Rushing towards Europe

As the European banking sector narrows the scope of its lending operations, a recent flurry of fund closes indicates strong LP demand for European private debt.

Fundraising for private debt-related vehicles certainly kicked off the year with a bang.

Earlier this week, Farallon Capital Management closed on $300 million for its European lending vehicle. Around the same time, Private Debt Investor confirmed that Fortress Investment Group had completed a first close on $888 million for its debut fund for Italian non-performing loans.

As if that weren’t enough, KKR announced that it had doubled its $1 billion target for its special situations fund on Thursday, holding a final close on $2 billion. In a statement, KKR disclosed that it had already completed at least five investments through the vehicle, three of which were in European companies. The statement highlighted KKR’s enthusiasm for the region – the firm has committed $2 billion to European companies over the last two years.

The recent string of successful fundraises provides tangible evidence of limited partners’ growing interest in European private debt, where the opportunity for distressed assets has been buoyed by banks’ increasing willingness to offload troubled assets in order to come into compliance with a mandatory 8 percent capital ratio set by the European Central Bank.

Last week, Cerberus Capital Management managing director Lee Millstein labeled the capital ratio requirement the “big potential catalyst” for deal activity in the region going forward. If that offloading of assets is coupled with a continuation of curtailed bank lending, non-traditional direct lenders entering the market with fresh capital will also stand to benefit. Though distinct, both strategies are well positioned to take advantage of the narrowing of European banks’ strategic focus. 

To be sure, the evidence of LP support for these strategies was already apparent. Last year, Probitas Partners’ Private Equity Institutional Investor Trends 2014 Survey found that just 21 percent of institutional investors said they did not invest in distressed strategies, compared to 26 percent the year before. European respondents’ interest in distressed strategies also ticked upwards, from 14 percent to 16 percent (though interest in mezzanine declined).

All told, demand for European debt assets corresponds with the widely held belief among GPs that European strategies will drive debt-related investment strategies moving forward. Oaktree Capital Management’s Howard Marks said as much at Goldman Sachs’ financial services conference, and Apollo Global Management’s Marc Rowan said the same.

Investors should proceed with some degree of caution, however. Remember, it was Marks who claimed that distressed opportunities would yield substantial returns two years ago, a prediction that took until now to come to fruition. As more capital makes its way into Europe, the impact of another misfire could leave fund managers scrambling to find ways to put their LP capital to work. 

Fortunately, such an outcome seems unlikely, given the level of investment activity that has already taken place. The renewed sentiment for European debt assets is a welcome development in the ever-growing private debt space.

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