In lending, as in marriage, the motivation for partnership sometimes lies in a desire to compensate for one’s weaknesses and make the most of one’s strengths. This desire helps to explain why several banks have, over the past year, cut deals to partner with asset managers on corporate lending.
European banks can offer a strength in origination – the art of finding borrowers – that asset managers can only dream of.
This holds true even for those rare asset managers, such as M&G Investments, that have well-established direct lending operations.
Asked why his firm is eager to source deals through Royal Bank of Scotland (RBS) even though it has lent to companies without going through a bank for more than a decade, William Nicoll, co-head of alternative credit at M&G Investments, says: “The question implies that corporate lending is a very well-fixed market, like buying bread, and the question is whether to buy a loaf from a baker or a supermarket … That’s not really the case. It’s a question of finding the loaf of bread.” RBS’s agreement with M&G, signed in December, also includes AIG Asset Management and Hermes Investment Management. Deals have been done so far with a laundry company, a fast-food chain and a software services company with another five or six under discussion, according to Richard Roach, head of financial sponsors at the bank.
So far all three firms have partnered with RBS, though each is free to choose and reject each deal that the bank offers it. The agreement covers UK mid-market leveraged finance.
This is partly a question of pedigree and partly of personnel numbers.
“Banks have been around for hundreds of years, so they’ve developed great origination networks that are very hard to replicate,” says John Bohill, senior advisor at StepStone Group, a private market advisory and asset management firm.
Regardless of an asset manager’s history in direct lending, “banks will always have an advantage, with all those expensive origination networks, including all those branch offices”, he adds.
Asset managers, for their part, can offer something which has become more problematic for the banks than before: the ability to take on debt.
Banks are constrained by stricter capital requirements, including the Basel III rules, which force banks to hold more capital against loans.
Moreover, many banks are eager to reduce their maximum loan exposure to all but the most highly-rated companies – while remaining keen to hang on even to those clients that want to borrow a lot of money.
“We’ve put the agreement with AIG, Hermes and M&G together for origination purposes,” says Roach. “The market is increasingly competitive, with new debt funds that are quite happy to write £100 million ($144 million; €129 million) holds on their own. Through this agreement, we can lend similar amounts.”
By keeping the number of borrowers to which it lends as high as possible – even if the amount which it lends is much lower than before – banks can continue earning revenue from maintaining client relationships. Roach cites derivatives, short-term lending, cash management and foreign exchange as examples of revenue-generating opportunities.
Analysts might say that aside from the asset managers’ lack of origination capabilities and the banks’ more constrained approach to debt the rest is mere detail.
However, Bohill thinks that disagreement over the details is delaying the rise of the bank-asset manager partnership model, though not halting it altogether. “I think it will take a while to grow, because it will take pension funds and asset managers a while to understand the peculiarities of the banks,” he says. “But it will happen.”
The varied explanations given by bankers and asset managers for how their partnerships work confirms that there are, indeed, many ways to skin this particular cat.
The RBS four musketeer model involves a large number of parties sharing the loan and therefore the risk, but some asset managers want a bigger role than this.
“We tend to prefer it when we’re needed to complete transactions,” says David Allen, managing director of the Canada Pension Plan Investment Board’s (CPPIB) Principal Credit Investments group, based in London.
Allen estimates that the CPPIB’s average commitment is 50 percent of the deal, though it has stretched as far as 100 percent. Its reward for this high commitment? “For the vast majority of private loans we can decide everything, including covenant, coupon, maturity, call protection and structure.”
GSO Capital Partners, the credit arm of private equity firm Blackstone, goes one step further, through its March 2015 agreement with Intesa Sanpaolo, the Italian bank, covering domestic corporate loans.
GSO will provide the term loan risk while Intesa will retain its corporate relationship via ancillary facilities and services, says Paulo Eapen, senior managing director at GSO.
This clear demarcation allows GSO to negotiate terms with the borrower that fit its particular return targets. “Depending on where we think the best risk-reward is, we’ll tailor the capital and structural protections we require,” says Eapen – citing return targets of 7-10 percent for first-lien debt, 10-12 percent for unitranche and 12-15 percent for subordinated debt. GSO has agreed three deals so far.
The division of responsibilities for the loans is similar to that in the December agreement between Ares and Barclays, with the latter providing the revolving credit facility and the alternative investment manager providing the long-term loans, according to Karl Nolson, head of debt at Barclays Corporate.
However, in one respect, the Barclays-Ares relationship differs from other partnerships: Ares will introduce loan opportunities to Barclays and vice versa, according to Nolson. The situation reflects Ares’ larger origination network, as an experienced direct lender, than that of most asset managers. No deals had been signed but a number were “very near to completion” in mid-February, says Nolson.
Barclays also has an agreement with BlueBay Asset Management, signed in January 2014, to make unitranche loans primarily to companies with private equity sponsors.
The size of the borrower also varies, depending on the preferences of each asset manager and bank.
For example, CPPIB prefers larger transactions of €300 million, €400 million or even €1 billion, because for these large deals “the competition is much lighter”, according to Allen – allowing it to negotiate higher rates than for smaller deals.
CPPIB can allocate such large amounts because of the size of its private credit portfolio: it has invested €9 billion in this sector in the six years since Allen joined. These deals are much bigger than those pursued by RBS and its partners. GSO is currently looking, through the Intesa partnership, for loan sizes of between €30 million and €100 million.
The nature of the relationship between bank and asset manager partner also varies.
For example, Nicoll of M&G is pleased at RBS’s willingness to let partners come up with their own views based on their own credit analysis. This contrasts with arrangements he has discussed with potential bank partners where “asset managers would sit behind the bank and accept all the credit work done by it”.
To Nicoll this is unacceptable because M&G’s clients need to know exactly what the manager is getting them into.
PATTERNS OF RETURN
The issue of who does the credit analysis is just one among many possible tensions. There are many other issues to be worked out at this early stage of the partnership model.
Bohill cites another: how patterns of return work. He notes that banks like one-off fees that can be booked quickly, whereas asset managers prefer steady returns. Because of this, “banks have to get used to generating asset management fees on an annual basis rather than trying to extract the largest upfront fees they can”.
Given all these complications, it is not surprising that many asset managers prefer to gain exposure to direct lending through specialist funds. These funds also offer the appeal of targeting higher annual returns than the 5-7 percent available through most bank partnerships, according to Bohill, because they seek “more angular deals” that contrast with the “cookie cutter” approach of the banks: more complex deals, for which a higher rate can be charged.
Asset managers partnering with banks can achieve higher rates than this, but only if, like GSO and CPPIB, they are prepared to take on either a large proportion or the entirety of the term loan, allowing them to agree deals that are “more complex”, as they put it, though sceptics might prefer the word “riskier”.
For example, GSO is prepared to lend to companies that need money in order to shrink – a circumstance that many banks might reject. In Italy and many other European countries, making people redundant is costly.
There is, however, one attraction in using a cookie cutter, as any weekend baker knows: it rarely produces surprise results. Asset managers that have joined forces with banks hope for the same predictability.