At the crossroads

Not long ago, when the weather in London barely qualified as autumnal and winter seemed quite far away, PDI gathered a group of experienced credit managers to share views on issues in the market and the state of private debt in Europe.

The group discussed a large range of issues ranging from the technical – the pros and cons of covenant-lite loan agreements – to the harder to pin down, such as the impact of Europe’s poor economic outlook on the private debt market.

Those present were from diverse backgrounds – the institutions represented were of varying size and strategies – though we found out early on that several of the group had spent time at the same institutions over the course of their careers.

This cross-over was replicated in our discussion as the most interesting topics clustered around market intersections: where distressed meets real estate, or leveraged finance knocks against direct lending.


Just as individuals rarely thrive alone, finance professionals cannot afford to look at their own market in isolation. And when Anthony Shayle, a managing director and head of global real estate, UK debt at UBS Global Asset Management, expanded on the real estate credit markets, the non-real estate speakers listened and questioned him closely.

“If you look at central London offices, it appears we are heading back towards a peak again, or pretty close to it,” was Shayle’s opening gambit.

Yields in London’s commercial property market are back at pre-crisis peaks or even under them, in some areas. Huge foreign capital inflows have driven yields down and asset prices up, but Shayle argued that this is not just down to capital seeking safe haven, it is also because prime office space in London and other European capitals offer solid prospects of rental growth.

Loan to value is roughly static at around 60 percent to 65 percent, and while there is some downward pressure on margins for top assets, they will not compress much further, Shayle insisted.

“The question is, are covenants becoming progressively more relaxed? And that to me is just the most frightening thing that could happen,” he warned.

Headlines, not to mention data, throughout 2014 have suggested that covenant-lite structures as well as gearing levels are on the rise in the leveraged finance markets in both Europe and the US. And it was on covenants that Shayle was keen to hear from his corporate-focused colleagues.

But not before the table burst with laughter as he held up a recent copy of PDI and read out the headline: “No fear of cov-lite”.

Robin Thywissen, a vice president within the private debt unit at Partners Group, argued that there had been too much of a fuss about the so-called return of cov-lite.

“I think the real cov-lite structures started in March this year in Europe and there’s just a handful of them. You also have some deals with looser covenants, that’s true, but you see more recently lots of transactions in the syndicated loan market which were flexed up and that just shows you that, you know, troubled equity markets, some IPOs which didn’t happen as expected, and some deals which were expected to be cov-loose, have reintroduced some covenant protection,” Thywissen explained.

The lending market, he suggested, is resisting a full-on adoption of cov-lite as standard.

Tikehau Investment Management’s Cécile Mayer-Levi, co-head of private debt at the French direct lending firm, agreed that the market is resisting cov-lite, and pointed out that quantitative easing programmes have been the driving force behind rising leverage and looser structures.

“In most private debt teams, people were exposed to the 2007-2008 cycle. We have developed, however, a bottom-up approach and if you look at a situation from an individual company perspective, you may decide to invest in a situation if this is the right company and dislike the next one. Overall people get really concerned by this rise in leverage because it’s above five times again, and that has been a growing trend. But at the same time, I can feel some teams are more conservative as they have been exposed to the consequences/aftermath of too high a leverage,” Mayer-Levi said.

On the distressed side, Gordon Watters, senior advisor to LCM Partners, was not too concerned about covenants with regard to his firm’s strategy of scooping up non-performing loan portfolios, but he also pointed out the pitfalls of cov-lite for loan-to-own distressed investors.

Without covenants in place, creditors have few rights to step in until after a default has occurred. This limits the opportunity of distressed investors to take control of struggling assets and if credit conditions improve, as they did after central bank monetary easing kicked in, struggling borrowers can refinance with ‘amend and pretend’ deals.

“It’s a saving grace for the private equity guys going forward, if they can retain the covenant-lite. It’s not great for the overall market and certainly not for the distressed loan-to-own investor because they’re just not getting the opportunities that otherwise they would have,” said Watters.

