Private credit poised to fill defence sector funding gap as geo-political risk intensifies
PRIVATE credit funds
could be well placed to fill the funding gap in the European defence sector, as alarm bells are raised around the availability of defence financing on the continent.
Global geo-political tensions have fuelled the need for more defence spending, particularly in Europe, where the sector has been underfunded for decades. Amid a shortage of bank funding, private credit has been touted as a viable alternative. An executive director focused on credit at an investment bank said that it was “very plausible” that private credit would capitalise on the opportunity.
“Private credit is good in filling the gaps and providing funding to the under-funded sectors or companies that would otherwise struggle to get bank funding,” he said, speaking on the condition of anonymity.
“This would of course come at a price (and would be more expensive
than corporate debt or syndicated lending), but this is the exact unique selling point for private credit. It can pick up good quality credit that for whatever reason does not neatly fit into the bank lending investment criteria.”
According to a study from the European Commission, there is an equity financing gap of approximately €2bn (£1.68bn) and a debt financing gap of between €1bn and €2bn for small- and mediumsized enterprises (SMEs) in the defence sector.
The same study found
that SMEs operating within the defence sector find it much more difficult to access finance than others.
“For private credit firms, there is an opportunity there,” said Arnaud Journois, vice president at Morningstar DBRS.
“There is a financing gap for European SMEs in the defence sector. They have difficulties not only accessing funding, but also having bank accounts.”
A recent report from Morningstar DBRS said that banks are expected to play a pivotal role in financing the defence
sector, as public spending is not sufficient to fund the growing needs. However, banks appear to be reluctant to lend to the defence sector due to the sector’s incompatibility with environmental, social and governance (ESG) guidelines.
This has created an opportunity for both private equity and private debt firms to step in and support the 2,500-odd defence SMEs which play a central role in the complex defence supply chains in Europe.
“I think the real opportunity is in the SME sector,” said Journois. “The lack of funding will have to be filled by external funding.”
The need for more SME defence financing has led the European Investment Bank (EIB) to implement a rule change which allows it to invest more easily in defence firms; as well as creating a fund to buy into defence SMEs, as well as non-defence SMEs.
Earlier this year, >> 4
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The booming private credit industry has seen a plethora of acquisitions and partnerships of late, suggesting that the sector is entering its next stage of maturity.
US behemoth Blue Owl has been on a buying spree, snapping up Atalaya Capital Management last month to boost its alternative credit and asset-based finance capabilities.
This follows its expansion into real estate finance through its purchase of Prima Capital Advisors and its acquisition of Kuvare Asset Management, which boosted its insurance solutions.
Blue Owl isn’t the only firm that’s been busy. Bain Capital has bought a controlling stake in a US property lender Archwest Capital, while Temasek’s Seviora has acquired a minority holding in private credit manager ADM Capital.
Then there’s the joint ventures. Oak Hill Advisors has teamed up with One Investment Management to invest in European credit, while Marathon Asset Management and Webster Financial Corporation have embarked on a private credit partnership.
And that’s just in the last month or so.
There are different motivations behind all of these deals, whether it be expansion into different asset classes and geographies or asset manager-bank partnerships. But it shows that private credit is going beyond organic growth and, to an extent, consolidating in a fiercely competitive, crowded market.
It will be interesting to see how this develops as the year progresses, and what this means for emerging managers in the space.
SUZIE NEUWIRTH EDITOR-IN-CHIEF
cont. from page 1
the EIB announced that it would invest another €6bn in European defence and security. However, Journois said that this is “very marginal compared to the total needs of the sector.”
“We've seen a changing trend in Europe since the invasion of Crimea in 2014, and this has really accelerated since February 2022 with the invasion of Ukraine,” Journois added.
“This is a very quickly evolving situation. The European Union has
been built on a social contract of peace being there on the continent, and this is the first direct war since the end of World War II. In that context, there is a need for Europeans to be ready on an industrial level.”
Many private credit firms have already stepped in to meet the demand for funding, albeit with certain limitations. There is little appetite to fund controversial weaponry such as cluster bombs
or landmines, and as a result some investment houses have implemented internal policies regarding defence investments.
For instance, Rothschild & Co has a policy of not investing in companies involved in the production of weapons prohibited by the Oslo Convention on Cluster Munitions (2008) and the Ottawa Anti-Personnel Mine Ban Treaty (1999). Meanwhile, in the equity markets, defence investments have been
top performers over the past year. Weapons manufacturer BAE Systems has seen its stock price rise by almost 40 per cent, while military tech provider QinetiQ Group shares have risen in by more than 38 per cent. Dual purpose companies have witnessed an even more pronounced bump. Jet engine manufacturer and car maker Rolls Royce has seen its stock jump by more than 206 per cent over the past year.
