US asset manager BlackRock closed its first European middle-market private debt fund in July this year.
The €1.1 billion fund will, along with several separate accounts, bring total assets under management for this strategy at the firm to €1.8 billion. For an investment firm with €6.3 trillion under management this doesn’t sound like much, but Stéphan Caron, head of European middle-market private debt for the global credit team, is very happy with where the fund is positioned.
“Of the largest European direct lending funds, a dozen are now over €2 billion in size,” he tells Euromoney. “They are moving into the upper mid-market and doing much bigger transactions. Their competition is the capital markets and syndicated loans.”
Indeed, Los Angeles-based direct lender Ares increased its European direct lending strategy commitment to an eye-watering €10 billion within days of the BlackRock fund’s close.
Conditions at the upper end of the market are such that larger direct lenders will increasingly be pitching against large cap cov-lite terms for deals, something that private lenders that stick to the core mid-market are less likely to have to do.
Middle-market borrowers are generally considered by BlackRock to be companies with annual ebitda of less than €50 million, revenues of less than €500 million and debt of less than €500 million. The sector comprises approximately 140,000 firms in Europe, which generate one third of private-sector GDP.
“You have to have the right sized fund for your strategy,” Caron explains. “We are one of the few funds in the core mid-market to have local origination, so we are in a nice spot. We will have to ask ourselves what is the right size for the fund – but I can tell you that it won’t be €10 billion.”
It is not hard to see why Caron likes the core mid-market as an asset class. According to the Fitch Leveraged Credit database, the average annual default rate from 2011 to 2015 for European issuers with outstanding debt of less than €500 million was just 2.6%.
In January this year, the 12-month European Leveraged Loan Index (Elli) default rate for leveraged loans from 2007 to 2015 was 4.8%, and in high yield 12-month issuer-weighted speculative grade, default rates from 2007 to 2015 were 3.4%. How these numbers will hold up if and when the cycle turns is far less clear cut, however.
The new fund is part of BlackRock’s global credit platform, which is co-headed by chief investment officer James Keenan and Tim O’Hara. It has $84 billion assets under management in four strategies: multi-strategy credit, leveraged finance, hedge funds and private credit. Mid-market investing sits in private credit alongside opportunistic debt and specialty finance.
Keenan described the close of the mid-market private debt fund as “a milestone for BlackRock in helping to establish our footprint as a strong player within European middle-market debt, and will aim to further expand our capabilities in Europe. This is another important step on our path to establish a leading global private credit platform”.
The firm’s 11-strong European middle-market private debt investment team is based in London, Paris, Frankfurt and Munich. Germany, which accounted for just 10% of European direct lending last year, is a particular focus. In the first half of 2018, 48% of corporate mid-market leveraged buy-outs in Germany involved a private debt fund – the equivalent figure for the first half of 2017 was just 30%.
“The big story this year has been Germany,” says Caron. “We have a strong conviction that Germany will grow.”
The UK, which has historically accounted for 40% of non-bank transactions in Europe, will see this percentage fall post-Brexit, with France (25%) and Germany likely picking up the slack.
“In order to succeed it is very important to be local,” Caron says. “A lot of funds are based in London and have someone who speaks French and someone who speaks German. That is very different from being on the ground: we have hired local people, so are closer to sponsors and management teams.”
Before joining BlackRock in 2014, Caron – a two-time Olympic medallist in swimming – was chief commercial officer at GE Capital Bank, where he was responsible for originating, structuring and executing mid-market lending and leasing transactions.
The new mid-market fund has invested roughly 30% of its capital commitments since first close with eight investments in the portfolio so far. The lion’s share of business has been with private equity sponsors, but that could change as more European corporates become aware of the alternatives on offer.
“It takes a lot more time to source sponsor-less deals, but they can be very attractive,” Caron points out. “More than half of our current business is sponsor, but we hope that it becomes more balanced over time.”
It seems inconceivable that BlackRock will not become one of the largest players in European direct lending just because of the sheer weight of infrastructure that the firm can deploy. Certainly, with its differentiated sourcing strategy and the strength of the BlackRock name, it represents fearsome competition in an already very overpopulated marketplace.
“There will always be funds pressured to deploy, and larger managers can be more disciplined,” says Caron. “There will, therefore, be much more disparity in performance between debt funds. This will allow investors to differentiate.”