Going private: How investors are accessing new lending opportunities

by

24 Apr 2014

Over the past two years, private assets have  become a firm fixture on the investment  scene as institutional investors search for  yield. Opportunities have abounded and generating enhanced returns was relatively  easy. Today, spread compression and the threat of rising rates are taking their toll and  the pickings are slimmer than in the past.

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Over the past two years, private assets have  become a firm fixture on the investment  scene as institutional investors search for  yield. Opportunities have abounded and generating enhanced returns was relatively  easy. Today, spread compression and the threat of rising rates are taking their toll and  the pickings are slimmer than in the past.

Over the past two years, private assets have  become a firm fixture on the investment  scene as institutional investors search for  yield. Opportunities have abounded and generating enhanced returns was relatively  easy. Today, spread compression and the threat of rising rates are taking their toll and  the pickings are slimmer than in the past.

“There has been a significant interest in private  debt such as real estate, direct lending  to corporates via uni-tranche structures  (a combination of senior and subordinated  debt) and various other types of credit strategies,”  says Bob White, portfolio manager in  the global multi-asset group at JP Morgan  Asset Management.

“The biggest driver in Europe has been the de-leveraging of banks  and four years ago it was a great time to lend  capital. However, as the economy is healing,  the size of the opportunities and returns are  in decline.  The return premium is not necessarily a function of illiquidity – it is a function of the types of strategies that can be executed  within a less liquid vehicle. We generally think of these additional sources of value as including more flexibility in active management, greater use of manager skill  and wider access to niche strategies.”

White notes that one of the questions investors should ask when assessing an illiquid commitment, is whether it provides something materially different than can be obtained  through a more liquid, cheaper  structure. Investments today could include, for example, the purchase of a small €2m block of partially or wholly-defaulted loans that could be packaged, restructured and sold off. This is a far cry though from three  years ago when the asset manager would put  hundreds of millions to work on some form  of non-agency residential mortgage-backed  security and reap a double digit return.

Being selective 

Susan Kasser, head of private debt at  Neuberger  Berman, also believes the environment  has become tougher. “In Europe, the main theme has been the banks recapitalising  and retreating from lending. While this is an interesting trend, I am not sure it is an interesting opportunity,” she says.

“There  is a lot of money chasing a defined number  of deals and the returns may not justify the  investment. Also, banks may be retrenching  but they are not disappearing, plus many  smaller private equity backed companies –  those sitting on $40m of EBITDA (earnings  before interest, taxes, depreciation, and  amortisation)  are finding the high yield markets  a more attractive place to raise capital.”  Not surprisingly perhaps, selectivity is the key, according to Kasser.

“Overall, the global  macro-economic environment has improved  and people in Europe tend to feel more positive  about the region’s prospects. Corporate margins are stable and coverage ratios are good. However, investors have to be patient and look carefully at the structures.”

Forbearance is not only required for identifying the best deals, but also for working out the finer detail of the structures. Café Nero’s recent £275m refinancing package is a reflection of the labour intensive process, as  well as number of moving parts to contend  with at the smaller end of the spectrum.  The transaction, which took seven months to complete, included a slug of £100m senior debt, a £150m junior slice and £25m of cash.

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