Q Within the European market, what jurisdictions or sectors do you find the most exciting?
SC: In our opinion the market has become truly pan-European. The UK still represents roughly 40 to 50 percent of the market, France is around 25 percent and Germany nearly 17 percent. The rest is made up of Benelux, Nordics, Italy and Spain. We are encouraged by the recent pick-up in activity in across Europe, notably in Spain and the Benelux countries. Spain, though it might change with all the political uncertainly, has certainly been a very active market over the last two years as the country has seen a 47 percent increase in direct lending activity. Interestingly, activity in the Benelux countries has also increased by over 47 percent over the last two years. Nordics, meanwhile, have historically been a little less active in terms of direct lending because the banks are very competitive and less constrained in terms of hold size. Putting that aside, I’d say we are seeing the fastest growth in Germany. There has been incredible expansion in this market over the last 12 months, even more so in the last three or four months. We have always had a strong conviction that Germany would be a big market for direct lending activity.
Q What are the factors that have made Germany such an attractive market for private debt?
SC: There are several reasons. First, it’s a market where there is a deep pool of mid-market companies: the Mittelstands generate circa 30 percent of GDP, and a lot of these companies are family-owned businesses that were created after the war and have successions they must deal with. So, invariably some of these companies will either be looking to sell to private equity to manage their succession issues or look for a financing solution where they can retain control and pass it on to one of their family members. There is also a much better understanding and acceptance of private debt financing solutions in Germany by the local private equity and advisory community. The other aspect is the fact that German banks now have more stringent balance sheet constraints. As a result, regulators have been more forceful with the German banks, particularly around large exposures. Banks are less flexible than they were a couple years ago, so inevitably this has opened a significant opportunity for private debt funds to move in and fill up that gap. That’s not to say the banks are not active in Germany, they are, but they’re less active than before. We will see increasingly more private debt activity and I think that is a trend that will continue.
Q How long do you expect this to continue?
SC: Unlike the US, where there’s talk about reducing regulation, in Europe new regulations are still being implemented and I think the European Central Bank (ECB) has made its rationale clear. The European banking system is still about three times the size of the region’s GDP whereas it’s about one to one in the US. Europe still has a long way to go in terms of deleveraging, and there are more and more banks looking to sell assets. It’s a gradual process and regulators are still very much focused on reducing the systemic risk in the system, reducing the size of the banks and making sure the banks are not taking on too much risk. The most recent example of how they’re doing that is when the ECB introduced its leveraged loan guidelines back in June. I think it’s very healthy, as the European banking system was too dependent on the banks before the global financial crisis and it’s healthy to have a diversified pool of potential alternative lenders. The regulators across Europe are gradually making it much easier for alternative lenders to originate private loans directly to companies.
Q Why are direct lenders an attractive alternative, how do you differentiate yourself?
SC: First, we are flexible and can move fast. Also, we are not as constrained in terms of hold sizes, and it is easier to deal with us because we are a small and agile investment team. Companies are dealing with the same team throughout the life of the loan, so there is continuity in the relationship and that helps a company looking to grow when they need to amend their debt facilities over time. A lot of the finance that we do in this space is event driven. It’s typically acquisition financing, leverage buyouts and management buyouts, and therefore we regularly work with private equity sponsors. As a result, about two thirds of the financing in the private debt market is leverage buyout financing. We differentiate ourselves from our peers by having originators based in the local countries, by leveraging the BlackRock network to supplement our sourcing efforts, and we benefit from being part of a large platform and also robust risk management systems and infrastructure. Borrowers also appreciate the fact that we’re a well-known brand with a focus on long term patient capital, who can support their business needs throughout their lifecycle and across all markets (private debt, high yield, public debt, investment grade, public equity).
Q How do you see the relationship between banks and private debt investors evolving in the future?
SC: I think we are going to see more partnerships between the banks and the funds. We’ve started to see that in the UK and we’ve seen more and more of that in Germany. Our investment team has been approached by many banks who would like to partner with us. When you think about it, we’re not a direct competitor of banks as they are now more interested in the ancillary services. We’re not looking to take away that side of the relationship, we just focus on the investing. So quite often they’d rather partner with us than another bank, for example, where they would be competing for a small share of ancillary services. We have many on-going relationships with these banks and therefore both sides value the opportunity to engage in this sphere as well.
Q How does your European platform compare to your US private debt business?
SC: The US is a single market and we have a larger team of around 20 people dedicated to middle market private debt. In Europe we are still growing, currently we have 10 people dedicated to private debt but we will be looking to add early next year. We have investment professionals in the local countries, including Germany, France and the UK and we have dedicated coverage to the Benelux region, Italy and Spain. I think it’s important to have local expertise and this is consistent with BlackRock’s approach overall.
”When you think about it, we’re not a direct competitor of banks as they are now more interested in the ancillary services. we’re not looking to take away that side of the relationship, we just focus on the investing”
Q What is the average size of your investment? Can investments in smaller companies be a challenge?
SC: There’s this misconception because BlackRock is a big firm, with significant assets under management, that we focus only on large-cap deals, but we are quite nimble on the private debt side with a focus on middle market companies. The minimum investment size is around €20 million and our funds typically lend to companies that have revenues between €50 million to €500 million, and an EBITDA between €7.5 million and €75 million per annum. So, it’s quite a broad range of companies across all sectors, the funds we manage do small deals and have the capacity to do larger transactions as well. We enjoy working with companies where we can support their long-term growth needs regardless of size.
Q Are you seeing an increase in non-sponsored deals too?
SC: About a third of what we do is sponsorless finance. I think that’s an area with tremendous growth potential. These opportunities are more difficult to identify and take a little bit more time to analyse as the level of the diligence isn’t quite the same as when you are working with a private equity sponsor. However, sponsorless opportunities tend to come out with very attractive terms, so I think that side of the market probably has a lot more potential to grow. It will take time, because a lot of these companies have been dependent on banks for many years and the level of awareness and understanding of working with alternative lenders is still quite low across Europe. This type of financing is typically more expensive, however in exchange for the premium they can work with a flexible team who can act quickly. Sponsorless finance requires more origination work, alternative lenders need more investment professionals and local resources. It also helps that there are more debt advisors serving this market and given the opportunity for our investors, we will continue to invest in this area.
Q Currently the UK is the largest private debt market in Europe but will that always be the case?
SC: We think the UK still has a lot of potential for private debt, it’s the most established market with a large private equity community that has bought into the concept of private debt. There is also a deep professional community: debt advisers and lawyers that really understand private debt. For these reasons, we believe the UK will continue to be an important market for private debt. In the short term, everybody’s waiting to see what’s going to happen with Brexit and subsequently the economy, and we are starting to see signs of a slowdown in consumer demand. When you’re looking at the UK, you need to be in a position that is a little bit more defensive. We are still very interested in the UK, but I think it makes more sense as part of a pan- European diversified strategy.