When Barclays Corporate Banking signed a partnership agreement with Ares Management in December 2015, it looked like a blueprint for future relationships between banks and direct lenders in the mid market.
The non-exclusive deal saw Ares buy a £500 million portfolio of loans from the UK bank. It also looked like a trend: at the same time RBS was busy signing a series of similar partnership agreements with AIG Asset Management, Hermes Investment Management and M&G Investments.
The expected flourishing of bank and fund partnerships has, however, been slow to take off in mid-caps.
The logic behind such deals is pretty straightforward: the funds, which do not face the same capital constraints as the banks, can do the lending while the banks pick up all the other business associated with the deal.
“The relationship with the banks is an interesting one because the leveraged finance team will see us as competition – and we are. But the CIOs of the banks actually view us as quite useful,” muses Benoît Durteste, chief executive at UK-based alternative lender ICG.
“They like having specialized lenders who are doing the long-term financing, which, by the way, they are better suited for, because they have better asset liability matching than the banks do for these long-term loans because they are illiquid by definition. The banks can keep all of the ancillary business and the commercial relationship with the company. That is not a bad split of the roles.”
The split might become blurry, however, as the amount of dry powder that is held at direct lending funds gets ever bigger. Thirteen North America-focused funds raised a total of $10 billion in the first quarter of this year, according to data provider Preqin, while five Europe-focused funds raised $3.5 billion.
Although this marks a slowdown in fundraising, dry powder stood at $235 billion globally by the end of the quarter. Deloitte now suggests that funds may start to explore the provision of revolving credit facilities themselves.
“While product diversification is high on the agenda, one area in which the alternative lender community can further dislocate the traditional banking market, but which only a relatively small number of funds can do, is funding of revolving credit facilities,” notes Floris Hovingh, head of alternative capital solutions at the firm. “While the operational flexibility and infrastructure required does not necessarily lend itself to the direct lending market, the risk/return profile looks favourable relative to other products if funds can create critical mass and are able to use leverage facilities.”
As these funds get larger and larger they could conceivably move into areas of more traditional bank business. There is no doubt that corporates and sponsors are far more willing to work with direct lenders than they were even a few years ago.
“When we started our partnership with RBS two and a half years ago there was a lot of wariness among mid-market PE sponsors of funds – and that is not there now,” says James Pearce, head of direct lending at M&G in London. “The banks are now having to compete against people with a different model who will provide larger tickets but may charge more for it and be more flexible on covenants and can move very quickly sometimes.”
M&G is a firm that already has broad-reaching bank relationships and is keen to do more.
“Our relationship with a bank is not just on direct lending,” explains William Nicoll, co-head of alternative credit at M&G. “We fund banks in a whole variety of different ways. We buy bank debt, we do regulatory capital trades, we do specialty finance and we are talking to banks about their capital provision. We are also talking to them – and have been since the crisis – about how we can help them maintain and possibly de-risk some of their business model.
“We have a very different pool of capital than the banks; my frustration is that we don’t get those partnerships as often as we would like. As the world shifts around, then the absolute persistence and consistency that we offer usually becomes very, very attractive. The originate-to-share model is a good one.”
Durteste at ICG is, however, far more circumspect about his firm’s relationships with the banks.
“We have been approached for partnerships with one bank,” he reveals. “We have informal relationships – you may want to call them partnerships – but it is very difficult to get into a hard partnership because that almost implies a mutual exclusivity, which is very difficult for the bank and for us: when you get into the practicalities it is actually quite difficult.”
ICG does not work with banks on larger deals.
“We are never involved in situations where the banks syndicate,” he says. “If it is a bank deal, then it is no longer a deal for us.”
For Nicoll at M&G, however, there is a niche role to be filled here.
“The banks offer good-quality corporate borrowers money at low rates,” he says. “The reality is that we can’t compete, but there will be situations where we can because maybe a deal is too big for all the banks and there is space for someone else to come in and do something longer dated, or if it is a sector or jurisdiction which creates a conflict for the banks.”
He concedes that the banks remain extremely competitive with direct lenders for high-quality corporate borrowers: “In general, the sort of corporate that many market participants want to lend money to probably has access to money elsewhere.”