Mayer-Levi made the point that covenants are an important feature for lenders and emphasised that they are not included for the benefit of distressed investors.

“Our investor will expect that we do provide very disciplined type of documentation, and for sure, we will put them in place,” she said, adding that it is Tikehau’s relationship with the borrower and in most cases an observer seat on the board that is its true source of reassurance.


For Shayle, covenants execute an essential function for lenders – not as a stick to beat delinquent borrowers, but as a trigger point for discussions and seeing what can be done to keep the facility on track.

“So covenants when they’re made lite, you completely avoid the opportunity to have a discussion with your borrower. I think it allows the borrower to kind of do the ostrich, and this must be the one of the most dangerous features of going cov-lite,” asserted Shayle.

So what factors are driving the increase in cov-lite?

Quantitative easing and the cheap money supply it handed traditional bank lenders is certainly part of the answer, according to both Mayer-Levi and Shayle.

“QE is still set for some time, and I think has potential to be a continuing source of subsidy for bank lending for some time,” said Shayle.

Blaming cheap bank funding implies that banks are driving leverage up allowing looser covenants. Speaking to traditional leveraged finance bankers, PDI has heard more than once that CLOs and private debt funds are the source of the excess liquidity in the market, and forcing lenders into looser deals by over-competing with banks with higher leverage multiples and less restrictive terms.

Our roundtable members unanimously rejected that suggestion.

“From a real estate perspective, that’s hard to understand,” insisted Shayle pointing out that across Europe, the alternative lending market for real estate totals €30 billion, a fraction of the size of the bank market. “The reality, the true reality to that comment, is that lenders have driven those rates down because the alternative debt space can’t readily afford to drive rates down since they have to service their fund investors.”

Thywissen echoed Shayle, pointing out that private lenders have to consider more factors than bank lenders as they do not recycle their balance sheet.

“We are take and hold, so we care about risk. We care about leverage, documentation and we care about pricing,” Thywissen added.


The growth in private debt is clear and has encompassed a wide range of strategies and sizes with firms ranging from the very small to the very large. And though there have been a few examples of mergers and buy-outs, the group said the emphasis is still on growth.
“There’s a mutation and disintermediation wave now in Europe, which is really driving the emergence of a clearer private debt industry,” said Mayer-Levi.

As for when that wave of growth could be followed by a wave of consolidation, Watters argued that it will take a large market shock where some funds find themselves struggling, to prompt that.

“You could almost liken it back to what happened with the CLO market – a lot of US money came into it originally. You’ve got a lot of US money now coming into the private debt market,” Watters suggested. “When that capital was pulled back, you had a lot of individual CLO managers left with probably just one or two portfolio loans across the European market. That’s not a sustainable business model.”

Whereas at the moment, the private debt markets are still experiencing strong investment inflows.

For Thywissen, a drying up of deal-flow would also represent a shock potentially large enough to change the landscape of the market.

On the real estate side, there are no signs of consolidation, said Shayle – only growth.

“Investors want something for their balance sheets. And what they want is LDI, liability damping investment or long duration investment. There are some significant future obligations in some pension funds, stretching out from now into the future. We have an aging population with overhanging pension obligations looming up, so they need very stable, long-term cash flows … I think, therefore, one of the reasons why the private debt industry has to grow, is that the demand from investors is actually very substantial,” claimed Shayle.


The growth in the industry, is also being driven by positive regulation. Mayer-Levi highlighted the searches being conducted by insurance and mutual funds to both find higher yielding assets in a low-interest rate environment, and more particularly, new regulatory initiatives encouraging investors to support growth in the real economy through those investments.

As a direct lender, Tikehau’s business model is premised on sourcing companies essential to that real economy. And in Europe some governments are helping drive investor demand for private credit and encourage the development of private placement markets, explained Mayer-Levi.

