There has been a sea change in European debt markets over the last 3 years and yet the radical restructuring in corporate finance has gone largely unnoticed by mid-sized businesses. Private debt and capital provided by non-bank fund managers is fast becoming a mainstream alternative to bank lending for European borrowers. Backed by some of Europe’s largest pension funds and insurance companies, European private debt managers are estimated to have around €55bn of ‘dry powder’ (committed funds they need to invest over the next 2-3 years) a 9x increase on 2006. That number is likely to rise, increasing the pool of capital seeking good quality borrowers.
Non-bank lending may seem a novel innovation to Europe’s corporate CFOs, but it merely reflects a trend that is well advanced on the other side of the Atlantic. In the US, private debt lenders have been a major financing partner for local firms for over 10 years. The result is a market where around 80% of all corporate debt is lent by non-bank institutions – a stark contrast to Europe where banks still provide the majority of debt finance.
That situation is changing with the expansion of the European private debt market driven by 3 major factors. The new banking regulations, coupled with a lower risk appetite, mean that banks are unable and unwilling to meet the needs of many corporate borrowers. This looks set to continue as European banks continue to shake off the hangover of bad debts and settlements that have dogged the sector since the financial crisis. On the lender side, traditional investors in publicly traded investments have recognised the shortage of capital faced by European firms and have responded by investing heavily in providers looking to meet that need. Finally, strong public sector backing has boosted the emergence of the market, with regulators and politicians alike looking to wean Europe off its dependency on unstable bank intermediated finance. The UK’s BritishBusiness Bank has been instrumental in catalysing the growth of the non-bank lending market in the UK. On the continent the European Investment Fund is looking to orchestrate a similar story, while the invigoration of alternative lending markets is a key goal of the ECB’s new Capital Markets Union.
Nevertheless, for private debt markets to reach the heart of corporate Europe a change is required in the mentality of the borrowers. Unlike their US counterparts, many European companies are new to the concept, viewing it as secondary to their usual bank lender. Where contact with direct lenders has been established, it is often via a line of costly intermediaries, while the borrowers arrive at the negotiation table ill prepared for the demands of due diligence.
Private debt has come a long way in a short period of time but challenges still remain. How those difficulties are met will go a long way to ensuring the market’s long run sustainability.
With increasing publicity driving public awareness, combined with the push by the UK’s British Business Bank and the British Bank Referral Scheme, UK non-bank lending is set to grow and potentially reach the scale of North America in the medium term. The rest of Europe is also likely to follow suit through similar local initiatives.