Patrick Marshall of Hermes compares direct lending markets on both sides of the Atlantic
The direct lending landscapes of Europe and the US offer investors different risk-reward parameters, but which market offers superior opportunities?
To determine this, investors must first understand their differences. Europe's emergence as a direct lending market is relatively recent, driven by the changing regulatory environment in the post-financial crisis era. Direct lending in Europe is a bank relationship-driven market. Banks control the majority of loans, which can make it difficult for direct lenders to access high-quality loans. But through strong origination networks - particularly those featuring formal co-lending agreements with European banks - investors can consistently access high-quality loans on an exclusive basis.
Across the Atlantic, the US remains the world's largest direct-lending market. US bank disintermediation began in the early 1980s. The US market is more than five-times the size of the European market in terms of primary issuance (see chart below). And although the US market gives investors more depth of choice, its bank-led European peer is still growing in size.
There are other distinct characteristics. For example, US funds tend to provide higher returns than European. That's because they tend to use fund leverage, which is unusual in Europe.
The rapid growth of direct lending in Europe and diversity within the market offer many benefits, which include:
- Attractive upfront fees
- Lower volatility
- High equity contributions
- Lower average leverage multiples
- Limited exposure to oil and gas markets
- Longer average loan life
- Higher recovery rates in Northern Europe
We believe that a Northern Europe-focused direct lending strategy driven by a skilled team with a strong origination capability can exploit opportunities that can match or surpass those found in the US.
In Europe, origination is key
We aim to provide investors with a healthy yield plus capital preservation. The Hermes Direct Lending Strategy targets returns of LIBOR plus 6% on a gross annualised basis by investing primarily in senior-secured loans, which ensure that investors receive income before all others and guarantee first claim on assets in the event of default, to a diverse range of high-quality SMEs.
The strategy has exclusive access to high-quality loans due to our origination contacts in Europe and a co-lending agreement with the Royal Bank of Scotland (RBS), the UK's second-largest creditor to SMEs. Under this agreement, RBS is legally bound to invite us to participate in all new loans on equal economic terms, while we independently conduct credit analysis and due diligence, and retain discretion over any deal we commit to.
We aim to be credit 'pickers' rather than credit 'takers' - that is, to ensure we have consistently strong deal flow in order to select the best loans to invest in on behalf of our investors.
Patrick Marshall, head of private debt and CLOs
This information is for Professional Investors only. Past performance is not a guide to future performance. The value of investments and the income from them can fall as well as rise and you may get back less than originally invested. The views and opinions contained herein are those of Hermes Direct Lending Team, and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products. No responsibility can be accepted for errors of fact or opinion. This document is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. This document has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. This document is published solely for information purposes and is not to be construed as a solicitation or offer to any person to buy or sell any related securities or financial instruments. Figures, unless otherwise indicated, are sourced from Hermes. The distribution of this information contained in this email, in certain jurisdictions may be restricted and, accordingly, persons into whose possession this information comes are required to make themselves aware of and to observe such restrictions. Issued and approved by Hermes Investment Management Limited ("HIML") which is authorised and regulated by the Financial Conduct Authority. Registered address: Lloyds Chambers, 1 Portsoken Street, London E1 8HZ.