CJ Doherty
Welcome to the Lending Lowdown. I'm CJ Doherty, Director of Analysis at LSEG LPC. Today we're going to go across the Atlantic to hear about non sponsored lending opportunities in the European middle market. It's an area we haven't touched on before in this podcast series, so I'm looking forward to an interesting conversation.
My guest today is Chris Ross, Co Head of European Private Credit at Investment Manager Ninety One. Chris, thank you for taking the time out of your busy schedule to join me.
Christophe Rust
Thank you, CJ. Pleasure to join you myself.
CJ Doherty
Great. And it's always good to start with some background on yourself and your form in order to set the stage. So can you share a a little bit of that with us?
Christophe Rust
Absolutely, with pleasure, CJ. So in terms of Ninety One, Ninety One is a global asset manager with about $150 billion of assets under management. The firm used to be called Investec Asset Management before it spun out of Investec Group about five years ago.
And my partner Lay and I, with whom I previously worked for a number of years at a firm called Oakhill Advisors, joined Ninety One five years ago to develop the European private credit business here at Ninety One.
CJ Doherty
Thanks for that background, Chris. Now let's start to discuss the market. You know, when we generally talk about private credit in Europe, we often are talking about traditional sponsored direct lenders, but that's not the case here today. So to to what extent are there lending opportunities in the European non-sponsored middle market?
And in your opinion, is this an underserved part of the market?
Christophe Rust
That's a great question, CJ, and the answer is that there's actually very large opportunity set in Europe to provide loans to performing but indeed underserved mid market borrowers.
Specifically borrowers that are not owned by financial sponsors, but rather that are so-called non sponsored borrowers. In other words, they are owned by families, entrepreneurs, founders and the like, but not by private equity firms.
Why do I say this is a large opportunity set? The answer is that Europe is very much a SME dominated economy. There are about 26 million.
SMEs in Europe, they form, they form the backbone of the European economy, and many of these businesses are excellent businesses with good business models. They are credit worthy and they deserve to exist.
However, the market in Europe for these medium sized businesses is quite inefficient when it comes to debt financing. What I mean by that is that these businesses picture a German family owned industrial business.
With about 10 million of EBITDA, that business wants to raise 20 or 30 million euros to fund growth. The reality is that it's too small to access the capital markets.
Because the business is not owned by a private equity fund or being sold to one, it is not going to be a good fit as a deal for most direct lenders who focus of course on sponsor owned borrowers.
The question then is, what about the banks? Well, the reality is that the banks have been retrenching from lending activity in Europe for many years now, certainly since the GFC, and they have been particularly.
Retrenching in the SME lending space, which means that many of these borrowers, despite being good quality, despite being credit worthy, may not at a point in time have access to these traditional funding sources.
Which creates a gap into which we can step in and provide that kind of alternative financing that is very much needed for these businesses.
CJ Doherty
Yeah, makes sense. And let's dig in a little bit then. Can you give an overview of the market from your perspective? You know what size of company or size range do you typically lend to in this segment and do the opportunities have a tilt towards any particular sector or country focus?
Christophe Rust
Yeah. So in our case, our strategy focuses on borrowers that size wise range between 5 and 20 million euros of EBITDA per year. In terms of enterprise value that corresponds to let's say roughly 50.
Million to 200 million euros and in terms of funding needs and loan sizes that corresponds roughly for our strategy to between 15,000,000 euro and 50 million euro. So typically we lend.
252030 million euros that represents roughly the size of the bars that we target. By the way, there's a reason for which we target these bars. That is also that is because that's where we see the greatest need.
For alternative private credit, but also it's that segment of the market that we view as the least crowded and the least competitive. The bigger the deal sizes, typically even in the non sponsored market, the more competition there is.
A lot of managers don't want to deploy less than 50 million euros or dollars per deal, many of them not less than 100 million. So what that means is in the sub 50 million loan ticket size space, there really is a very gappy.
