State of the market: direct lending funds
The European private debt market is here to stay - that was the general consensus among peers at the conferences I attended throughout the second half of 2018. Funds are open, they’re growing, new funds are entering the space and so are new players.
There’s a record $200bn in assets under management, and a specialisation emerging in lending to small and medium-sized enterprises (SMEs), filling the gap left by the banks.
Although, when it comes to what defines SMEs in Europe, no single set of attributes can be agreed upon. The European Commission’s specific definition includes companies with a maximum of 250 employees and maximum turnover of €50 million, and/or with a balance sheet total less than €43 million. This is in line with a general accepted definition of ‘Mittlestand’ in Germany, while according to the UK's Companies Act 2006, a small company is defined as one that does not have a turnover of more than £6.5million, a balance sheet total of no more than £3.26 million and does not have more than 50 employees. A medium-sized company is defined as having less than 250 employees and a turnover of under £12.9 million.
The reality in the funds space is that lenders are looking more at EBITDA as an objective parameter.
Growth potential
In the lower middle market and SME lending space, the biggest risk to the growth potential of direct lenders right now, is the chance of banks re-entering the market. In recent months we have seen them more open to lending to certain larger mid-market companies. New rules or new business models from banks would pose a real threat to direct lenders. However direct lending funds are proving very successful and have a lot of ‘dry powder’ to invest.
It’s broadly agreed that in Europe, the low mid-market segment is currently in the later stage of its business cycle. If interest rates start - and continue - to go up, there may be a further need for direct lenders in the SME space.
Mid-Market CLOs in Europe
While US CLOs play a big role in the US mid-market, 2020 or beyond is widely viewed as when we might see development of a European mid-market CLO. US direct lenders loans go into CLO platforms. So there could be growth in this market at a later stage of the credit cycle as CLO spreads push managers towards mid-market loans when they look for yield.
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