This content is from: Corner Office

European Loan Fund Boom Sparks Concern Over Risk-Taking

Institutional investors such as pensions have been increasing their allocations to private loan funds to broaden their income sources in a low-yield environment.

The rising level of capital overseen by European direct lending funds has sparked concern that investors’ money may be lent to less credit-worthy companies.

Institutional investors such as pensions have been increasing their allocations to private loan funds to diversify their portfolios and broaden their income sources in a low-yield environment. At the end of July direct lending funds in Europe were sitting on a total $27.9 billion of capital to invest in deals, up from $25.5 billion at the end of 2016, according to financial data provider Preqin.

The so-called dry powder is building up as asset managers raise money at a faster pace to increasingly fill the void left by banks in midmarket lending. The availability of capital is making it easier for riskier companies to obtain loans on more favorable terms.

“The desire to deploy capital is leading to investors competing for assets, and leading to the market being red hot,” said Fenton Burgin, partner and head of U.K. debt advisory at Deloitte. “Borrowers are achieving terms that would have previously been reserved for the highest quality credit.”

Direct lending funds typically provide loans to midmarket companies. Those focused on Europe had a total $42.1 billion under management at the end of 2016, up from $26.9 billion a year earlier, according to Preqin data. This year, twelve funds raised $10 billion through July, compared to a total 18 funds garnering $11.4 billion in all of 2016, the firm’s data show.

With more capital pouring into private debt, companies have more options to find the best deal, Burgin said, adding that it means lower rates on loans and smaller returns for investors. The market will likely see some “gradual weakening for structural protections,” with a correction possible in the next couple years, he said.

Direct lending funds that have closed in the past 12 months include Muzinich’s €180 million (about $213 million) pan-European private debt fund and Tikehau Capital’s €610 million TDL III Fund.

[II Deep Dive: IR Hires Show Shifting Demand in Alternatives]

Brian Coleman, a managing director at J.P. Morgan Alternative Asset Management, sees increased interest among investors in middle-market corporate loans in Europe and the U.S., but believes it’s premature to be overly concerned. “I wouldn’t characterize direct lending as ‘frothy’ yet,” he said, “but I would say it is dislocated.”

While Coleman said he has witnessed yields “coming down a bit,” he views them as stable. And although he said leverage “has picked up,” Coleman doesn’t see a massive correction on the horizon.

“With direct lending, you have to be more careful now,” he said. “I don’t agree with the doomsayers who say they will see a lot of enormous problems in a recession.”

Related Content