Market. So that's in terms of the size of the borrowers, the size of our loans and why we focus on this particular segment. To answer your question on the sectors, the reality is that the businesses.
That we target these performing non sponsored businesses are active across just about all sectors. This being said, we stay away from sectors that are very cyclical, are asset light or are facing structural.
Headwinds, we prefer sectors that are either growing or asset rich and or stable. And So what that means in practice is that we are active in traditional sort of industrial sectors, but also in sectors to do with, for instance, renewable energy.
Energy infrastructure, we're seeing a lot in the battery energy storage space, et cetera. We don't like shipping, we don't like oil and gas. We stay away from retail office, that sort of thing.
CJ Doherty
OK, great. And let's talk about the deal structures now, Chris, you know a lot of our listeners are focused on the sponsored side of the market. So just to give them a reference point, how do lending terms compare in the non-sponsored market to the to the sponsored deals?
Christophe Rust
Well, one of the features of the non-sponsored lending market, especially if the manager is targeting A segment that is particularly gapy, is that that manager, in this case ourselves.
Typically has more negotiating power because when we source these deals and bear in mind we source deals that genuinely are off market, they're not widely market. There's not a Goldman or Rothschild marketing a deal. We have to find these deals.
It takes more work, but it means that typically we are engaged in bilateral discussions with these bars. The way we source these deals is not from these larger advisors, it's not from the PE sponsors.
It's actually by having relationships with these borrowers advisors. So these family owned businesses, oftentimes they're not based in the capital cities of Europe. They're not in London or Paris or Zurich. They tend to be very often in secondary or even.
Tertiary cities and they work with their local advisors, their local accountant, the local lawyer, maybe their wealth advisor, etcetera. So for us to find them and then to find us, we need to have access to their local advisors.
Now we've created this origination network of over 4000 local advisors and sources of deals over the last decades. That's how we access these bars. What it means is that typically, as I was saying a moment ago, we are engaging directly and bilaterally with them.
And there's no structured competitive process around the deal. That means that we have pricing power and negotiating power in a more to in a traditional direct lending deal as you know and your listeners will know these tend to be.
Highly competitive structured processes where an advisor is appointed and a bunch of direct lenders are asked to fill out their terms and submit them and you win a deal based on how competitive those are. So to answer your question what that means in practice.
Is that number one, the leverage of our loans is typically lower than a direct lending deal. So if I were to say a bog standard illustrative unitranche acquisition financing deal.
Might be levered, say 5 1/2 six times, may have one covenant, may have none, may be priced at a high single digit return in in dollars and have basically share place security, let's just say.
By contrast, the kind of deals we do will have leverage of, say, three times, not 5 1/2, six times. It'll have multiple forms of securities. So not just a pledge on shares, but actually most of our borrowers, their shareholders get.
Personal guarantees and we have an asset back lending strategy, meaning we always have collateral in the form of an asset. So we have more security. We have at least three quarterly financial maintenance covenants.
So there's nothing covenant light about this three or more covenants. Pricing tends to be in the mid teens or more and the loan documentations are generally very lender friendly and much tight, so a lot of limitations on indebtedness.
On dividend payments, on acquisitions, on asset disposal, et cetera. That is what happens when you operate in a inefficient gappy market that you're able to access, but you're one of the few players able to access it.
CJ Doherty
OK, great. And next question, you know, are there any common misconceptions around the risks associated with non-sponsored lending? And importantly from an investor perspective, what is the risk adjusted return picture look like?
Christophe Rust
There certainly are a lot of misconceptions about the non-sponsored lending strategy. One of them is that non-sponsored borrowers are inherently riskier than sponsored borrowers.
Oftentimes there's a view that they're smaller businesses and therefore they're also less credit worthy, not as good credits. And in general there is in some parts of the market a view, Simply put, that it is a riskier or high risk strategy.
Now our view on this is that it really depends on the specifics of the strategy and on the manager's skill set, because many of these non-sponsored bars actually are fantastic businesses.
