European direct lenders moving towards US model

Direct lenders tend to focus on assets that aren't mainstream securitisation candidates and in that sense can be complementary to banks. However, panellists at SCI's inaugural Marketplace, Direct Lending & Securitisation Seminar last month expected European direct lenders to gain more market share as the sector transitions towards the US model.

Richard Green, partner at Venn Partners, anticipates the European direct lending community to begin moving towards the US model, where direct lenders represent a larger share of the market. "Investors in the US are more likely to have a dedicated allocation for direct lending funds. European institutional investors, however, tend to allocate to them from their alternatives or fixed income buckets. But direct lending in the region would benefit from being recognised as a standalone asset class and a permanent part of institutional investor allocations," he observed.

Furthermore, Daniel Sinclair, md in the Ares Credit Group, believes that direct lending in Europe may move to a BDC/permanent capital funding model over the next 10 years, similar to the US. "Our US business is structured as a BDC, so we anticipate that there will be BDC-like structures in Europe, but this hasn't happened yet," he said.

He continued: "In the US, Ares manages the largest BDC as well as a mortgage REIT, and so we clearly appreciate the value of permanent capital vehicles. However, while REITs do exist in Europe, permanent capital for corporate loans doesn't. So, we have adopted a fund-based model to date."

Direct lenders can be complementary to banks, in that they can look at assets that are less loved by banks - such as operating assets - or provide mezzanine finance in deals with them. Indeed, Sam Mellor, partner, real estate at Chenavari Investment Managers, noted that direct lending is more appropriate for smaller cap and transitional assets.

"Private debt funds are needed to provide capital for higher lease-ups: borrowers are often property companies looking for growth capital to reposition properties. The broader structural issue on the real estate side is that banks are reluctant to underwrite developments," he explained.

However, direct lenders can be more responsive than banks. Green noted: "Flatter organisational structures means that direct lenders can be quicker, create more tailored solutions and offer a more client-oriented service. They bring a sharper focus, smaller teams and no legacy assets."

Sinclair said that borrowers are increasingly looking for scale and assurance of closing in securing their financing solutions. "Holding assets on-balance sheet and having the ability to originate and underwrite the credit provides flexibility for sponsors to execute speedily - in under two weeks in some cases - which adds significant value to both them and the management teams," he noted.

Ares, for one, typically targets companies with EBITDA of £5m-£75m with £20m-£250m of financing requirements.

In terms of working with banks, some direct lenders will partner with them to access their large customer base, while others have gone further and acquired bank licences in order to use their cheap deposit funding to support their direct lending business. But in the medium term direct lenders are expected to take more market share from banks.

"In terms of deal flow, we are seeing a large number annually, especially as banks continue to reduce their exposure to originating loans to middle-market companies because of changes in the regulatory schemes, as well as an increased focus on maximising the return on capital," Sinclair concludes.

CS