Emerging markets offer respite from private debt competition
AS COMPETITION amongst private debt managers in the US and Europe erodes terms, emerging markets offer an interesting alternative, according to Mihai Florian, senior portfolio manager at RBC BlueBay Asset Management.
“In general, loans are still executed under old style documentation, you have a full financial covenant package, you have restrictions in terms of disposals, moving assets, paying dividends, there are much better protections from a creditor’s perspective,” he told Alternative Credit Investor. “We keep looking at developed markets, where in Europe 90 per cent of deals are under
cov-lite, and we’ve seen a number of situations where companies draw down assets and raise money, priming the current creditors and creditor on creditor violence. We don’t have that in emerging markets.”
Florian runs the Emerging Market Illiquid Credit strategy at BlueBay, which invests across a range of geographies, including Turkey, Brazil and Mexico. It is fully invested and the realised IRR is expected to exceed 21.8 per cent on a gross basis on investments fully exited, beating its targeted return of 15 per cent.
Florian sees significant opportunity in emerging markets, where the
number of funds targeting these countries is significantly less than those investing in developed markets. But there are similar drivers, with banks under regulatory and capital constraint, which are creating a gap for private debt managers.
“In emerging markets, about 90 per cent of the funding needs of corporates come from the banking sector,” he explained. “You do not have the depth of local capital markets, there is limited availability of insurance company capital, so you have this overreliance on the banking sector.
“It’s very rare to hear about EM private credit
strategy, there are not that many managers out there looking at this. In Europe alone you have 200+ managers. It is a fully developed market that is sponsor driven. They just put a package on the table and say you’re in or not, some terms are prebaked.
“You don’t have any of that in EM. The vast majority – more than 90 per cent – of what we look at is sponsorless transactions, family owned, sometimes listed companies. You have a shrinkage of the banking sector, you don’t have 20 funds coming into a market trying to lend. You’re able to dictate a lot of terms of the documentation.”
GP-led credit secondaries long way off
AS THE private debt market grows, there is an increasing opportunity for secondary players, but it appears that limited partner (LP)-led secondaries will continue to dominate the market.
In private equity, general partner (GP)-led secondaries have grown in popularity. These are where the fund manager typically moves an asset or a group of assets into a continuation vehicle, giving existing LPs the option to either roll over or
exit the investments. These have taken off to the extent that GP-led secondaries account for nearly half of the market, according to some estimates.
However, it appears unlikely that GP-led secondaries will have similar success in the world of private credit.
“The general feeling is that the vast majority of credit secondaries are still being led by investors who are looking to rebalance their portfolios,” said Christopher Good, partner
at law firm Macfarlanes.
“It’s very obvious in private equity, why the manager might need more time and more capital to invest into an asset, because that’s the nature of these illiquid investments. Whereas with a loan portfolio, it should in most circumstances be self-realising.
“I think that’s why there have been limited circumstances of GPs repackaging portfolios of loans and moving them into a continuation fund.
“On the other hand, I can see why, if you're a very big investor and you've got a large exposure to credit funds, you might take a moment to parcel some of that up and sell it as a block.”
He thinks that GP-led transactions in private credit will remain rare and will be due to a duration mismatch, an investor’s request for exposure to a specific portfolio, or when debt funds need to take over ailing businesses.
LGT Capital Partners diversifies private credit strategy
LGT Capital Partners is allocating more of its private credit portfolio away from direct lending, as fierce competition brings down yields.
Thomas Kyriakoudis, partner and co-head of credit solutions at LGT Capital Partners, said that direct lending will remain its largest private credit allocation but the firm is now investing more in other areas.
“In 2023, it was the most attractive market for direct lending I’ve seen in my career – wide spreads and good yields,” he told Alternative Credit Investor.
“But this year, particularly in the second quarter, there has been a lot of compression on
those yields. I’d definitely identify that upper mid market – firms with more than £75m EBITDA – to be more competitive now.”
An influx of new entrants to the direct lending space, combined with the recovery of the broadly syndicated loan (BSL) market, has intensified competition for larger deals.
Deloitte data for the first quarter of 2024 showed that the BSL market recorded a total issuance of €29.3bn (£24.8bn) in Europe, the highest level since the second quarter of 2021.
As a result, private credit firms are looking elsewhere for yield.
