At a time when the trends and dynamics underlying the European private credit market have evolved considerably, Adam Wheeler, Barings’ Head of Europe and Asia Pacific Private Finance, explains why a disciplined approach to investing in the space is beneficial for investors.
The trends and dynamics underlying the European private credit market have shifted in recent years, creating what we believe is an attractive investment opportunity, particularly for long-term investors. Increased regulation and challenging market conditions have continued to limit the activity of banks, creating a gap in the market for direct lenders to fill the shortage of capital.
Lenders with the ability and willingness to meet the financing needs of middle-market companies have gained access to a diverse set of investment opportunities with a potential yield premium compared to the broadly syndicated loan market. The key, in our view, is to achieve a disciplined approach in this evolving market, rather than chasing yield through investing in either higher leveraged packages, or those with looser covenant structures. Both of these options increase risk in an attempt to maintain absolute performance, which can actually reduce their overall risk-adjusted return. Asset selection is therefore critical.
FINDING A SWEET SPOT
The European market has evolved considerably in the past decade, and it is in the middle of two distinct ends of this market’s spectrum that we believe lies a lucrative opportunity. Banks, at one end of the spectrum, have been restricted to holding smaller pieces of debt following the financial crisis. Regulations under Basel III imposed additional capital requirements and heightened underwriting standards on banks, forcing them to simplify and reduce leverage, which has impacted their ability to lend to borrowers. A private equity house considering a €150 million debt funding requirement, for example, may have to seek out as many as 10 banks to source the capital, which creates complexity.