Direct lenders are gearing up for more business in the U.K. as they see banks shrinking their sterling corporate loan books in the wake of Brexit-linked volatility and slower economic growth.
Private credit fund managers say they are already witnessing an increase in deal flow as traditional lenders turn more cautious in the run up to Britain leaving the European Union, a trend that may accelerate if there's a disorderly exit.
"We think banks may become less active in lending to U.K. companies given concerns around the potential Brexit fallout, leaving part of the market to private debt players," said Cecile Mayer-Levi, co-head of private debt at Tikehau Capital SCA. "This could be positive in a way, as it would open up opportunities in certain parts of the market."
The risks around Brexit mean the execution of sterling-denominated loans has become difficult in the leveraged finance market as banks sharpen their focus on credit quality. Private credit funds, with increasingly deep pockets and an ability to write big checks, continue to emerge as a option for companies looking to sidestep the syndicated debt market.
What's direct lending? Old-fashioned bank lending — without the bank. As tougher regulations reshaped the post-financial crisis landscape, traditional banks have cut back on business lending.
"We have seen instances where underwriters of syndicated credits are struggling to know where to price deals, especially in times of market turmoil like we saw late last year," said Patrick Schoennagel, a director in Houlihan Lokey Inc.'s capital markets group. "In such times, a private credit solution can offer borrowers more confidentiality and greater certainty with regards to pricing and execution of the deal."
Stepping carefully
Some funds are also eyeing assets that have become cheaper due to sterling weakness, in sectors considered more immune to the economic cycle.
"With more deals to choose from and some assets cheaper, it's a good time to be lending in the U.K.," said Patrick Marshall, head of private debt at Hermes Investment Management in London. He cites the the premium paid for borrowing in sterling, less competition from banks and a strong legal environment as some of the benefits of investing in U.K. loans.
Private credit firms are already more active in the U.K. than in any other European country, so any Brexit-induced caution among banks could help entrench this form of financing even more firmly. Of all the direct lending transactions recorded since the end of 2012 through the second quarter of 2018, the U.K. has taken a 38 percent share, according to a report from Deloitte LLP.
Despite their familiarity with the British market, the potential risks arising from Brexit mean that fund managers have had to undergo extensive risk assessment when choosing investments in Europe's second-biggest economy. Mayer-Levi said Tikehau is keeping a "very cautious and selective" approach to its U.K. lending.
"Lenders are closely assessing how each asset could be impacted by a worst-case Brexit scenario," Schoennagel said, adding that the "bar has been raised" for new U.K. deals.
