14 years in the private credit market

February 19, 2016

More than seven years have passed since the credit crisis emerged in the wake of Lehman Brothers. It is now safe to say that the major shifts we have seen in a number of markets have been structural, rather than cyclical. One of these major structural shifts has been the reshaping the European corporate funding market.

Before 2008, there was an enormous dominance by banks in the market for corporate funding in Europe, where for example, funding provided by banks accounted for more than 80 per cent of the total leveraged lending market. Since 2008, the European bond market has grown considerably and is today approximately as large as the traditional leveraged loan bank market. During this period, the private debt market has also started to emerge as a yet underdeveloped, but rapidly growing and maturing market. Even if there is no comprehensive data available describing the development of this market, there is evidence that some 50 active alternative lenders have emerged in Europe. Together they have been involved in more than 500 transactions over the last three years - and the market is growing rapidly. The European financing market for mid-sized companies is particularly compelling for private lenders, given that this part of the market does not have full access to the bond and traditional leveraged loan market.

There are a number of driving forces behind this shift, although the main reason is that banks are increasingly restricted by regulatory tightening and thus become more selective in using their balance sheets. European banks’ balance sheets have started shrinking from the peak of around 400 per cent of GDP in 2011 to around 300 per cent today. This is still high, but the trend is clear. Banks have sold non-core assets and reduced their credit activity and have also increasingly become underwriting institutions, rather than warehousing risk on the balance sheet. Although banks are less active across Europe, the level of activity continues to differ from country to country and in different market segments. Another driving force is the increased interest from institutional investors’ in private credit and bond markets. In a low interest environment and with increasing regulation also on insurance companies and pension funds, many of them have discovered the attractiveness of replacing some of the corporate funding from banks.

This has led to a major inflow from institutional investors into leveraged loans, bonds and private debt funds. Between 2010 and 2015 the European leveraged loan and high yield bond market has seen new issuance from institutional investors totalling some EUR 325 billion. During the same period of time, European private debt funds have received new capital commitments exceeding EUR 50 billion. Many are questioning whether there has been too much money entering the market too fast. In reality, the overwhelming majority of this capital is focused on sponsored transactions in private equity and other parts of the market where it is possible to build volume quickly; i.e. situations that are easy to find, transparent and reasonably easy to analyse and invest in.

Proventus, with its long history of active and contrarian investing in primarily equities since 1969, started to be active in this market in 2002. Initially the focus was on bonds, but already in 2003 our emphasis started shifting towards private loans. Launching a credit strategy at a time when there was ample bank capital and in a region where banks were both active and well-functioning, there was no room for plain vanilla credit investments outside the bank market. This is why Proventus from the very beginning focused on acting as a problem solver in complex funding situations. Proventus has also continued to work alongside banks, acting as a partner when banks are restricted from providing capital.

Since then, we have concentrated on adding value through our creative approach to analysing and structuring complex situations in order to provide the flexibility and funding the company needs, while at the same time protecting our assets. For us, complexity does not equal risk - we look for low risk structures in complex situations. We are risk avert, not only in the interest of our investors, but also to avoid credit stress in the interest of the companies we fund. Over the last 14 years, we have carried out almost 90 credit investments in midsized companies in Northern Europe and only in a couple of cases have we had to go through a restructuring. Another lesson we have learnt from our long history as investors in Northern Europe is the importance of relationships. We take on the role of a strategic financial partner to companies, their management teams and owners. We stay close to the companies we fund in order to keep well informed and to be able to act quickly when a new opportunity, or challenge, emerges.

During the second half of 2015, Proventus Capital Partners also received complete repayments of several investments across our funds as these companies entered into new and promising phases of developement. In August 2015, our first institutional fund, Proventus Capital, was completely repaid through the repayment of its final loan to STRAX, a German based leading wholesaler of mobile phone accessories. The Proventus loan was refinanced by a consortium of German banks. In October 2015, our second fund, Proventus Capital Partners II, received repayment of its loan to Norwegian company EWOS, a leading producer of salmon feed worldwide. The Proventus’ loan was repaid following the acquisition of EWOS by Cargill, the American agricultural and energy conglomerate. In November 2015, Proventus Capital Partners II received repayment of its loan to the UK based low-cost gym operator, The Gym, following its successful public listing on the London Stock Exchange.

In December 2015, our most recent fund, Proventus Capital Partners III, received its first loan repayment from Irish based telecommunications company, Digiweb. The loan was repaid following the sale of a wholly owned subsidiary of Digiweb, Viatel, to US-based Zayo Group. For us, these 14 years have merely been the start of a long-term engagement in the emerging private credit market in Europe. We look forward to continuing to develop together with our investors - as well as all the exciting companies that we have the pleasure of funding; some of the most recent ones are described in more detail in this newsletter and on our web.