Kyriakoudis noted “more resilience in
spread compression” in the lower mid-market as private credit firms are not competing for deals with banks.
“We want to be balanced,” he added. “There’s a minimum size for us, we wouldn’t go for the smaller companies but there’s a band of interest below those deals that would compete with the BSL market.”
Other areas that the alternative asset manager finds attractive include net asset value lending, asset-backed lending,
significant risk transfers, structured credit such as CLOs, mezzanine finance and CLO equities.
“I think [asset-backed lending] has the potential to be bigger than direct lending in terms of the absolute size of the market,” said Kyriakoudis. “It’s potentially a very interesting area. The market has many of the same dynamics as it did post-GFC, when you saw banks be less aggressive, so there are opportunities for private lenders to come and deploy capital.”
LGT Capital Partners manages over $5bn (£3.8bn) of private credit assets, on behalf of the LGT endowment and external clients.
Solve the housing crisis by supporting SME housebuilders
MORE SUPPORT FOR small- and mediumsized enterprise (SME) housebuilders is vital if the new Labour government wants to solve the housing crisis, easyMoney has claimed.
Keir Starmer’s government campaigned on its promise to build more homes, with a target of building 1.5 million houses within the next five years. However, Jason Ferrando, chief executive of property lender easyMoney, believes that access to funding is the bigger threat to the UK property market.
“A focus on greater supply is admirable but it’s housebuilders who deliver homes, not politicians,” says Ferrando.
“Unfortunately, the big housebuilders aren’t inclined to burn their land banks as flooding the market with supply will only devalue their product in the process and if even they did, the top 10 housebuilders are unlikely to build the 300,000 homes a year we need.”
Instead, Ferrando has called up on the government to “revitalise the SME landscape and support SME housebuilders to help tackle the housing crisis.”
“Tax relief is probably the most effective method to get them building and in doing so, many smaller hands could make light work when it comes to hitting annual supply targets,” he added. easyMoney is one of the most active property lenders in the UK, with more than £380m in written bridging and development
loans to date. These loans are funded by retail and sophisticated investors, who can access the platform’s competitive returns with investments of as little as £100.
“Peer-to-peer lending allows anyone to invest at any price point via our Innovative Finance ISA and by pooling this investment we are able to fund the construction of new developments across the country, further boosting the supply of new homes reaching the market,” says Ferrando.
He added that there hasn’t been a great deal of noise from the new Labour government with respect to the lending landscape, with the initiatives announced so far largely focussing on supply and reform, particularly with regard to both the leasehold and lettings sectors.
“Time will tell how they plan to make property lending more accessible but what we certainly don’t want to see is the introduction of high loan-to-value products such as 95 per cent mortgages, as these only destabilise the market
by fuelling demand, ignoring the issue of supply, and encouraging buyers to over-borrow,” he adds.
The year to date has been characterised by slow and steady growth, with buyer activity remaining somewhat muted due to the continued obstacle of higher mortgage rates. However, house prices have held their own and in recent months have started to show signs of positive growth.
“With the election now done and dusted and with the prospect of a rates cut on the horizon, we expect mortgage market activity to increase over the coming months, with house prices following suit,” says Ferrando.
“With such a focus on housing delivery, let’s hope that historic trends will be reversed and we will see a notable boost to housing supply over the next five years.”
Don’t invest unless you’re prepared to lose money. This is a high risk investment. You may not be able to access your money easily and are unlikely to be protected if something goes wrong.
Funds begin using unsecured NAV financing
NET asset value (NAV) loans are increasingly being used by general partners at a time of limited exits in an effort to obtain some liquidity.
Although still a small part of the industry, NAV loans have become more popular recently, with several asset managers launching dedicated funds to take advantage of the opportunity. While most of these loans, that are provided at fund level, are secured by the assets in a portfolio, industry insiders say instances of unsecured loans are also increasing.
“The unsecured structure provides a greater level of flexibility to the borrower,” said Magnus Goodlad at Rede Partners.
“They're perceived to be a lower risk transaction.
In the event that there's a default, then the consequence is less severe.
“It can't bring about the extreme requirement to realise an asset and therefore in our NAV financing report, what the lenders expressed is that if there's a tension between the cost of capital and flexibility, then a majority had a preference for a greater level of flexibility.”
Although for the lenders it might mean
higher risk, it can also provide higher returns.
It is also important to note that these loans are not fully unsecured as some will be secured against the bank account of the borrower where any distributions will go into.
