The rise of private debt funds came as banks, under new regulatory pressure following the financial crisis, started to withdraw from the lending space. Many have found opportunities in the LBO market, but as the market has matured, more funds are now looking to do non-sponsored deals, providing traditional loans in more complex deals. Europe-focused manager Kartesia is in the process of raising its fourth fund in a region where non-sponsored lending is expected to play a major role in its portfolio.
Q Why do borrowers without a sponsor turn to alternative lenders?
Some companies may have been over levered before the crisis and there is an issue with the capital structure. We help the owner and shareholders to solve that issue by buying at a discount from the banks and then reducing the debt burden. This gives them more time and flexibility so the company can grow again.
Another type of transactions that we look at include changes in the shareholder structure. Sometimes a sibling wants to buy out the other and their experience with banks may not have been positive during the crisis. Alternative lenders come into a deal with flexibility; a fresh mind and the skills to structure a deal that makes sense for the company. The shareholder wants a customised financing package and that is something beyond the banks.
Q Are you finding that the opportunities are increasing?
The market continues to see an improvement in terms of the value add of private debt funds in sponsorless transactions. That is the result of people getting comfortable with private debt funds and not seeing them as vulture funds or shadow banks, but as professionals that are equipped to assess the risk and provide a customised solution.
It is an illiquid market, however. It’s not that easy to syndicate, which means you need the skills within the fund structure to customise deals. But you’ll find with sponsorless transactions that the person across the table is not as focused on returns and costs as a private equity firm. They really value trust. If it’s the first time they’ve done this, and if you’re able to offer different options within a debt financing packaging, then that helps to make them comfortable with this type of financing solution.
Q How important are relationships with banks when operating in this market?
Very important. We provide liquidity to banks willing to dispose of loans no longer desired. Additionally we work alongside banks in the context of restructuring existing capital structures. Finally Kartesia also finances new transactions together with banks.
For these different reasons building and maintaining quality collaborative relationships with banks is a prime objective of Kartesia.
A bank is best equipped to do a standardised deal. As banks get healthier across Europe they will be very competitive on standardised transactions. But when there is a breach of covenant or the maturity is coming up and there is a need to post additional equity, then it stops being a standard deal.
We have to do the non-standardised deals. Banks can offer revolving credit facilities or bonding lines and we give the company enough freedom to use those types of financings which is typically for sales and operations. So, we will work alone on the outset of the transaction, but give borrowers the freedom to work with banks.
Q Are you finding investors are starting to recognise the benefits of a non-sponsor strategy?
We’re in the early days of private debt, so many are quite new to the market and are content with not having the premium, but instead opting for the standardised model. And that’s understandable. I don’t think it gives you the best risk-adjusted-returns, because by having a more customised approach you can reduce the risk and get in the premium at the same time.
There are already investors that do appreciate the element of having a sponsorless transaction and recognise that we are as demanding on the downside protection. In the next wave, when people get comfortable with sponsorless transactions, we will have a good track record in the field.
Q What is the impact of Brexit on the broader market?
We think some companies will suffer volatility and some investors will think twice about increasing their exposure to the UK. As a result, we hope to find good opportunities in the UK over the next three to four years.
London will be fine in the long-term because I believe the ecosystem that it provides in terms of advice, lawyers, intermediaries and brokers is very strong. It will not be replaced – parts of it may go to Brussels or Ireland, but London will remain the best environment across Europe. You will always want to have that balance between being local in some of the countries in which we invest, but also remain part of London that keeps us on our toes in terms of what is changing in the investor/LP race universe.
COUNTRY BY COUNTRY
How is the non-sponsor market across Europe shaping up?
GERMANY “Germany is very interesting in the lower end of the market, because there are so many companies. Even if you have a bank being aggressive by looking to provide very cheap financing, there is always going to be the odd transaction that for one reason or another may require a more customised solution.”
UK “Between 2009 and 2011 the UK was a very interesting market. Since then it has become quite competitive – both from the banking side and from other alternative lenders.”
FRANCE “France is a very competitive market because banks and direct lenders are very active. It is a lot more structured and there are a lot more secondary LBOs than say Germany. But in a way that removes part of the advantage of having local relationships, because a lot of people may have looked into the deal. However, buying debt in deals that may have been over levered offers opportunities because of the discount. We remove that over leverage and give the company enough freedom to grow again.”
NORDIC COUNTRIES “Even though there are not that many banks in the region, the Nordics are competitive and very well equipped to address the needs of the market and so you see a limited private debt market and a little more focus on growth capital and mezzanine compared to the rest of Europe.”
SPAIN “Our approach is appreciated because we are dedicated to helping companies grow. Banks have suffered a lot in recent years and that has created some animosity between lenders and borrowers. Spain is a market that has not invested a lot in the past because companies were merely surviving, so one year of investment now can offer a very good return.”
This article is sponsored by Kartesia. It appeared in the Mid-Market Lending Report, published with the June 2017 issue of Private Debt Investor.