Capital Talk: Breaking with the consensus

There are those who argue that direct lending in Europe is a flash in the pan. Others with less entrenched doubts, but still sceptical, argue that it will remain a marginal market and make little headway in regions with stronger banking systems – like the Nordic market. 

But nobody appears to have told Stockholm-based Proventus Capital Partners (PCP) that it couldn’t be a successful private lender in its own backyard. And Daniel Sachs, chief executive, has no doubts about the ultimate longevity of the growing asset class.

In the early 1990s, the banking systems of Sweden, Norway and Finland each went through a crisis. Taking the pain almost two decades before the rest of the world was similarly affected meant that banks in the region were better capitalised and came through the global financial crisis in better shape that the rest of Europe. 

And it is that competitive and stable bank environment that means even private debt cheerleaders tend to assume that alternative lending will struggle to make gains in the Nordic regions. 

But the general consensus hasn’t stopped Proventus from breaking ground both in fundraising and deal making, particularly in the unsponsored end of the market.

Two-thirds of the firm’s loans are to companies not backed by private equity sponsors, Sachs says. The strategy is one that institutional investors are eager for exposure to, amid a landscape of retreating banks and mounting regulation. 

Those who dismiss private debt lenders criticise them as only doing the deals that banks won’t touch. It’s not a criticism that worries Sachs, who confirms that PCP is thriving in this area. But the firm invested in private credit before 2008, when, Sachs says, the Nordic banks were very aggressive and liquid.

That the global banking system shattered reinforces the firm’s view that something more permanent changed. “Quite early on in our analysis we found that bank dominance and bank balance sheets in relation to GDP had been exploding over the last 20 years and that it was not a sustainable situation. At some point there needed to be some sort of structural shift and a more diverse corporate funding market,” he says.

Lehman Brothers was the catalyst and against that backdrop PCP, originally a family-office investment firm, scaled up and raised third-party capital to invest in private credit.

EVOLUTION

PCP has had a ringside view of the structural shifts to occur in Europe over the last 45 years. Proventus AB, founded in Stockholm by businessman and philanthropist Robert Weil in 1969, launched its third platform, private debt, in 2005. This evolution was preceded by two others: the original strategy, Swedish equities, and investments in companies in need of structural change. 

During this time the firm listed on the Swedish stock exchange, going private again in 1995. Sachs has a private equity background, having worked as managing partner at Segulah. He joined PCP in 2003.

Since its first investment in private credit in 2005 and launching its maiden debt fund in 2009, PCP has grown assets under management to €2.5 billion, executing more than 85 deals.

The firm recently exited the final investment from its first fund. PCP I, which raised €216 million, will return 100 percent of its capital to its investors and suffered no losses. The fund included 19 transactions. PCP has consistently produced IRRs in the low double-digits, PDI understands. Sachs will only say that the firm delivered a return higher than its target for its first fund. 

Now onto its third vehicle, which raised SKr12 billion (€1.3 billion; €1.45 billion) and held a final close last November, PCP is investing capital at more than double the pace anticipated; 45 percent of the capital from PCP III has been deployed since June last year. 

Looking at these numbers, it’s unsurprising that Sachs is convinced that structural change is sweeping European lending.

New geographies drive much of PCP’s activity. In its third fund, lending so far is roughly split between the Nordic countries and the UK with Germany providing a minority of facilities. However, Germany, another notoriously competitive market, is catching up, says Sachs. PCP is also moving into the Netherlands and Sachs hopes to strike deals there soon. 

With heavyweights Swedbank, Nordea and SEB dominating activity in the region, the lending gap never appeared in the Nordics, says one bank source. 

Asked whether opportunities are better outside the region, as a result of tougher competition from the banks at home, Sachs is ambivalent. 

“Yes and no. I think in this quite young and immature market it’s important for us to be active in a reasonably broad geography because the individual markets shift over time. Recently, we’ve seen quite a lot of activity in Germany and in Ireland, but we also see quite a lot in the Nordics.”

He adds that it’s a complex set of factors that dictate how interesting a region is for the firm at a particular point in time. 

Sachs concedes that achieving consistent returns in the current environment is not easy. The firm is putting money to work in a variety of ways. It has branched out into shipping, airline finance, guarantees and revolvers and is increasingly doing senior secured and unitranche transactions.

