The ability of Europe’s non-bank lenders to build on their gains in 2021 will depend on how well they manage the damage done to their credit portfolios by the coronavirus pandemic.
With expectations for economic recovery buoyed by progress on mass vaccination programs, the prospects for private credit firms looks rosy -- as long as they’ve done their homework on risk control, said Robin Doumar, who founded Park Square Capital LLP in 2004.
“There are some lenders who have portfolios that are less good,” said Doumar, also managing partner of the London-based firm with about $10 billion of assets under management. “But for people who stuck to high quality businesses -- and critically, in stable sectors -- we are emerging from this much stronger.”
Private credit in general, and direct lending in particular, has exploded since the last financial crisis. In Europe, private credit grew to $259 billion as of March 2020, of which $142.7 billion was in direct lending. That’s up from $44 billion in European private debt a decade earlier, according to data provider Preqin.
Growing Firepower
Europe's direct lending funds grew 163% between 2015 and 2019
Source: Preqin
Note: All figures as of 31 December except for 2020, which is as of 31 March
Following a pause to take stock after the pandemic first struck in March, direct lenders increased their share of business compared with banks in major European markets from Germany and France to the U.K., according to GCA Altium, an advisory firm.
In the syndicated loan market, typically arranged by banks and used to finance large-cap companies, issuance in Europe was down 27% year-on-year, as of Dec. 11, according to data compiled by Bloomberg.
In the U.K. mid-market, -- the largest in Europe for deals of between 20 million euros ($24.3 million) and 500 million euros -- the market share for private debt funds rose to 72% in the first nine months of this year from 48% in 2019, GCA Altium data shows.
More Trepidation
“The historic banks are probably a little bit more careful,” said Aymen Mahmoud, a partner with law firm McDermott, Will & Emery UK LLP in London. “I don’t think they know the extent of their exposure and so I think there’s more trepidation.”
Private lenders backed mergers, shored up balance sheets and executed their largest ever deal this year, the Ares-arranged 1.875 billion-pound debt financing for U.K. insurance broker The Ardonagh Group.
Read More: Billion Dollar Deals See Private Credit Step Out of the Shadows
Firms are now replenishing their funding coffers as they prepare to take on more business. Hayfin Capital Management LP is lifting a self-imposed 5.5 billion-euro cap on its most recent fund, and Ares Management Corp. has launched its fifth European direct lending vehicle with a 9 billion-euro target.
Big players continued to move into the asset class with Abu Dhabi’s Mubadala Investment Co. revealing two new direct lending partnerships this year and Credit Suisse Group AG teaming up with its shareholder, the Qatar Investment Authority, to set up a private credit platform.
Measuring Success
High comparative returns draw investors to private credit
Source: Preqin
Note: % internal rates of return (IRR) for private debt globally and three sub-sets of the asset class over one-year, three-year and five-year time horizons
However, a key test looms for the industry as governments start to unwind the credit and tax-relief programs they put in place to help businesses weather the pandemic.
The European Central Bank predicts gross domestic product for the euro region will shrink 7.3% this year. It sees real GDP recovering only gradually to reach the 2019 pre-crisis level by mid-2022.
“It’s going to be interesting how the next year pans out in the real economy as you see government subsidies and schemes start to leave the system,” said Taj Sidhu, managing director and head of The Carlyle Group Inc’s credit opportunities fund. “All of these things are going to create capital needs.”
Further Losses
Businesses such as retailers, hotels and restaurants are only the most obvious victims of the steps taken by the authorities to rein in the pandemic by restricting movement. Further losses surely await lenders as the pandemic continues to wound borrowers across the economic spectrum.
Even as economies recover, it may take months or years before the full impact of the pandemic on portfolios becomes apparent, said Abhik Das, head of private debt at Munich-headquartered Golding Capital Partners GmbH, which advises investors on alternative investments including co-investments.
“There are multiple government measures that allowed firms to weather the initial storm so that we’ll only really see the effects in 2021, maybe even 2022,” said Das. “The jury is still out.
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