“Whilst there is increasing talk about unsecured NAV financings, it is not something we have yet seen becoming prevalent in the European market,” said Ian Callaghan, corporate and structured lending partner at Linklaters.
“The first point to note when referring to unsecured NAV financings is that it is something of a misnomer because
entity to cooperate with realising the assets in order to repay the debt.”
He added that often in PE NAV financings, after a default, there will be a period, during which the lender and the borrower or sponsor are obliged to try to agree a workout plan.
there will typically still be bank account security granted, even in so-called ‘unsecured’ NAV financings.
“For a lender trying to get comfortable with a PE NAV financing which doesn’t benefit from any share security, as well as insisting on lower LTVs, they would need to form the view that, as long as they have a debt claim into the fund or an SPV which sits above the whole portfolio and they have security over accounts into which distributions and realisation proceeds from the portfolio companies have to be paid, then, in a default scenario, they would have sufficient leverage to compel that
“So the borrower/ sponsor would be obliged to discuss with the lenders a plan for selling down assets and repaying some of the debt and come up with a strategy and a timeline for that to be implemented," he added. “Other than in the case of certain events of default –such as payment default or insolvency – it’s only once that process has been gone through that the lenders are permitted to accelerate and enforce the security. That feature reflects a commercial acceptance that, where you are lending against illiquid, privately held assets, it may in any case be difficult and value destructive to enforce security and sell assets quickly and without the cooperation of the sponsor.
“Once you’ve accepted that, you can see it opens the door to arguments about whether the share security is needed at all. That being said, in our experience, most lenders still want to have the ultimate fallback of being able to enforce security so they can take matters into their own hands.”
NAV finance: Behind the headlines
17Capital senior managing director Stephen Quinn explains how the noise around NAV finance is playing into its growth as a standalone asset class within private credit. By
Hannah Gannage-Stewart
GIVEN THE AMOUNT
of commentary on NAV finance in recent months, investors may be forgiven for thinking that this is a relatively new investment vehicle. In fact, NAV finance has been around for about two decades.
17Capital has been a specialist for most of that time. The firm has focused solely on NAV finance for 16 years, dealing in no other form of debt. It has deployed $13bn (£10bn) to date and forecasts the overall market opportunity for NAV finance to grow from $100bn in 2020 to more than $700bn by 2030.
Senior managing director Stephen Quinn joined 17Capital in June 2019 from Lloyds Banking Group, where he was the global head of financial sponsors.
Having worked across private equity and private credit for 30 years, he is unfazed by the recent disquiet around NAV finance although he is keen to introduce some perspective to the debate.
“The vast majority of the capital that we provide is intended to create growth over and above the cost of financing, so that the net result should be accretive to you as investors,” he says.
“It's the only reason why it makes sense for the GP as well, it's this value creation that's at the centre of it, and you're going to create more value in a stronger performing fund, than a weaker one. That is why our focus is on
stronger performing funds.”
17Capital typically works with relatively mature, large, portfolios. What Quinn likes to term 'trading businesses', in that they are widely known names, as opposed to unicorn-style startups with massive valuations but no tangible track record.
According to Quinn, the primary consideration behind whether to take on NAV finance should be whether it will create value, and ultimately, return that value to investors. Although, there has been criticism levelled at the sector for being used to enable distributions, Quinn is sceptical that there is any basis for that concern in real terms.
“In general, the distribution part of the market is 10 to 15 per cent. I would argue that in
“
isn't the use case for the financing that we provide. If you didn’t get beyond the headlines, I can see why you'd be a little bit sceptical.”
Private credit of all ‘flavours’, as Quinn likes to characterise the various forms of lending, has come in for criticism in recent years, as it continues to challenge the position of banks and other traditional financial institutions.
Recently, regulators have publicly queried the reliability of private credit valuations, implying that because they are often dealing with unlisted companies, they are less transparent than their public counterparts, and may be less accurate.
Quinn, along with many of his private credit peers, believes the criticism is unfounded, and
NAV finance was never intended to be the panacea of investor liquidity”
the last 12 months, it's probably less than 10 per cent, probably low single digits. So, although it’s created most of the headlines, it's actually by far the minority of the business,” Quinn explains.
“NAV finance was never intended to be the panacea of investor liquidity. Investors are getting less liquidity than they have in years gone by, that's just a fact, and NAV finance hasn't cured that with the best will in the world, because it
based mainly on commentators’ unfamiliarity with the market.
“Clearly, we scrutinise the valuations, and scrutinise the process that goes on behind those valuations,” he says. “We look at the track records of managers, and how they have performed in terms of what they said a company was worth and what they've sold for. All that diligence goes into the front end.”
