Europe’s missing ingredient

Firms and investors at our annual London event expressed agreement that the non-sponsored deal market has failed to live up to expectations. By Andrew Hedlund

When credit managers, their investors and advisors came together in London to examine the state of European private debt markets, it became clear bank retrenchment is still a major driving force. It gives the continent a unique opportunity compared with the US, where banks have retreated much more from the mid-market.

As private credit has grown up, so have its limited partners, and alternative lenders have developed appetites for certain deals over others. Brexit remains a big question mark, but it was not the only issue evaluated by conference attendees.

It’s still all about the banks

Even a decade after the credit markets and world economic meltdown, banking activity is still driving the growth of the private credit markets, panellists noted.

“Banks will continue to retrench and focus on their core products and industries, which will open up more opportunities for funds,” said Luis Mayans, head of private debt in Europe for Canadian pension plan CDPQ. Transactions previously thought out of reach for alternative lenders have begun to materialise due to bank retrenchment and larger fundraises, he added.

In addition, Stephan Caron, a BlackRock managing director and head of European mid-market private debt, noted that the lower mid-market – companies with €10 million-€30 million of EBITDA – has become slightly less competitive. Increasing private fund size, he said, has allowed some managers to move upmarket and target larger deals.

Growth lending has also been attractive, due in part to the almost full-scale bank withdrawal and lower mid-market credit managers that are backing businesses in the larger end of the segment. US-based growth lenders are focused on the UK and Ireland, another reason why firms focusing on transactions in continental Europe face little competition.

“Banks rarely play in our sector,” Ross Ahlgren, partner at Kreos Capital, said. “You might find local or regional banks providing overdraft facilities and other banking services but not originating growth loans.”

Non-sponsored IS non-event

In addition, the non-sponsored deals that European credit managers pinned their hopes on several years ago haven’t materialised, several speakers said.

“The non-sponsored market hasn’t become the ‘holy grail’ that some hoped it would,” Caron said. “Sourcing non-sponsored transactions is more difficult. Businesses are making their way to direct lenders, but it’s slow.”

Blair Jacobson, Ares Management’s co-head of European credit, noted his firm was “very cautious” on the non-sponsored market. He thinks such transactions will “fare poorly” in a downturn compared to deals involving private equity-backed companies. That is a sentiment other market sources have expressed to PDI, noting specifically the extra capital and management expertise buyout shops bring.

“You are the private equity sponsor in those deals, you provide governance guidance,” Ben Davis, chief investment officer of Permira Debt Managers, said in a keynote interview. “You could own the company in a distress/restructuring scenario.”

While non-sponsored deals failed to gain the traction some thought they would, lending to non-private equity-backed companies is still a way to stand out from the crowd, said Timothy Atkinson, a director at advisory firm Meketa.

“Another way to differentiate [yourself] is to be open to doing non-sponsored deals,” he said. “It’s a lot more work, but you can have more say in [the deal] structure and get a little more return.”

A ‘more sophisticated’ LP base

As private credit has become its own portfolio allocation for many LPs, the asset class’s investors have become much savvier; they are digging beyond the headline numbers, attendees said.

“LPs are becoming more sophisticated,” said Laurent Bénard, a managing partner at Capzanine and its global head of private debt.

“[They] used to just be focused on returns. Now they are focusing on risk as well. [The] level of sophistication on private equity and private debt due diligence from LPs is becoming similar”, rather than LPs being more discerning about the former.

Investors are also beginning to understand the importance of the credit cycle and the more nuanced, even wonky aspects of the asset class.

“Half of questions posed to us by LPs are based on the credit cycle, the robustness of our portfolio,” said Pascal Meysson, an Alcentra managing director and the co-founder of its direct lending business. “Erosion of deal terms is not a key focus, but erosion of documentation is.”

John Bakie contributed to this report.