It has been some time since we’ve updated our alternative finance landscape introduction, and, as 2018 is already rushing past, it feels like the perfect time to do so.
The rise of “direct lending” is transforming the financing of small and medium sized businesses.
There has been notable change in European debt markets over the last 4 years, yet, the radical restructuring in corporate finance has gone largely unnoticed by SMEs and mid-market businesses. Private debt and capital provided by non-bank fund managers is fast becoming a mainstream alternative to bank lending for European borrowers.
The rise of the private debt market in Europe is driven by two major factors. Firstly, a banking sector that is unwilling and unable to lend to corporate borrowers. This is due to changes in regulation and risk appetite resulting from the financial crisis. Secondly, there is investment by traditional investors into funds looking to address this gap in lending. These institutionally backed lenders are investing record levels of non-bank capital directly into mid-sized firms by applying techniques and processes pioneered in public markets.
The main obstacle that this market faces is not a lack of capital investment but a lack of commercial awareness by firms.
Backed by some of Europe’s largest pension funds and insurance companies, European private debt managers are estimated to have €191bn (£168bn) of ‘dry powder’ (committed funds they need to invest over the next 2-3 years) at the end of December 2017. This number has risen from around €185bn (£163bn) in 2015 as confidence in the market solidifies, increasing the pool of capital seeking good quality borrowers (source: Preqin).
However, without the brand familiarity of a high-street branch network, establishing trust with a new type of lender can take time.
Direct lenders have a tight focus on their investment mandate and where contact has been established, it is often via a long line of costly intermediaries, leaving borrowers to arrive at the negotiation table ill-prepared for the rigours of private market due diligence.
Regulators and politicians alike have been looking to move away from unstable bank intermediated finance. The British Business Bank has catalysed the growth of the non-bank lending market in the UK. In Europe, the European Investment Fund has orchestrated a similar story which was a key goal of the ECB’s new Capital Markets Union.
Nevertheless, this market requires the borrowers’ change in mentality to reach the heart of corporate Europe. In the US, private debt lenders have been a major financing partner for local firms for over 20 years. Many European companies view private debt as a novel and secondary ‘alternative’ to their usual bank lenders. However, for their American counterparts, it merely reflects a trend that is well advanced. The result is a market where over 75% of all corporate lending is done by non-bank institutions – a stark contrast to Europe where banks still dominate the debt finance domain.