Few people think that the shift in European corporate financing – marked by growing volumes of lending passing from the hands of banks into those of institutional and other investors – is a passing phase.
Across Europe, banks are still struggling to meet the demands of regulators to shrink their balance sheets in the wake of the financial crisis, and this is severely constricting their ability to lend money.
Large investors on the lookout for fixed-income assets to give them extra return in a continuing low-interest-rate environment are emerging as the new lenders in a process termed debt or bank disintermediation.
In its latest report on access to finance for small and medium-sized enterprises (SMEs), the ECB reported that companies were finding it increasingly difficult to get bank loans, and that they were having to pay more in interest, despite historically low central bank lending rates.
Encouraged – and in some cases pushed – by government initiatives at national level, institutional investors are now starting to fill the gap as new lenders to corporates at the smaller end of scale.
For example, the UK government is investing £1.2bn (€1.5bn) to increase lending to SMEs, through its Business Finance Partnership initiative announced two years ago, along with a series of schemes to help smaller businesses. The money is being allocated to asset managers, on condition that it is matched with at least the same amount from private sector investors and invested on commercial terms.
ICG, which puts together mezzanine finance and leveraged credit as well as minority equity investment funds, is one of the asset managers involved in the programme.
“Direct lending as an asset class did not exist in Europe 2-3 years ago,” says Dagmar Kent Kershaw, ICG’s head of credit fund management. “Up until recently, this was not an area of the market that institutional investors had any great involvement in. What we’ve seen in the post-crisis era is banks having to look harder at their balance sheets and grapple with Basel III, and as a result of that they are reducing their lending to small and medium-sized corporates.”
Like its counterpart in the UK, the Danish government has come out with several measures to ease the lending drought faced by its SMEs. In 2012, it introduced a series of steps and held talks with the pensions sector to find ways in which it could provide alternative finance.
Major pensions institutions PensionDanmark and PFA have each entered DKK10bn (€1.3bn)deals with the country’s Export Credit Agency (EKF) to provide financing to help exporters secure and fulfil contracts, with PensionDanmark pointing out that the returns on offer were higher than government bond yields, even though the loans were state-backed.
Then, at the end of 2013, as part of a deal to help pension funds deal with the negative effects of low bond yields on their reserve requirements, the government included a pledge by the funds to promote lending to SMEs.
Last year, Ireland’s National Pensions Reserve Fund (NPRF, soon to become the Ireland Strategic Investment Fund), invested €200m in a credit fund to invest in larger SMEs and medium-sized companies managed by BlueBay Asset Management. The NPRF met a capital-raising target of €450m, including co-investment and a €40m investment from the country’s Construction Workers Pension Scheme. In other business financing deals, the NPRF has extended a bridging loan of €250m to the new Irish Water company.
In Italy, after the contraction of bank lending left many businesses hard pressed to find financing, PensPlan Invest stepped in last year with a new ‘minibond’ programme. The asset management firm – part of the PensPlan group of schemes in the Trentino-Alto Adige/South Tyrol region – launched a regional fund investing in the corporate bonds of local SMEs, which the government had introduced as a new vehicle to give SMEs another source of financing after banks withdrew from lending.
A big project in the Netherlands to boost financing for SMEs is also under way, with banks ABN AMRO, ING and Rabobank joining forces with pension providers MN and Syntrus Achmea, on the initiative of the exchange Euronext Amsterdam. The banks and providers have set up the NL Ondernemingsfonds fund to provide loans for businesses in the country, on a co-financing basis. The fund is extending its first loans this year, and within five years expects to have lent as much as €1bn. The loans will be for at least €10m, and are aimed at companies with sales greater than €25m but in later phases the project may cater for smaller businesses as well.
The project – whereby institutional investors are not taking over where banks have left off, but investing alongside them – is unique to the Netherlands, according to Anton van Nunen, director of strategic pension management at Syntrus Achmea.
Investors favour this approach, partly to make the most of the good reputation the banks have in lending to companies, he says, adding that banks and pensions institutions are not competitors, so additional sources of finance are welcome – preventing supply problems and offering a wider range of available creditors.
SMEs are the sector that is most vulnerable to the reining in of corporate lending, but without state and quasi-state intervention institutional investors are put off investing in loans to this wide and varied universe of companies because of the illiquidity risks and high cost involved. For this reason, many of the mainstream investment managers have decided not to offer products in this sector, focusing instead on loans to mid-market or larger companies.
Pension funds may be long-term investors, but liquidity is seen as an important factor when it comes to picking a loan strategy, says Kevin Petrovcik, managing director at Invesco. “We’re seeing a lot of pension funds in Europe interested in the European syndicated loans market, as well as the US syndicated loans market,” he says.