The banks are the elephant in the room for governments and regulators trying to encourage the flow of credit to small- and medium-sized enterprises across Europe. Since the financial crisis, lenders in the US and Europe have been deleveraging by reducing lending and shedding assets. That process appeared to accelerate this year as European lenders prepared for the results of the European Central Bank-led comprehensive assessment which included stress tests and an asset quality review (AQR). Several banks raised capital and a series of non-performing loan portfolio sales pointed to lenders improving their balance sheets ahead of the results.

As Partners Group’s Thywissen recalled, the US banks have been much more successful, with total banking assets down to around $14 trillion, while in Europe, banking assets are substantially larger, totalling roughly €45 trillion.

“We believe that this de-levering trend will continue with high governmental debt, banking leverage and the results of the stress tests. Now, for us, does it mean more deal flow? Not necessarily, because we are focusing more on high quality, non-stressed situations and generally, these loans trade at par or above par today, and are not yet attractive for us until further volatility hits the market. So it’s currently more in terms of new lending opportunities. I think, given the constraints of the banks, there will be opportunities for alternative debt providers to invest,” said Thywissen.

For Tikehau, the situation is similar, the AQR provides no direct opportunities, but Mayer-Levi also said its effects on the private debt market could be profound: “I would say that – from a very imminent, practical point of view, it’s not going to change the private debt market per se, but simultaneously, it’s giving another signal to the market and among management teams that again, there is a maybe troublesome situation for banks. And so it’s allowing us to stress that the private debt type of alternative financing is here to stay, and that it’s now a clearer, solid financing solution.”

For Watters and his colleagues, the AQR has been, and continues to be a direct, and very welcome source of new business. But it is not a standalone factor in driving banks to shed assets and providing LCM Partners with a business opportunity, rather they foresee a series of events which will have a domino effect on lenders, forcing them to sell business units and whole portfolios.

The fallout of the AQR will be followed by the introduction of Solvency II before accounting standards change with the introduction of IFRS 9. Those three factors will be topped off with the introduction of Basel III. As a result, banks will have to cut their total assets to remain competitive while complying with new internal reporting and asset valuation standards, argued Watters.

And that, he went on, then makes it quite an exciting time for people who have that interest in the market to pick up those type of assets: “They won’t necessarily all be [non-performing loans]. Some of them will be, some of them will fall within securitisation vehicles being driven out from some of the regulatory changes. But where investors are looking for that type of asset class, then I see lots of opportunity coming up over the next three to five years and I think it’s very exciting.”

Continuing Watters’ excitement, the conversation turned to the €136 billion of unacknowledged non-performing exposures that was discovered during the recent stress testing by the ECB, the European Banking Authority – the eurozone’s new regulator – and national authorities.

While the pipeline of asset sales looks solid, for other distressed strategies, Europe is not necessarily the rosiest of markets. There are plenty of reason why it should be an oasis of opportunity but the reality is that it has not produced nearly as much deal-flow as many had anticipated.

For senior level debt, defaults have been low and recovery rates have been high, noted Mayer-Levi.

“Coming from the US, [there were a lot] of funds with a distressed strategy, buy and hold type of culture and at the end of the day, they didn’t find that many companies to take a grid on,” she added.

Watters agreed, adding that many of the ‘loan to own’ strategy funds were having to switch course and start to look at buying up non-core and non-performing assets from lenders instead.


Like the capital shortfalls revealed, the increase in overall non-performing assets, which brought the European NPE total to €879 billion, represents an opportunity for the private debt market. Some, like LCM Partners, will seek to take direct advantage, while for others, it’s more about the indirect boost.

Of the €136 billion in unacknowledged impairments, 27 percent were real estate debts and though Shayle is not a distressed investor, he said when that statistic was revealed, he had a fist pump moment: “I’m an old-fashioned banker, probably too old-fashioned in many ways, but I always believed that if you are recycling your capital from the balance sheets through the CMBS system, you are doing something that is fundamentally alien to the concept of prudent balance sheet lending.”

