Capital Talk: BlueBay Asset Management

“This is old-school banking.” That’s the conclusion of one investor who has now committed to both of BlueBay Asset Management’s European direct-lending vehicles. He’s a charismatic advocate for the growth of direct lending in Europe and, more narrowly, how BlueBay are going about it.

From returns to the management team producing them, this particular investor is happy.

When London-based BlueBay set up their direct-lending team in 2011, though, the strategy had fewer cheerleaders. This particular investor believed in the basic theory that Basel III meant a different lending environment must emerge post- global financial crisis and so took a punt. BlueBay’s first fund raised €810 million and with some recycling of capital and co-investment extended over €1 billion in credit.

This time round, the theory is proven, says the investor, in fact, he says, if you had a large enough fund, you could replace banks.

Having a large enough fund was a major consideration for the BlueBay team when they came back to market in 2014 with their second vehicle. It was launched with a €1 billion target.The firm raised the new vehicle in five months and BlueBay Direct Lending Fund II was closed to new investors in June, though the vehicle remained open to existing investors – more than 80 percent of whom reinvested. Fund II closed at its €2 billion hard-cap at the end of November following a roughly 40 percent oversubscription.

The first vehicle promised net returns of 10-12 percent, market sources con- firmed. It’s on track to beat those and is really a mid-teens vehicle, says the investor. The target range for the new fund is 9-11 percent, sources confirmed.
Private Debt Investor spoke to several BlueBay investors as well as advisors who have looked at the manager and its strat- egy. None identified the lower target as an issue, saying it was a small reduction and expected in a maturing asset class.And the increased appetite for the second vehicle suggests that it was in no way a disincentive for investors.

BlueBay’s head of direct lending Anthony Fobel, without identifying num- bers, acknowledged that the firms second fund has a slightly lower target than the first. But, he added, based on the eight deals in the new fund so far, it is on track to meet the returns promised by the pre- decessor investment vehicle. By December, he said, more than 25 percent of the new fund will be deployed.

Fobel joined BlueBay from Och-Ziff to head up the firm’s new illiquid credit strategy. In just five years, he and his team have built private debt from zero in assets under management to more than €4 billion (including a €450 million Irish direct lending fund backed by the Ireland Strategic Investment Fund).

And it is that team that is the selling point for another anonymous investor. He hasn’t allocated money to any other Euro- pean direct-lending strategy because he looks for teams with an origination edge, and believes he’s found it at BlueBay.

The original seven staff behind the strategy are all still with the firm but the team is now 16-strong, supported by the wider infrastructure of the BlueBay group which is in turn owned by Royal Bank of Canada. Fobel leads the group but says it is a very flat structure. Each of the group’s investment professionals focus on a particular
European jurisdiction.

At the firm’s West London office, PDI met Fred Nada, head of central Europe, and Ben Harrild, head of UK, both of whom have been part of the team since launch. Also present is the firm’s head of Germany, Klaus Petersen and the two newest team members, head of Spain, Vincent Vitores and head of France, Christophe Vulliez.

Vitores joined the firm from GE Capital where he had worked for the past 13 years in both debt origination and in the firm’s private equity arm. Vulliez has similarly strong credentials having spent eight years as a managing director within Ardian’s private debt team as well as a stint at AXA Investment Managers.

Direct lending is having a moment.The strategy is very popular with investors and a whole heap of managers in Europe and the US are jumping on the bandwagon. But BlueBay’s approach is different from other managers in the space, they say.

Of course, every manager will tell you that what they do is different, but in this case, there is a major difference from many other lenders – the firm is targeting net returns at the upper end of the spectrum compared with other vehicles which, on the face of it, are doing the exact same thing: lending to mostly private equity- backed European mid-market corporates.

And the difference is not leverage.

BlueBay uses none at the fund level. “The key is to demonstrate – and I mean demonstrate to investors rather than just promise – that you can achieve higher returns on lower risk. Anyone can achieve higher returns on a lot of risk,” says Fobel.

As well as being in line with targets for Fund I, the portfolio is lower risk than Fobel and his colleagues had anticipated, with lower average net leverage on deals, more senior risk exposure and with 85 percent of return coming from cash (they had expected 50 percent cash yield). Every investor and advisor that PDI spoke to agreed that this was the case.

The average leverage of portfolio companies in the first fund is 3.5x.

“We look for situations where we are providing real flexibility and value added through our loan,” says Fobel. “There could be a whole host of reasons for that but where companies or private equity firms that are trying to achieve some greater objective, rather than just maximising leverage and minimising cost.” 

The strategy may remain the same, but things have changed a lot for the firm since it launched its private debt unit in 2011, says Nada, who has been there since the start. “We are a known quantity to the people that we’ve worked with in the past and increasingly new partners know what we can deliver,” he says.

His colleagues agree. Petersen recounts a telling anecdote: “One of the deals we did in Fund I, it took me nearly six years to convince them that private debt is the right strategy – two years at BlueBay and four years talking to them when I was at Park Square.”

Vulliez, who helped launch a French mid-cap debt fund during his time at AXA Investment Managers, agreed that there has been a big shift in attitudes to non-bank lenders. “Direct lending is definitely a credible alternative to more classic financing solutions,” he says. “In some cases, CEOs even call us directly just to test ideas.”

And over the first fund, the BlueBay team say they have proven themselves to borrowers and investors alike. And while investors are clearly showing themselves to be repeat customers – more than 80 percent of investors in the first vehicle have come back into the second – it’s important that the firm’s private equity clients do the same.

