Private Credit James Pearce, Head of Direct Lending 2 nd of October 2018
How do companies fund themselves? Pre financial crisis Companies Global Investment Banks Senior Funding Tier 1 Funding Equity Funding Synthetic CDOs Bonds Loans RMBS CMBS Fund Managers Insurance companies and pension funds 2
How do companies fund themselves? Today Companies Global Investment Banks Bonds Loans Fund Managers Insurance companies and pension funds 3
Cumulative number of deals Proportion of Deals Growth of direct lending in Europe Cumulative transactions since 2012* 1,600 Private debt backed deals in Europe: Banks v Non-Banks** 100% 1,400 1,200 1,000 90% 80% 70% 60% 28% 35% 27% 44% 42% 42% 61% 800 50% 600 400 200 40% 30% 20% 10% 72% 65% 73% 56% 58% 58% 39% 0 Q4 2012 Q4 2013 Q4 2014 Q4 2015 Q4 2016 Q4 2017 0% 2011 2012 2013 2014 2015 2016 2017 Bank Private Debt Firm Non bank lenders playing an increasing role European mid-market lending 4 Source: *Deloitte Alternative Deal Tracker Q1 2018. **Preqin Markets in Focus June 2018
European direct lending today Mid-market transactions by deal size H1 2018 Unitranche activity by geographic location 12% 90 80 70 68 78 11% 15% 29% 33% < 50m 50 to 100m 100 to 150m 150 to 200m > 200m 60 50 40 30 20 10 0 44 25 35 32 21 21 1312 11 6 7 7 7 7 2 2 1 4 4 2016 2017 LTM 5 Source: Alix Partners Mid Market Debt Report September 2018
Dry Powder ( bn) European direct lending today Dry powder is increasing Europe focused private debt dry powder 60 Market today is characterised by; Oversupply of capital 50 40 30 20 undifferentiated propositions The result Highly competitive processes 10 Weakening structures 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Dry Powder ( bn) Lower pricing M&G has turned down over 95% of deals shown in 2018 6 Source: Preqin 2018
Is there a different way? Working with the banks Banks have traditionally been the primary source of finance for mid-market companies and have; Large origination teams Established relationships Long track records But balance sheet constraints mean that their deal sizes are now limited In 2015, M&G entered into a groundbreaking partnership with RBS to lend to the mid-market Partnership allows M&G to benefit from RBS origination resources and company relationships RBS are still able to offer one-stop-shop despite their constrained deal size Every deal goes through M&G credit process & M&G is under no obligation to participate 7
Working with banks A case study ByBox Group is a provider of technology enabled solutions that help customers solve supply chain problems Founded in 2000, RBS had been providing finance to ByBox since it was a start up In 2016 the company was sold to private equity firm LDC 65 million of debt finance was provided through the RBS partnership In August 2018 a second buyout occurred RBS partnership were the sole lenders providing a 95m 7 year term loan o Existing relationship enabled partnership to move quickly o Partnerships scale offered an attractive one stop financing solution 8
Asset based lending Traditional term loan financing offered by majority of direct lenders is not suitable for all borrowers Asset based lending is an attractive alternative Flexibility to adapt to borrower financing requirements Lending fully backed by security over key assets Nature of covenants enables rapid de-risking of lender s position if credit quality worsens Requires significant specialist expertise and therefore limited competition Receivables Property Inventory Plant & Machinery 9
Asset based lending Attractive risk adjusted returns on SME Loans Economics of true SME lending is challenging for banks / asset managers Bank capital treatment Origination cost Too small for institutional lenders However, new technology driven platforms provide solution to many of the issues Efficient origination Streamlined credit risk assessment Enables institutional investors to access strong risk adjusted returns But Alignment of interest is key! 10
Asset based lending Accessing debt in a format suitable for institutional investors Capital on Tap is an online lender to small businesses, founded in 2012 it has provided over 500 million in funding to more than 40,000 businesses in the UK to date In 2016, M&G provided 25m of senior finance secured on a pool of loans Short term nature of loans and strong covenant package combine to create strong credit protection M&G leveraged extensive ABS experience to structure the entire transaction M&G secured off market returns for risk due to transaction complexity M&G have continued to support company growth Currently provide c. 45m across senior and mezzanine debt as part of a wider funding package secured in August 2018 11
Direct Lending today Parts of the market are crowded Too much capital is chasing too few deals Selectivity is important Don t be a forced buyer of assets Step away from deals if no longer compensated for the risk Product differentiation is key Flexible sources of capital Origination capabilities Trying new things 12
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