Pointing to the US experience, Shayle highlighted that the property crash on the other side of the Atlantic was shorter and shallower, a consequence of the fact that US bank lenders hold no more than a 60 percent market share while in Europe, the equivalent figure is 90 percent. “I think what the AQR study will bring forward, is the banks may have further to go to rationalise their real estate lending portfolios.”

And the same issue is at the heart of the corporate lending market. Added Thywissen: “In the LBO corporate space, as in the real estate sector, the situation in the US vs. Europe is similar in that probably around 14 percent of lending is in the hands of banks, and 86 percent is with alternative lenders and the numbers are almost at 50-50 in Europe.”


Most of these numbers are very familiar to anyone involved in private debt, and despite making progress, it is now six years since the collapse of Lehman Brothers, and in Europe, alternative lenders are still just that, alternative, with the awkward status conferred by not being mainstream.

Despite a slow and painful deleveraging process that has seen SMEs in most European struggle to secure financing, private debt remains on the edges on the continent.

In the face of a €45 trillion banking behemoth, will Europe’s non-bank lenders persuade borrowers to switch to them and claim a larger share of the market?

After a strong year so far, the PDI Roundtable was upbeat.

“The main reason why people will really consider the private debt alternative versus a bank, is that we are reliable, fast, and highly flexible,” Mayer-Levi said.

Once again, the discussion had arrived at a point of intersection and each member of the group agreed that it is relationship and reputation that will drive growth for non-bank lenders and debt investors.

According to Watters, it’s also deliverability and reliability: “They’ve traded with you before and therefore there’s a willingness to trade with you again,” he said before also making the point that even when not originating deals, relationship is key. Many of the lenders that LCM buys portfolios from, have sold down to them before, and know that their reputation will remain intact, even after shedding the asset.

The difference between private debt funds and large bank lenders is taking root with borrowers, particularly among sponsor-owned entities. “There is a major change and shift among management team that this private debt alternative is now a real mainstream solution. It’s not, you know, a backup solution because the banks have declined your financing,” continued Mayer-Levi.

Thywissen added that debt advisory firms have also played and continue to play a key role in boosting the share of private debt funds by pitching them alongside bank-led financing solutions and emphasising the alternative options with borrowers.

The institutional connection between private debt funds and private equity funds will influence and remain a part of non-bank lending for some time to come, says Watters, keeping private debt geared towards leveraged finance. Several factors beyond ownership will continue to reinforce this, he said, including the speed at which leveraged finance deals can be done offering more potential to allow managers to recycle cash through the fund, not to mention the higher margins offered with higher leveraged deals.

For Partners Group, the GP connection is a vital part of their origination capability, Thywissen said, and they have invested with over 600 funds globally, making the LP/GP dynamic key to sourcing deals.

“I think you’ll probably find that, you know, as each private debt business becomes slightly more mature, the balance will sway a little bit more towards corporate, but it will never be, and certainly not in the next sort of five to ten years, never be the main part of their portfolio,” commented Watters.


Following the crisis, European authorities often appeared a bit punch drunk. They couldn’t secure agreement on how to deal with the problems plaguing the worst hit peripheral economies and the banking system was dealt several body blows in the years following.
And though many of the factors that led to the crisis have been addressed, including for the banks, the main issue of capital, the financial system in Europe remains pretty fragile.

PDI asked the group if they thought that another financial crisis could crop up, like 2008/2009, or the less serious but still damaging credit crunch in 2012.

For Shayle, addressing bank capital is key to avoiding more financial turmoil and he said that this was an issue that has been addressed.

However there are other and potentially unforeseen risks in the market. Over-easy credit, another reliable cause of financial crises is creeping back in.

“You only need to watch some of the television screens, read some of the press advertising, and all the companies who are providing cheap or flexible finance are actually all gradually coming back into the market,” said Watters. With that freedom of capital starting to come back into the market and that freedom of finance, then I think there is a potential problem there starting to build going forward.”