He adds that part of the reason 17Capital does not focus on real
estate or venture financing is because those valuations can be complex and are outside of the firm’s expertise. It is when lenders start to dabble in disciplines they are not expert in that things can go wrong, he says.
For 17Capital, the driving force behind what they do is a desire to offer strategic flexibility to private equity, through NAV finance.
“This is not distressed capital, this is not last roll of the dice capital,” he adds. “This is capital that's designed to be value accretive. Obviously, the execution needs to be delivered well, but certainly the plan and the expectation is that it will be accretive.”
Asked whether he has seen approaches for NAV finance that have no obvious justification in terms of generating growth or being otherwise beneficial for LPs, he suggests they are given short shrift at 17Capital. “They tend to leave my mind very quickly, because they're so quickly off my desk.”
While the majority of 17Capital’s business is with large cap managers, Quinn is clear that the size of the portfolio is not the primary consideration. “We don't just look
at size. What we're looking for is quality. So, we can do a lower-midmarket manager, for example. What we're looking for is performance, an institutionalised manager, strong governance, a broad bench of senior leadership that bring scrutiny and challenge into their businesses.”
As far as Quinn is concerned, NAV finance is no more of a risk than any other kind of private debt, but it does offer another way for private equity firms to fund strategic growth – and as the market becomes better understood, demand for that option is only going to increase.
17Capital recently opened an office in Dubai, headed up by investment director Pierre Garnier. The office is currently a small hub, enabling the firm to be close to a growing base of investors in the region. Quinn says there are no other international expansion plans to date but he would not rule it out if there were a need to be close to investors somewhere else.
Looking ahead, he sees private credit, and NAV finance in particular, continue to establish itself as a viable funding option for a wide spectrum of businesses. “We're not
going to see the industry levels of 2021, but certainly the sense from our network is that we do expect private equity deployment start to ramp up a bit,” he says. “It's hard to know if that's happened already because of the lag in numbers.
“I think private credit will continue to be a big element of that support for private equity investment. I'm reticent to use the well-worn phrase ‘green shoots’, but, certainly, some of the lead indicators are better than they were 12 months ago.”
Speaking just days after Kier Starmer’s election as UK prime minister, Quinn was not convinced that the change of government would have much bearing on the future of private credit.
“Beyond whether we have a Labour government, particularly looking at the last four or five years, there is a renewed emphasis on growth,” he explains. “Growth that simply hasn’t been coming through in developed economies worldwide.
“It's not about the government change, we've seen private equity and private credit navigate some really challenging markets, and there's nothing that makes me think that will do anything but continue.”
Moreover, the fall in inflation and interest rates is creating a positive trajectory, and a climate of stability that gives the market more confidence than it has had in the recent past. Quinn seems hopeful that this renewed sense of stability will create an environment more conducive to investment.
This leads Quinn to believe that 17Capital’s prediction that NAV finance will establish itself as a standalone asset class within private credit and hit $700bn by 2030, is looking increasingly likely.
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The winners of the awards will be announced on the night, celebrating the most influential fund managers, lenders and service providers making their mark on the alternative credit space.
Attendees can expect a glittering evening, comprising a drinks reception, gala dinner and awards ceremony.
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Take cover
As fixed income flags, insurers are turning to private credit in their search for Solvency II-approved yield. Kathryn Gaw reports…
INSURERS ARE UNUSUAL amongst institutional investors. They have phenomenally deep pockets, with approximately $26tn (£20.02tn) in funds under management, and this money has to be invested. However, they are also subject to strict regulations and scrutiny which can drastically limit their investment options.
Under Solvency II rules, insurers must maintain certain capital requirements so that they are
able to meet any payout claims. This means that for insurers, the priority is capital protection. And private credit can offer just that.
Solvency II has identified private credit as a lower-volatility asset class, given its lack of correlation to the main equity markets. Private credit can also provide diversification in investor portfolios, offsetting some of the ongoing macro-economic risks which are currently playing
out on the public markets.
Of course, there is another key reason why insurers and other investors have been attracted to private credit investments – the returns.
A Goldman Sachs Asset Management survey carried out earlier this year found that insurers expect private credit to be one of the asset classes that delivers the highest returns over the next 12 months, beating private equity for
the first time. A separate study by Moody’s confirmed that insurers are prioritising yield and diversification in their portfolios this year.