FOUNDATION

Analysis is one of the cornerstones of the firm’s strategy, which Sachs refers to often and explains is the “red thread” throughout the firm’s history. PCP also keeps a close eye on the macro-environment and is contrarian in its approach, looking at parts of the market that are less developed. 

“We focus on situations that are more complex, that require problem solving, structuring deals in an agnostic manner to address the needs of the company at the same time as limiting our risk. We then live very close to the companies we fund with the ambition to be strategic financial partners to these companies, their management and owners.”

PCP attracted investment from US investors for the first time in its third fund. The firm launched the private debt platform using its own equity and has committed around 10 percent of the capital in all three funds. 

“The first fund we raised was based on going around to Swedish institutions and other family offices, and saying, ‘This is where we want to invest our money, do you want to invest with us?’ That’s a very different approach than just wanting to manage other people’s money.”

One of Sweden’s national government pension schemes, AP4, a cornerstone investor in its first fund before re-investing a second and third time, demonstrated its confidence when it increased its commitment to the first vehicle after a private pension fund entered liquidation. 

Six years on, the make-up of the investors has changed and one-third of the latest fund’s limited partners are from outside Sweden, Sachs says, adding that the firm explicitly went international to diversify and build relationships.

MARKET FUNCTION

Sachs extols the virtues of debt managers holding higher risk assets that banks are constrained from holding. “As long as credit funds largely remain unlevered and without too much of a maturity transformation element, then it’s better to have those risks on the credit funds than on the banks’ balance sheets,” he says.

Touching on shadow banking, he adds: “It’s been talked about as a major risk in the system, but I would argue that it’s primarily an important opportunity, both for the corporate sector, investors and society at large, since the need for funding in the corporate sector is so much larger than the banks can handle with their new capital, liquidity and regulatory restraints.”

Sachs also has strong opinions on how leverage at fund level should be treated: “The dividing line for me is between levered and unlevered funds. As soon as you introduce leverage or maturity transformation on a larger scale, shadow banks also become part of the broader systemic risk landscape.

“From our point of view, if leverage is a way to make up for decreasing returns it’s usually not a good idea, but of course you can have investors that do want to add risk and enhance returns. We leave that decision to our investors and have remained unlevered. As soon as shadow banks take on leverage or engage in transforming maturities and thus become systemically risky, there needs to be a certain level of regulation.”

TIPPING POINT

Institutionally, PCP claims to have a conservative approach when analysing the downside risk in its deals. 

Commenting on investor concerns about high valuations, step-in rights and the potential lack of equity subordination in deals not backed by a private equity sponsor, Sachs is relaxed. For him, it’s about the cash flows and the ability to service the debt.

He also spends little time thinking about loan-to-value metrics. “We spend more time looking at loan-to-cashflow ratio and repayment and debt service capacity. If you focus on those fundamentals and structure the credits well, you will hopefully avoid most of those situations where loans underperform.” 

Contracts and structuring are important too, he says, with the experience of managing problem credits in the past. Around 10 percent of its 85-plus deals have experienced problems in one way or another.

“On the one hand it’s very important to have the formalities in place so that we have all the protections we need from the documentation and structure. At the same time, we don’t want to have to use our formal rights, they are more important as a baseline to introduce an informal discussion with owners and management on how to address the situation.”

This raises the accusation that all private debt lenders are loan-to-own investors. That may be the case for some, says Sachs, but not all.

“Eighty-five deals over 12 years and we’ve never accelerated a single loan, even if we have had the possibility to do so. We have fought really hard to avoid that and to keep our borrowers operating as a going concern. I think that record speaks for itself, if we were interested in loan-to-own, we wouldn’t be very successful,” he jokes. 

Indeed, there is the scenario in the future where Sachs might have to take the keys, but it is not the end goal he aims for. For credibility and reputation, PCP is in the business of lending.

But, as all lenders must from time to time, PCP can work through restructuring. The firm has a skill-set that the majority of institutional investors don’t have, as one of its investors testifies to PDI

A more important skill for the firm, however, has been its ability to break with the consensus. Proventus has built a private debt business that has expanded from its base in a region considered one of the most competitive in Europe. It has gone from deploying around €100 million a year to €700 million annually. And it has established a track record strong enough attract investors from across the globe. 

Not too shabby for a flash in the pan.