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The Current State of European Direct Lending

Alternative lenders — which consist of a wide range of non-bank institutions — have become increasingly more relevant across the globe over the last decade. They’ve become established players in the U.S. lending markets, and investor demand for higher yields and portfolio diversification offered by these alternative lenders has scaled rapidly amongst institutional and individual investors.   

Europe is not far behind, as local European alternative lenders, as well as experienced U.S.-based firms, have expanded their footprint to take advantage of the growing opportunities Europe offers.

The fastest growing alternative lending asset class in Europe is direct lending, which focuses on middle market companies. The opportunity set is both geographically and industrially diverse, and similar to the trajectory in the U.S., alternative lenders are now beginning to fill the role traditionally held by banks, as the total number of banks has declined.

Total number of banks decreasing

Source: Federal Deposit Insurance Corp Quarterly Banking Profile and European Central Bank. As of June 30, 2019

European direct lending has seen expansion, with a compound annual growth rate of 29% from 2016-2018, but there can be a significant runway for growth as the market continues to consolidate and if these businesses continue to thrive. For the right manager – one with the ability to do the on-the-ground research and necessary due diligence – it presents a unique and growing opportunity set.

Source: Deloitte Alternative Lender Deal Tracker Autumn 2019

What Does Direct Lending in Europe Currently Look Like?

European candidates for direct lending are typically middle market companies that are healthy and experiencing growth. European middle market transactions continue to increase their deal flow by providing bespoke structures. It’s primarily a Northern European opportunity at this point, with the UK leading, but followed closely by France, Germany and the Nordics.

Source: Deloitte Alternative Lender Deal Tracker Autumn 2019

The loans are often event-driven, such as a change of ownership, refinancing, acquisition or recapitalization. In terms of structure, loans are private primary loans that are directly sourced and negotiated between the company and the borrower, usually with a long-term time horizon. They can be either senior (first or second lien), subordinated (mezzanine) or unitranche.

In recent years, unitranche loans, which are a combination of senior and subordinated debt and have a pricing structure that combines the two, have outpaced senior alone and now account for 59% of loans in the UK and 49% of loans in Europe1.

Who Is Successfully Realizing the Opportunity?

Alternative credit managers are focused on idiosyncratic risk (company risk) instead of macro risk. At this point in the cycle, lenders are identifying strong opportunities, particularly focused on senior secured credit. Fundraising and deployment remain in lockstep, and lenders continue to grow AUM. Managers with very broad footprints across Europe and with a large origination platform can create a big opportunity funnel, which is necessary to identifying the strongest opportunities.

European direct lending presents a growing opportunity for credit managers with the ability to have an established on-the-ground presence in Europe through which they can source and originate deals.  Credit managers that are able to access deal flow from Europe can incorporate geographic and industry diversification, as this market may continue to expand.

To learn more about European direct lending, please contact your financial advisor.

 

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