“Lower mark to market volatility is considered attractive, as private valuations tend to lag public markets, although from a credit perspective this could obscure underlying deterioration in such investments,” says William Keen-Tomlinson, a vice president and senior analyst at Moody’s Ratings in London.
senior secured loans to high quality mid-market companies are generating low-double-digit gross returns with strong downside protection from robust equity cushions and lender protections.”
Due to their preference for long-term, fixed income assets,
“ The private credit opportunity is particularly attractive in today’s market”
it can take a while for any new trends in insurance investments to emerge. But there has been a visible shift towards private credit over the past year.
based finance vehicles, evergreen US direct lending, Asia private credit and CLO formation.
Northleaf has also been reaching out to insurers.
“We continue to see strong demand from insurers for private credit because of the return and diversification benefits that the asset class can provide to their fixed income portfolio,” says Ross.
“For longer term liabilities such as annuities, especially in the UK, asset liability management is a further factor. Private deals such as infrastructure and private placements can offer fixed cash flows over very long periods, and often include call protection which eliminates reinvestment risk.”
Insurers are funded by clients who pay premiums in exchange for protection from various risks. In order to keep pace with inflation and fund big pay-outs, insurers must invest these funds, ideally in long term assets which provide a fixed return. However, recent concerns about an economic slowdown have been weighing on the fixed income markets, forcing insurers to look at alternative asset classes which might be able to offer similar benefits.
“The private credit opportunity is particularly attractive in today’s market as it provides compelling absolute and risk-adjusted returns for an insurer’s portfolio,” says David Ross, head of private credit at Northleaf Capital Partners.
“With elevated base rates,
Earlier this year, SLC Management – the $277bn fixed income and alternatives asset manager – launched its own dedicated insurance group aimed at expanding its work with the insurance community. Just a couple of weeks prior, US-based alternative credit asset manager Invictus Capital Partners launched an insurance
“It is important however for insurers to be able to invest in private credit in a regulatory capital efficient way, and we are speaking to insurance investors about the variety of private credit structuring solutions that are now available to them, such as rated feeder funds, separately managed accounts, and co-investments.”
There have been countless analyses about why insurers are favouring private debt at the moment. M&G believes that insurance investors have been seeking to increase their exposure to less liquid markets, such as private debt, over recent years.
“ As insurers have built their corporate direct lending exposure, we are increasingly seeing them look to add asset-based specialty lending to their portfolios”
solutions business of its own.
Partnerships between insurers and private credit managers are also on the rise. Last year, KKR acquired the insurer Global Atlantic, and subsequently saw its assets under management increase by six per cent quarter-on-quarter. It said that new capital raised over the quarter was driven by inflows at Global Atlantic, as well as asset-
Neuberger Berman has claimed that private credit could be a particularly good fit for insurers due to the sector’s predictable cash flows, risk diversification and illiquidity premium relative to public markets. And Moody’s’ KeenTomlinson has pointed towards the sector’s diversification possibilities and higher credit spreads.
In recent years, there has been
another compelling reason for insurers to consider private credit: the inflation-beating returns. Across the UK, US and EU, interest rates have remained persistently high, while stock market volatility has spooked the more risk-averse investors. The search for yield has sent institutions flocking to the private credit market, which is now said to be worth more than $1.8tn globally.
Last year, Morningstar DBRS data revealed that US-based private debt funds returned an average of 13.3 per cent, while European funds returned 13.4 per cent. This represented the highest annual return for such funds since the global financial crisis in 2008 and the secondstrongest return ever recorded.
For most investors, the illiquidity of private credit is seen as a negative, but insurers often have liquidity to spare due to their liability profile, so private credit allows them to boost their portfolio returns while remaining compliant with their regulatory capital requirements.
However, in return for this illiquidity they tend to prefer investment grade assets, either with good quality counterparties or favourable loan-to-value ratios. They have traditionally shown a particular fondness for asset-based finance (ABF) and asset-based specialty finance (ABSF) which comes with in-built collateral to assuage any fears of capital loss.
While ABF typically relies on real estate as the underlying asset, ABSF is a growing segment of the financial market that covers almost every aspect of the economy, with one of the largest segments being the consumer and
“ Lower mark to market volatility is considered attractive”
commercial space, such as credit card receivables or auto loans.
“As insurers have built their corporate direct lending exposure, we are increasingly seeing them look to add ABSF to their portfolios, which typically has low or no correlation to their direct lending or traditional fixed-income
exposure and helps to mute overall volatility and reduce correlation across the portfolio,” explains Ross.