But still: looking over the European private debt market, it was easy to see why our discussion group members were upbeat. This year has proved a good one for each of their businesses.

Partners Group invested $1.5 billion in debt, of which around 60 percent went into European deals, says Thywissen, and the group – though it has global stretch and presence – views Europe as one of the best sources of debt investment opportunities.

“We’re looking at two things: and one is we need to invest in companies that have cash flows resilient enough for them to take on leverage, and there we have the reference point of the 2009/2010 crisis, which is always a good indication of how a company can perform in a very difficult environment,” said Thywissen. “The second thing is, as Cécile mentioned, we’re also looking for international companies, or companies which have the potential to go abroad, to diversify their revenue streams. We are very cautious with businesses which depend on consumer spending.”

For LCM, the message was the same. They achieved a €350 million first close on their third fund and are busy investing it and moving towards final close. Market dislocation continues to throw up opportunities for the flexible firm, which encompasses both performing and non-performing assets in its strategy, said Watters.

For Shayle, 2014 has been a very interesting year, as UBS Asset Management just launched its UK version of a US business model offering whole loans up to 80 percent loan to value in Britain. The UBS Participating Real Estate Mortgage Fund was launched in December 2013 and raised £140 million, of which about two thirds has been invested, said Shayle.

Levi-Mayer echoed her colleagues. Tikehau has had a good year with plenty of direct lending activity, a new senior loan fund as well as a separate managed account to occupy her team in combination with a French government-driven initiative to provide debt financing for business.
Geopolitical volatility, a drop in the oil price and the kind of wider market volatility seen in early autumn have not dampened the group’s expectations of another good year in 2015.

But of course there are some burning questions. How will quantitative easing in Europe affect both real estate markets in the bloc and liquidity in leveraged finance? If cov-lite becomes de rigour in leveraged loans, will it prompt commercial property borrowers to push harder on their terms?
And we have yet to see the full impact of the AQR and comprehensive assessment. The European regulators are turning on under-capitalised banks – it’s a case of ‘no more Mr Nice-Guy’. That will almost inevitably translate into even more stressed opportunities as weak Irish banks shed mortgage portfolios and Italian lenders rid themselves of stressed SME debt.

Plenty to do, in other words, and plenty to look forward to.

ROBIN THYWISSEN is a vice president within the European private debt team at Partners Group and is in charge of the firm’s debt investments in the French market. In common with most of the discussion group, he started his career in investment banking and worked on M&A at BNP Paribas. He has also worked for Terra Firma and focused on mezzanine at MML Capital Partners before joining Partners Group four years ago.

CÉCILE MAYER-LEVI is co-head of private debt at Tikehau Investment Management. Mayer-Levi’s career began in M&A at Merrill Lynch before she moved to focus on leveraged buyouts at a private equity firm. She shifted into mezzanine and worked at the Credit Lyonnais controlled mezz fund, Mezzanis before joining AXA, now known as Ardian. Tikehau’s investment management unit was set up in 2006 and was a European pioneer in private debt financing.

GORDON WATTERS is a self-confessed ‘seasoned banker’ and senior advisor to LCM Partners. His career has spanned structured finance, leveraged finance, middle market and institutional investment asset management. His experience encompasses stints at a range of institutions including Bank of Scotland, Credit Lyonnais (at the same time as Mayer-Levi), Barclays and Ares. At LCM, he is focused on bundles of non-performing and performing loans.

ANTHONY SHAYLE is head of global real estate – UK debt within the property-focused division of UBS Global Asset Management. The real estate division manages $67 billion globally. Shalye heads up the new UK version of a real estate strategy that has performed well in the US form more than three decades, which he describes as unitranche for the real estate world. Shalye’s career has been primarily in banking and he has worked at Barclays, AXA and several French companies including CDC.