By Daniel Lanyon on Monday 21 November 2016
In has been another bumper year for direct lending with a raft of new fund launches, but what is in store for next year? Hermes Investment Management's Patrick Marshall shares his thoughts.
Direct lending funds specialising in the mid-market lending space will continue to benefit from Brexit-induced uncertainty in the form of higher than normal yields, according to Patrick Marshall, head of private debt at Hermes Investment Management.
An ongoing hunt for yield among investors and a search for fresh capital to fund mergers and acquisitions have been two of the most important factors driving a boom in direct lending investment in recent years as well as prompting the launch of several new funds operating in the space.
For Marshall, who runs Hermes own direct lending strategy, a new feature has emerged to boost the attractiveness of the asset class.
He says those conducting private lending deals in sterling should continue to see an advantage of those conducted in euros while the low value of sterling should also continue to supply a healthy amount of bid activity to meet investor demand for direct lending exposure.
“The uncertainty created by Brexit should continue to bolster yields in the sterling leveraged finance market, with the euro-sterling yield differential continuing to favour the depreciated UK currency,” he said.
“We believe that Continental European banks will be less active in the UK due to sterling funding pressures. With currency weakness making the relative value of UK assets more attractive to international private equity investors in the medium term, transaction flow in the UK should remain healthy.”
Despite the apparent uncertainty created by the Brexit-effect, loan defaults should continue to remain low as companies continue to benefit from persistently low interest rates and a benign economic environment, he adds.
“Nevertheless, an ability to originate high quality loans will still be a significant competitive advantage for direct lenders.”
Throughout the year several trends in the European loan market in recent months will also be an ongoing feature for investors in direct lending, Marshall says.
These include strong competition among lenders, reduced primary M&A transaction flow that is somewhat offset by increasing refinancing volumes, and the continued low default rates.
“Against this background, mid-market loans will continue to offer investors better value compared to large cap loans.”
“Lenders to large companies will continue to compete against capital markets at a time when there is plenty of liquidity chasing fewer transactions with diluted loan terms and lender protections – a sign of the increased structuring of ‘cov-lite’ deals.”
In contrast, he adds, the mid-market space remains the more attractive areas for investors, driven by the continued presence of bank lenders due to long-established relationships, resulting in more disciplined loan characteristics.
“With increased regulatory oversight of the banks, it is unlikely that there will be a significant loosening of lending terms in the European mid-market next year.”
Hermes Investment management, whose £26bn of assets under management includes the BT pension scheme, made the move into the alternative credit space this year with the launch of a new direct lending strategy. The Hermes Direct Lending Strategy has been principally backed by Royal Bank of Scotland and Hermes intends to follow this with the launch of a fund later in 2016.