January 2022 | Issue 241
Opinion Direct lending

Some observers believe Europe’s opportunity in private debt lies at the lower end of the middle market

Randy Schwimmer
Co-head of senior direct lending Churchill Asset Management
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European private debt has lagged its counterpart in the US. But a growth spurt may not be far off
US and European fundraising for private debt came into covid with a head of steam and, although momentum slowed, it has since picked up again.
The European opportunity looked attractive when US yields dropped at the end of 2020. But since then the difference between cross-Atlantic credit markets has not been substantial. The CEO of a large private debt asset manager reported: “European private equity firms have around £200 billion ($266 million) of dry powder they need to deploy.” That’s also driving private credit fundraising and investing.
Estimates put the value of funds being raised in the North American market at over $140 billion, $100 billion in Europe and $20 billion in the Asia-Pacific region. The asset mix of these efforts primarily includes senior, subordinated and distressed debt, with about $40 billion raised with interim closes in North America, $25 billion in Europe, and $5 billion in Apac.
Campbell Lutyens, a global private debt advisor, says US investors focusing on private credit are coming from a private equity perspective. That leads to higher return instruments, such as mezz and distressed. “In Europe,” it reports, “investors are coming from more of a fixed income background.” As a result, high single-digit returns are relatively attractive on that side of the Atlantic.
Campbell Lutyens also suggests that fund limited partners are sticking close to home. “We continue to see North American investors focused on investing in North American assets and European investors looking to deploy in Europe. The cost of capital among pension funds and insurance companies in Europe is lower, whereas American investors need to seek higher returns.”
Foreign exchange and hedging costs
When will investors look further afield for opportunities with private debt managers? One report finds that European investors have been staying close to home partly due to foreign exchange and hedging cost considerations.
Campbell Lutyens says: “We will continue to see the largest managers pulling away, and expect European investors to start looking towards North America again to augment their portfolios. How strong that trend will be remains to be seen, but European investors will see a bigger need to be in North America than vice-versa.”
European growth could surpass US
Regardless of the course of the coronavirus, the private debt asset class will remain popular with investors. As one veteran fundraiser points out, private credit retains favourable features, such as floating rate status, Libor floors and contractual yields. And it retains an illiquidity premium over public market equivalents.
That demand will accelerate the search for growth opportunities. A Proskauer survey reported 31% of UK/EU private debt fund managers are “considering purchasing a loan portfolio”, up from 17% last year. A whopping 92% are “currently raising a debt fund” or have “plans to fundraise”.
The same survey showed 78% of UK/EU managers were seeking performing senior secured loans, compared to 87% in the US. An even higher share (92%) were looking for acquisition financings (versus 86% in the US). European managers were reported to be showing more interest in pursuing second-lien and mezzanine strategies this year (78% and 84%, respectively) than US managers (67% and 53%).
European private debt has historically lagged behind the US, but some are predicting a growth spurt. A study by the University of Oxford’s Saïd Business School says private debt’s share of GDP in Europe could surpass its share in the US within the next five years. Of course, with vigorous US fundraising forecasted, AUM growth in North America private debt won’t be standing still.
With banks continuing to push issuer-friendly terms on private equity sponsors, some observers believe Europe’s real opportunity in private debt lies at the lower end of the middle market. As one advisor put it: “That’s an under-served part of the market with better structural protections and better risk-reward dynamics.”
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Global credit funds & CLO's
January 2022 | Issue 241
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