Managers see crowded market as lending race intensifies

Investment banks' renewed interest in direct lending isn't the only competitive threat that money managers have to worry about. They face formidable competition from peers as well.

Data by Preqin Ltd. show that, at the start of April, there were 348 private debt strategies in the global market looking to raise $168 billion from investors. Direct lending strategies account for 170 of that total, targeting $74 billion in assets.

"I do think there is probably a little too much mania going on in the space — there has been a ton of capital raised, broadly speaking," said Jim Neumann, partner at Sussex Partners U.K. Ltd. in New York.

The intensity of competition varies across the lending market, with the large-cap and unitranche spaces being where the most intense competition can be found, said Patrick Marshall, head of private debt and collateralized loan obligations at Hermes Investment Management in London.

"This competition has manifested itself in both lower yields and weaker lender protections, such as covenant-light features, which have made risk-adjusted returns less attractive," added Mr. Marshall.

In contrast, he said the senior-secured middle market has been less affected by those factors because banks continue to dominate the space "and there are high barriers to entry because of the challenges of effectively originating these smaller loan opportunities in high volumes. So while competition has increased, yields have remained relatively resilient and all of these loans continue to benefit from the inclusion of maintenance covenants," Mr. Marshall said.

While direct lenders are continuing to put money to work, assets under management are growing and the market could become further crowded, as "there's a risk that banks don't fall back much further than they have, given balance sheets are on their way to being repaired now," said Gregg Disdale, head of alternative credit at Willis Towers Watson PLC in London. "Alongside, there is a danger that too much money has been raised in Europe (by direct lending funds), particularly should refinancing slowdown from its current rapid pace," he said.

As the market and competition have developed, some managers have found themselves searching in different areas for opportunities.

Kirsten Bode, co-head of Muzinich & Co.'s Pan-European private debt fund, based in Zurich said the firm, which focuses on €5 million ($6.2 million) to €15 million-size tickets, sees a number of opportunities in Spain since banking consolidation has happened in that market. "There are only three or four banks looking into leveraged lending. That automatically gives an opportunity to direct lending funds. It is similar in the U.K., and equally in Ireland," while Germany has a "good pipeline, but as banking consolidation hasn't taken place there to the same extent, we see a slightly lower hit rate to complete deals," she said.

And North Wall Capital LLP is launching its first opportunistic credit strategy to invest in the "sponsorless European lower to midmarket" space, said Fabian Chrobog, London-based managing partner. The team looks for opportunities that, largely due to their complexity and size, "fall outside of the scope of direct lending funds and banks," he said.

M&G Investments executives also have found themselves looking at different areas for opportunities. "We have found ourselves trying to get expertise in new areas, building expertise in other areas, and (doing deals in areas where there is not much competition,)" said James Pearce, London-based head of direct lending at the firm. "That is more complex and requires more work, more resource and more expertise."

He said executives are broader in terms of their reach, while "the things we look at are more opportunistic as a way of finding value for our clients. But if we wanted to raise more money we could — we choose not to because we want to deploy in a safe manner," he said.