“It may only take one default to make you a busted flush,” said a market source in conversation with Private Debt Investor this week. It speaks to the precariousness of direct lending funds with relatively few individual loan positions and a return profile that simply doesn’t allow for too many failures before the strategy becomes unattractive.
In the good times that prevailed following the global financial crisis, this potential Achilles heel has gone untested. The covid-19 outbreak has served as a painful reminder that good times don’t last forever.
With many of the established direct lenders now eyeing their portfolios nervously, and funnelling more capital to those in need, less attention is being given to the possibility of doing new deals. This in turn is creating a possible opportunity for newcomers to the direct lending scene, with a couple of stories on our website this week hinting at what may become themes to watch.
One is the continuing growth of “private debt 2.0” platforms. These have typically targeted smaller loans than private debt firms are interested in and that have used technology to quickly and efficiently identify suitable borrowers and built up very large portfolios. Some of these firms, which have often received institutional investment at the company level, are now using those institutional relationships to expand into raising direct lending funds.
One example, which we reported on this week, was the first closing of German platform creditshelf’s debut direct lending fund, backed by the European Investment Fund. The firm says it saw loan requests increase 69 percent in the first quarter of this year compared with the first quarter of 2019 and sees an opportunity to capitalise on both ‘traditional’ direct lenders and banks being preoccupied with existing clients. Up to now, funds raised by the 2.0 firms are few and far between but the likes of Assetz Capital, Funding Circle and October have gone down this route and others may be expected to follow.
One thing that could perhaps stop any advance from technology-focused platforms is their own performance. While hardly their own fault, it’s often pointed out to direct lenders that the efficacy of the model has not been proved through a downturn. Precisely the same point could be made about the technology platforms. We were told by creditshelf it has seen “very normal behaviour” from its borrowers thus far, but there’s no doubt investors will be closely scrutinising the market as a whole.
The second possible theme is new ‘orthodox’ entrants to the lower mid-market. Over the past few years, the private debt market has seen very few start-up firms as investors stick largely to the tried and trusted. But this week we reported on a first close achieved by newcomer Harwood Private Capital, with half the capital committed by British Business Investments, a subsidiary of the government-owned British Business Bank. One crucial advantage for Harwood is that, with no legacy portfolio issues to deal with, it can focus wholly on new deals.
Of course, a new firm almost certainly will not get backing unless it has an experienced management team. In the case of Harwood, its managing partner, Haseeb Aziz, was doing mezzanine deals at Hutton Collins almost two decades ago and went on to become European head of private debt at HIG Whitehorse.
No one should expect a sudden rush of new players. Nonetheless, Harwood’s arrival on the scene almost seems emblematic of the ‘new normal’ in direct lending where market share appears to be up for grabs.
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