by Jon Berke
With banks starting to win back middle market direct lending business in Europe, private fund managers are increasingly choosing to migrate stateside in hopes of scoring investing opportunities in the US, said multiple market participants.
In recent months, CVC Credit Partners announced plans to roll up its US assets to make direct loans in the US middle market. Previously, their middle market lending efforts were all based in Europe. In addition, UK-based middle market lender Northleaf Capital Partners recently added partners in Chicago and Toronto to expand its lending capabilities in those jurisdictions.
So far in 2016, direct funds in North America have dropped off 40% year-to-date to USD 10.8bn, versus USD 18.1bn raised the same period the prior year, according to global data service Preqin. Meanwhile, European funds have collapsed almost 70% to USD 6.3bn from USD 19.8bn YoY. Separately, 22 funds closed in North America in 2016, as compared to 11 in Europe, according to Preqin.
“Everyone is expecting [European] banks to decline from leveraged lending, but they are very much in the market [competing to originate new loans],” said one capital markets lawyer, adding that funds have their own competitive advantages.
Private credit lenders had a much more opportunistic market in Europe in recent years as the market froze for leveraged lending due to austerity measures imposed on major European banks stemming from the recession. Filling the void was over USD 41bn in European direct lending funds raised from 2013 to 2015, according to Preqin. This included unitranche funds which offered the convenience of a one-stop credit facility, albeit with an increased interest rate spread of Euribor+ 700bps—300bps wide of traditional financing of around E+ 400bps.
However, in recent months banks including Lloyd’s of London, HSBC and Royal Bank of Scotland have started to surface, snatching back business from private lenders in Europe, said the lawyer. HSBC and RBS recently backed Graphite Capital’s buyout of Beck & Pollitzer. Originally, the deal received bids of 4x leverage on unitranche and some all-senior loan options on a company that had normalized EBITDA in the GBP 8m— GBP 8.5m range over the summer.
As the lending landscape in Europe shifts, the US has emerged as a lucrative alternative for private lenders looking to remain active in the space. UK-based private equity fund Equistone scored an all-US bank USD 165m deal to fund its portfolio company Mecaplast’s buyout of Key Plastics at 2.6x leverage, but that was considered the upper tier of what US banks will leverage, noted one market source.
Another alternative for European lenders has been to switch gears to a fund which only originates first lien loans at L+ 500bps. This has arisen due to interest from LPs such as insurance companies willing to accept a lower return as opposed to unitranche funds on one end, while on the other, it also offers a more competitive tool for sponsors to use when funding their buyouts, said one source close to the situation.
This all could be a short-term blip for the banks, however, as the European Central Bank looks to propose leveraged loan lending guidelines similar to the US, where agencies steer banks to keep senior leverage under 4x and total leverage below 6x. The new rules are likely to have a greater impact on deal flow in the European sponsor market, which has more loans locked up in banks, as opposed to private lenders, according to a Fitch research note on 23 September.
Before year-end, the ECB is expected to publish an exposure draft detailing proposed regulatory guidelines consistent with the US leveraged lending guidelines. The proposals would cover 129 eurozone-based banks captured under the Single Supervisory Mechanism—essentially a supervising body overseeing banks in the EU and presiding over the ECB.
European private equity sponsors certainly are not waiting around. Global asset manager EQT launched its first USD 726m mid-market fund, while Ardian formed a partnership with Seven Mile Capital Partners to fund lower middle market buyouts in the US.