John Redding, European bank loan portfolio manager at Eaton Vance, does see money being raised for loans to SMEs. “People are getting involved, and I would expect more to continue,” he says.
The US market for loans to larger companies generates around 5-5.5% yield for investors, whereas lending to SMEs can probably produce two percentage points more, with returns approaching 8%, Redding says. A low-yield environment makes it all the more understandable why investors might be attracted to this sector, he says.
Eaton Vance itself decided to move away from that part of the market, having lent to SMEs in the US 10-15 years ago. This type of business is more specialised and an investment management company needs to have a much larger staff to be able to source the deals, Redding says.
“When things go wrong with these companies – and things do go wrong with them – smaller companies have fewer options and are often less good at managing their liquidity,” he says.
Henderson Global investors investigated the lending opportunities it saw opening up after the financial crisis as a result of the funding gap, says David Milward, head of loans. “We felt there would be a good opportunity for our investors to enter a market they hadn’t been in before – direct lending strategies, infrastructure debt and commercial real estate debt in loan format.”
But he says feedback showed that although investors recognised the potential in providing lending to those markets, the one thing they were keen to do was maintain liquidity.
“We focused on broadly syndicated loans to corporates in the Europe and the US,” he says. Buying portions of loans that were greater than £200m meant there would be enough secondary market liquidity, says Millward.
Henderson Global Investors was interested in business financing measures announced by the government in 2012, he says, but felt it made sense to run loan funds alongside a bank. “The idea was interesting, but the Treasury were probably coming at it from a different angle, of lending directly rather than relying on banks,” he says.
Through a variety of investment channels, institutional investors are taking up some of the slack in the loans market left by Europe’s banks. But the jury is out on whether such lending will move away from the traditional banking sector to the extent that it has the US.
About 80% of corporate financing in the euro-zone is still provided in the form of bank loans, with the capital markets making up the rest in the form of bonds, according to Société Générale. In the US, this 80/20 split is reversed. Although the process of bank disintermediation should bring Europe closer to the US model, Société Générale says banks will retain a crucial role in the new order.
They will keep a proportion of the financing in most cases, it predicts, arguing that this will prevent the excesses of the total disintermediation models seen at the start of US subprime crisis.
Kent Kershaw also finds it unlikely that the credit markets will alter to the point where 80% of lending is in the hands of non-banks, as in the US, but says that institutional investors in Europe will have a greater share of the lending market than they have now. “There is definitely interest from pension funds and insurers and we see no signs of that interest abating,” she says. “Pension funds worldwide are grappling with the problem of how to generate a high return in this low-yield environment.”
While many of the new lending initiatives and loan funds centre around new lending to companies, existing corporate debt is travelling from banks to investors via the markets in the form of collateralised loan obligations (CLOs) – securitised pools of loans to medium-sized and large business. CLOs are being used by banks to cut their regulatory capital requirements, enabling them to sell large chunks of the commercial loan portfolios to international markets.
Kent Kershaw says the CLO market restarted in 2013 with some €7.4bn of new CLOs finalised during the year. This year, she says, issuance of the instruments has continued at a strong pace. Investment managers structuring CLOs are interested in the larger liquid loans, she says. Mid-market illiquid loans are not included.
M&G Investments says it has been a provider of bank replacement finance to UK companies since 1997 through private corporate loans and private placements. In 2012 the Prudential-owned firm launched the UK Companies Financing Fund 2, which included a business financing partnership mandate.
Calum Macphail, head of private placements at M&G Investments, says pension funds aiming to lend directly to businesses would be advised to consider using a third party such as an asset manager. Because the area is still relatively new, there are few with staff with the knowledge and experience do it themselves, he says.
Through such intermediaries, could pension funds become the new banks? It is possible, says Macphail, but this all depends on the time horizon.
“The pension fund industry is not renowned for moving very quickly, so it’s more evolution than revolution,” he says. “As the market develops, it will certainly raise awareness, comfort levels will increase and I’m sure they will get more involved – but that’s not going to happen overnight.”
Governments across Europe have acted to facilitate the flow of lending to businesses in the past few years, and particularly to SMEs, but Millward says more could be done by regulators. As things stand, loans themselves are not classified as UCITS assets. This means that retail investors cannot invest in them.
“It is a restriction on raising funding in the markets,” he says. “If you allow loans to be included in UCITS regulations, that does mean more investors can put investment in loan funds and that in turn will go to businesses that need the funding.”
While interests appear to be fairly well-aligned, broadening the market for European lending is still very much a work in early progress – especially when it comes to the crucial lower-mid market SMEs.