They have leading market positions. They've been around for 100 years or more. They're growing businesses. They're good credits. Moreover, actually, a lot of the owners of these businesses, even though they're not private equity funds.
Christophe Rust
They are incredibly aligned in as much as this is their business. It's been in their family for generations. Or maybe they founded it themselves. For them, it's not just a financial investment. It's not one investment out of a portfolio of 20. It's their livelihood. It's who they are.
It's it's it's so. So there's a lot at stake for them, not just financially but also in terms of their reputation and what the business means for them. And what we find is that the shoulders of these high quality non sponsored businesses.
They actually will do everything and anything to protect their company. And you cannot say the same about sponsor on borrowers where the P funds who own them, they take it very rational.
Economic approach to whether or not they're going to support a business. And you and your listeners will know that actually history is littered with examples of sponsors actually not supporting their businesses. Thirdly, I would say that.
For the reasons I mentioned about the deal structures, actually we would argue that the downside risk for some of these deals for lending to non sponsored borrowers can be a lot lower risk than the risk for direct lending deals.
And that's because if you have lower leverage, lower LTV, more covenants, better security, then in the event of a default, you have better rights to protect that investment and especially if you have assets.
Collateral. Your loss given default should be very low, if anything. That in any event is our underwriting approach and our investment requirement in the cash flow lending space, especially in the sponsor focused direct lending space. The reality is that if a credit struggles.
And defaults and leverage goes up, cash flows disappear or evaporate. Then the loss given default on a cash flow back uni charge loan can be very high. So in summary, to answer your question, there are.
Perceptions that non sponsored lending is riskier. Our view on that is not necessarily and indeed it can be less risky if the manager is sourcing the right deals and structuring the deals appropriately. So from a risk return perspective.
Actually, our view is that the right strategy, the right manager and the right market can offer really attractive and indeed arguably better risk return to investors than in the direct lending space.
Because if you can get mid teens plus returns for well structured, moderately levered loans to very good businesses with multiple pass through repayment, that's pretty good risk reward.
CJ Doherty
Final question before we wrap up, what is appetite like from investors for this strategy? You know, what is the fundraising environment like at the moment and has it changed over time?
Christophe Rust
So there's been clearly a lot of investor interest in and capital being allocated to more traditional mainstream direct lending strategies in the last decade or so. We've seen that in the States, in North America as well as in Europe.
Now that investors have allocated to those strategies quite significantly, actually where we see increased investor interest is in private credit strategies that are differentiated and.
Are less correlated to the performance of these other mainstream strategies. And on that basis we are actually seeing high interest for non sponsored lending strategies including ours, especially in a world where there's actually quite a bit of uncertainty in the macro economy.
And geopolitical space. So underwriting cash flow growth in an uncertain environment such as this can in the view of some investors pose challenges, whereas an asset backed strategy whereby the focus is on non sponsored borrowers and you're taking lower risk because you've got asset backing and less.
Leverage is actually proving to be very compelling for investors. And so in brief, we are seeing very good levels of interest from investors looking for these kinds of differentiated strategies, looking to diversify.
And the other thing I'd reflect on is that we are seeing more and more interest from investors in European strategies because again, many investors have allocated already quite heavily to the US, whereas at least.
Many of the ones we are speaking with say they are a bit under allocated to Europe and what they telling us is that notwithstanding that Europe is maybe not as high growth market as the States, it's actually a very interesting market to have exposure to because it is more inefficient.
And there's arguably better risk reward in an inefficient market with the right manager, of course. So these are, this is some feedback that we are receiving from investors.
CJ Doherty
OK, great. And with that, we will wrap up for today. Uh, thank you very much, Chris, for joining me and and sharing your vantage point in the market.
Christophe Rust
Pleasure, CJ. Thanks for having me on.
CJ Doherty
And thank you all for tuning in. As always, I invite you to check out our private credit news, data and analysis at loanconnector.com. I'm CJ Doherty. Subscribe to the Lending Lowdown on your favorite podcast platform.
