Managers are looking beyond the UK
Private debt activity in Europe has long been dominated by the UK. While that dominance is unlikely to disappear, it is certainly likely to wane. Inevitably, last year’s decision to exit the EU is going to be a recurring topic of discussion among the industry professionals on the continent. However, as the team at Pemberton explains, it’s not all about the UK. The firm is one of several in the region looking to expand their presence, tapping into opportunities on the continent. Much of this will be in France and Germany, but southern Europe is also yielding new possibilities.
Appetite for Germany is on the rise
In terms of private debt dealflow, the European economic powerhouse plays third fiddle to the UK and France, but industry players are eyeing up the potential for more deals emanating from the country’s small to medium-sized businesses: the Mittelstand. Global asset management giant BlackRock has identified Germany as the region’s fastest growing private debt market, with the head of the firm’s European private debt platform, Stephan Caron, noting its “incredible expansion” over the past 12 months.
The consensus in the market is that we can expect to see more transactions resulting from succession opportunities, restructurings and non-sponsored deals. Data from Deloitte Alternative Lender Deal Tracker show a record 26 deals were completed in the 12 months to June 2017.
Competition is heating up…
With greater interest in the region comes greater competition, and this is very much the case in Europe where, according to Deloitte, dealmaking for the region in the first half of 2017 is the highest it has ever been for H1s since records began. Furthermore, private debt funds with a European focus are currently targeting $57.4 billion which, if raised, is a lot of dry powder.
Much of this competition is at the larger end of the market and is having knock-on effects. First, covenants are getting looser as managers compete for business from borrowers. Second, larger firms are moving into the mid-market in the search for new opportunities.
… but opportunities remain untapped
For managers facing a crowded market, the solution has been to specialise or target those areas requiring greater levels of local knowledge or sector expertise. In the case of the former, BlackRock, along with a handful of smaller players like Patrimonium, have focused on the many unexploited opportunities in the German Mittelstand. However, southern Europe has also seen a pickup in interest as managers with a strong track record have more freedom to expand their European remit and target markets like Spain and Italy. Then there is the growth of private debt funds focusing on niche sectors, particularly in real estate and infrastructure.
Go big or go niche
It is a well-established trend in traditional private equity that is increasingly pronounced in the private debt world: you are either a massive generalist fund or a small-scale specialist, without much in the middle. In our European roundtable, Luke McDougall, a partner at law firm Paul Hastings, talks about the multiplier effect of track record, geographic coverage and resources that make it so easy for big firms to raise cash. By comparison, smaller firms will struggle to compete without scale, so they must specialise to justify their place in the market.
The banks can be partners
The withdrawal of European banks from the lending space partly gave birth to the private debt market in Europe as we know it today. But while bank activity has been diminished in the private debt space, it is not gone altogether. European banks still generate far more competition for dealflow than their US counterparts – some are now even looking to set up their own funds. The question for many private debt investors is whether they are a friend or foe? Despite clear areas where they could compete for transactions, many in the industry see banks as a potential partner. Banks still place immense value in providing ancillary services for transactions and it is for this reason that they more likely to team up with a fund than a rival bank.
Another crisis may not be far off
While there is no consensus on whether we are headed for a downturn, there are plenty of good reasons that managers in Europe are cautious. Most of the worries stem from the loose deal terms becoming commonplace in an overheated market. Cyril Tergiman, a partner at EQT Credit, cautioned in our roundtable that some companies are “disconnecting from budgets and business cases”. A recurring theme throughout this report is the need for discipline in an environment where leverage is being increasingly used by investors.