Petersen recounts a recent deal where the firm financed the merging of two large library services firms, one in the US and the other – Bibliotheca – headquartered in Europe. BlueBay underwrote a $110 million loan to finance the complex cross- border deal. There was a process to win the mandate but BlueBay had done two prior deals for the sponsor, One Equity Partners.

“What it boils down to is the certainty, the commerciality and the flexibility that we bring to the table, people have real- ised that it’s not only about price and they are starting to differentiate,” Nada says, explaining how they win deals, despite not being the cheapest financing.

The new fund does mean some changes for BlueBay’s private debt team. It is larger. And along with the extra manpower (literally), the team can write bigger cheques.

The firm’s lending range was €20 mil- lion-€50 million in the first fund. That has leaped to €50 million-€150 million in the new vehicle.

Head of UK, Harrild says that along with the firm’s established reputation, the size is an important differentiator: “Our ability to take a view on a credit and provide substantial financial resources for that company, both on a drawn basis and then to cater for future changes through accordion, acquisition or capex facilities; it’s our firepower, we’re one of very few funds that can do that.”

Other alternative lenders in Europe who can extend that kind of credit include Alcentra, Ares and ICG – a small group, the BlueBay men say.

GE Capital veteran Vitores is one of the newest members of the team – he just started in September along with Vulliez – and along with the increased capacity, he points to the increased coverage. “It’s a great time to be joining BlueBay, we’re now a truly pan-European fund.The first one was really the UK, Germany and Benelux fund.This second fund is truly pan- European,” said Vitores.

Petersen points out that it is only recently, and seemingly on the back of an official embrace by local regulators, that non-bank lending has made progress in Germany. And that progress, while at different stages in different jurisdictions, is significant enough that private equity firms are beginning to open up their larger deals to private lenders.

And having the capacity to finance those deals alone or with some investor co-investment is important.

Says Fobel: “We think there are very few banks that can individually take that underwriting position without a very broad syndication process to follow. In a complex situation, if you’re a business owner, do you really want to be subject to that kind of complicated syndication process?” And doing deals on their own, rather than price taking from the more syndicated end of the market, is key to BlueBay’s strategy. 

Some other direct lenders, Fobel says, will join club deals but with banks setting the terms and the pricing, it’s a more commoditised market, he says. Being the sole lender, or sitting beside a small slice of super senior bank revolver, is a much more comfortable position for BlueBay, in terms of downside protection. “There are those funds that look to
do deals alongside banks in a syndicated or club fashion and those funds that are focused on doing the whole deal on our own. We feel very strongly that it’s that latter strategy where you can achieve better returns on lower risk,” adds Fobel.

By focusing on the deals that tick all their boxes, though, in terms of lower risk, higher return and better downside protection by sole or majority lender status, are the BlueBay team introducing another risk?

One market source said that they thought the first BlueBay fund was under diversified in terms of the number of deals. BlueBay sees around 15 deals a week and told investors it would do 15-20 deals in the first fund. In fact they outstripped that and there are 23 facilities in the vehicle, says Fobel, keeping within the 3-5 per- cent maximum single exposure limit they set themselves.

One of the firm’s investors said that wasn’t a concern of his, that as long as his overall investment portfolio, which extends well beyond the London-based lender, is diversified, the concentration of that particular portfolio is not really a concern.

Growing from zero to over €4 billion under management in five years isn’t too shabby, but Fobel has no intention to limit the team’s vision to just senior direct lend- ing. He has his eyes on new products and new horizons. In terms of geography, west is the direction the firm is likely to go in first, he says.The US is not as attractive as Europe because it does not benefit from the same dislocations, Fobel notes, but it is the natural next step, with the wider BlueBay infrastructure to support them, he adds.

Broadening the offering will also include a full range of debt strategies from the current senior-focus to include subordinated and even quasi-equity solutions, he adds.

Fobel says: “These are areas where members of the team have considerable experience, in my case at Och-Ziff and CVC before that. Offering the complete suite of financing products means that essentially we can be a provider of capital solutions right across the capital structure, the one exception being, I cannot imagine any circumstances under which we would do private equity.”

For now, though, Fobel and his team have their hands full with deploying €2 billion. Unlike bands that get it right the first time round, Fobel isn’t too worried about his second offering and the weight of expectation.

“As we reflect at the end of this year on the entire progress of this strategy since 2010-11, I would say for us there’s never been a more attractive time to be doing what we do,” says Fobel.

BlueBay’s private debt investors, old and new, hope that he’s right.

DEALING WITH DIFFICULTIES

Several sources that PDI spoke to about BlueBay pointed to its handling of a deal that went sour, as evidence for why their faith in the manager is well placed.

BlueBay’s Fobel declined to discuss specific deals but said that the firm has not suffered any defaults.

German waste collection and sorting business Der Grüne Punkt was sold by KKR to private equity firm HIG Capital and a group of private investors in 2011. BlueBay extended a loan to the company but after some difficulties it breached covenants.

Investors said that the deal was marked down on the book as the firm worked to restructure the deal. The consensual restructuring saw some, but not all, of the company’s shareholders inject fresh equity. As part of the workout, BlueBay upped the pricing on its debt and took a slice of the equity.

The borrower never missed a payment and the facility is now set to be the firm’s best performing asset in the first fund, PDI understands.

Turning a problem into an income booster proved to be a good way to keep investors sweet on the strategy.