it could it be a sign that fund returns were not reaching their return targets and were searching for ways to inflate them.

Much recent commentary in the mainstream media has suggested the loan markets are overheating. Nicoll said that he had concerns about the leverage loan market, where the number of participants and ensuing level of competition had created a certain degree of froth. But he saw opportunities developing in the private debt and private placement market.

Marshall agreed that some segments of the market were overheated, while Meysson said that high leverage in some recent deals was worrying, citing a pub deal which was closed at 7x leverage. “The quality of assets has declined a little bit,” Meysson said.

Yet for all the talk of challenges, the mood was positive, as indeed it had been at PDI’s launch event 12 months previously. The private debt industry has made great strides in that time, and established itself in the European market as a major source of financing.