“At Northleaf, we focus on more niche asset classes within ABSF where the key characteristic is that they aren’t correlated to macro and market factors and also have high barriers to entry given the specialized skill set required.
“This provides enormous value to an insurance balance sheet, not just in terms of return, but also in terms of providing an investment opportunity that doesn’t correlate to what they are investing in on other places on the balance sheet.”
With such specific needs and
long-term investment horizons, it makes sense that private credit fund managers seeking to attract insurance investors would opt to create dedicated insurer solutions, or enter into partnerships to streamline their mutual due diligence. However, as more and more insurers tilt their portfolios towards private credit, a few alarm bells are already being rung.
An upcoming maturity wall has inspired many discussions about the possibility of mass defaults across the sector, particularly for those loans which were originated during the low-rate era of the pandemic. This could result in
lower returns for investors, or in some cases the risk of capital loss.
Just a few months ago, Citigroup chief executive Jane Fraser warned of the risk of arbitrage between banking and insurance, and said she intended to raise the issue at a committee meeting of Citigroup’s board.
“The piece I’ve noticed a lot of late that does worry me is there’s an arbitrage between banking and insurance that is going on,” Fraser said. “We all need to keep an eye on that one.”
A Citi representative confirmed to Alternative Credit Investor that this committee meeting took
place, but would not share any details of the discussion or how it impacts Citi’s investment plans.
Furthermore, insurers’ preference for real estate-backed loans could make them vulnerable in the event of a property crash. KeenTomlinson said that he has already noticed a number of insurers are growing cautious on office and retail in real estate, while becoming more bullish on logistics and fulfilment opportunities.
“A number of insurers we spoke to invest thematically and are more agnostic on whether opportunities are public or private as long as investment fundamentals are strong,” he says. With tightening credit conditions globally and a persistently high interest rate environment, many analysts have predicted a rise in defaults later this year. However, good private credit fund managers will be able to minimise the risk of losses using a range of strategies such as underwriting, due diligence, security and structuring capabilities.
As the private credit sector grows and becomes more competitive, it is very possible that we will see even more insurer tie-ins in the months and years ahead. These partnerships can be mutually beneficial. They allow fund managers to create confidentiality clauses which protect their investment strategies while giving insurers the transparency they require. For the insurers themselves, partnerships allow them to create bespoke portfolios which can be consistently managed by the same team over the long term.
There are clear opportunities for both parties, it is just a matter of navigating the regulatory nuance and risk factors.
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Avoiding receivership to maximise investor returns
RECEIVERSHIP
SHOULD be a last resort for peer-to-peer lending platforms, according to Folk2Folk’s managing director Roy Warren (pictured), and for good reason.
Receivership is an expensive proposition which comes with no guarantee that investor capital or interest will be recovered in the end. For this reason, platforms such as Folk2Folk prefer to focus on creative problem-solving as a first alternative to receivership when it comes to working to recover investor funds.
“Our policy on receivership is to use it strategically as a tool to maximise investor recovery when all other options have been exhausted,” explains Warren.
“We prioritise the best possible outcome for our investors, working to ensure their capital is protected.
“Receivership is initiated when it becomes the most effective means to recover the loan, leveraging the borrower's property assets to repay their investors.”
Receivership is a rare occurrence at Folk2Folk due to the platform’s stringent risk management and proactive management of loans. A commitment to ongoing monitoring allows the platform to mitigate potential issues early. However, when necessary, Folk2Folk will pursue receivership if it represents the best chance of recovering investor capital.
“We carefully evaluate each borrower’s collateral and financial health, ensuring that loans are well-secured,” says Warren.
“Our diligent monitoring and early intervention strategies enable us to address issues promptly, with a focus on protecting our investors’ capital, and maximising their returns.”
With more than 40 years within the finance industry and considerable experience in corporate banking, asset finance, risk and portfolio management, Warren is known for his calm demeanour, cautious approach to risk, and his problem-solving creativity. His depth of experience and knowledge has helped Folk2Folk to maintain an enviable zero loss track record over the years.
In the 11 years since the company was founded, just 12 loans have gone into receivership. In all closed cases, investors were able to recoup all their capital, and in nearly all cases interest was also recovered.
“Our primary focus remains on strategies that deliver the best outcomes for investors,” says Warren.
“We evaluate each situation to determine the most effective recovery method, always prioritising the protection and recovery of investor capital.”
Warren believes that exploring all possible recovery avenues first can often result in better outcomes for Folk2Folk’s investors. Before a loan reaches the receivership stage, the platform might seek to refinance or restructure the loan, or to facilitate the sale of assets.
“Immediate receivership can sometimes lead to a rushed liquidation of assets, or the perception of a distressed sale, which can very often depress the sale price, resulting in lower recovery values,” Warren says.
“By initially pursuing options like loan restructuring, third party refinance, or asset sales, we aim to maximize the value recovered.
“Only when these alternatives have been exhausted do we move to receivership, ensuring that we have taken all steps to protect and optimise investor returns.”
By treating receivership as a final option, Folk2Folk has been able to protect its investor funds even during rocky economic times. This approach has helped it to become the largest P2P platform in the UK, with a loyal and engaged investor base.
“Driving down the value of the asset together with expensive receivership costs can place investor capital at risk,” adds Warren.
“That’s why it is a last resort for us.”
Assetz Exchange is a property investment platform delivering long term stable income for investors, primarily through the purchase and leasing of housing for social good. Regulated by the FCA, it provides the opportunity for investors to create a diversified property portfolio and alternative funding options for the housing sector.
www.assetzexchange.co.uk
T: 03330 119830
E: info@assetzexchange.co.uk
easyMoney is a peer-to-peer property lending platform that is authorised by the Financial Conduct Authority #231680. It has £200m+ in investor funds deployed and no investor has ever made a loss. Among P2P firms surveyed by Alternative Credit Investor, it has the largest active Innovative Finance ISA portfolio and won Innovative Finance ISA Provider of the Year at the Peer2Peer Finance Awards 2023.
www.easyMoney.com
T: 0203 858 7269
E: contactus@easymoney.com
Folk2Folk is a profitable UK lending and investment platform. More than half a billion pounds has been invested via the platform with no investor losses to date. Loans are a maximum of five years, secured against land/property at a maximum 60 per cent LTV, with a fixed rate of between 7.5 and 9.5 per cent, per annum.
www.folk2folk.com
T: 01566 773296
E: enquiries@folk2folk.com
JustUs is an innovative peer-to-peer lender that provides a range of consumer and property-backed loans. It has lent out more than £25m and paid more than £1.7m in interest to lenders to date. Investors can enjoy returns of up to 10.98 per cent, with all products eligible to be held in an Innovative Finance ISA for tax-free earnings.
www.justus.co
T: 01625 750034
E: support@justus.co
Kuflink is an award-winning lender and online investment platform. With over £280m invested through the platform, investors can customise their own portfolio investing in specific loans or in a pool of loans diversified across a number of opportunities. Earn up to 9.73 per cent (compounded) per annum, with an IFISA available.
www.kuflink.com
T: 01474 33 44 88
E: hello@kuflink.com
LANDE is a crowdfunding platform that gives investors access to secured agricultural loans. It has created a unique scoring model, accessible infrastructure, and a variety of products so that farmers are able to access financing quickly and easily. With LANDE and its investors as partners, farmers can become more independent and sustainable, while improving their yield, efficiency and profitability. Projects offer interest rates of up to 14 per cent per annum.
https://lande.finance
T: +371 20381802
E: info@lande.finance
Lendwise is the UK’s only peer-to-peer lender that is dedicated to impact investing in education finance. Investors finance education for borrowers at universities and business schools across the UK and globally. Investors define their own risk appetite and use Lendwise’s AutoLend feature to diversify their strategy across a pool of loans, which can be invested in an IFISA wrapper earning average returns of up to nine per cent per annum.
www.lendwise.com
T: 0203 890 7270
E: lenders@lendwise.com
Lending for over eight years, Somo is a seasoned bridging lender specialising in providing short-term secured loans against UK property. Somo gives its lenders the opportunity to tailor their investments according to their risk tolerance, selecting interest rates and loan-to-value ratios that align with their preferences, with a minimum investment of £5,000.
www.somo.co.uk/how-it-works
T: 0161 312 5656
E: investors@somo.co.uk
The European Crowdfunding Network (EuroCrowd) is an independent, professional business network promoting adequate transparency, regulation and governance in digital finance while offering a combined voice in policy discussion and public opinion building. It executes initiatives aimed at innovating, representing, promoting and protecting the European crowdfunding industry. www.eurocrowd.org
E: info@eurocrowd.org
Q2 creates simple, smart, end-to-end lending experiences that make you an indispensable partner on your customers' financial journeys. Its modular platform gives you the ability to manage lending simply throughout the entire loan lifecycle, from application, onboarding, servicing to collections. The result is a better experience for both borrowers and lenders.
https://eu.q2.com
T: 020 3823 2300
E: info@Q2.com
