Private Equity Enters Banks’ Turf in Europe
Stock Chart for AXA SA (CS)
When French medical-testing company Biomnis needed a loan to fund acquisitions last year, it turned to buyout firm Axa Private Equity, instead of a bank.
The private-equity unit of French insurer Axa SA (CS) provided 100 million euros ($132 million) to refinance existing loans in May, and added 50 million euros for future takeovers. The Paris- based firm signed two similar deals last year and is looking for more, said Cecile Mayer-Levi, who led the transaction for Axa Private Equity.
“Banks weren’t vigilant,” Mayer-Levi said in an interview. “They didn’t think we would be able to do this.”
As Europe’s sovereign-debt crisis has worsened, banks have become more reluctant to lend to medium-sized companies. The gap created is luring hedge fund managers and private-equity firms like Axa, which can charge customers higher rates for loans that they might otherwise be unable to get from traditional lenders.
As in the U.S., the growth of so-called shadow banking in Europe is attracting regulators’ attention. Unlike their banks, the new lenders aren’t subject to traditional bank regulations and may be more aggressive about enforcing their rights in the event of a default.
“It’s a positive trend because there’s a big need,” David Thesmar, a professor at French business school HEC Paris, said in an interview. “But we’re up for a cultural revolution. Unlike the banks, private equity or hedge funds aren’t passive investors, and if the companies default, they won’t be scared to take the keys.”
European banks, which account for about 80 percent of lending to companies and households, are tightening credit and seeking to cut more than 950 billion euros in assets in the next two years to help meet regulators’ demand to boost capital, according to data compiled by Bloomberg News.
Loans to euro-area households and companies contracted 0.7 percent in December, the most on record, the European Central Bank reported on Jan. 27. At the same time, $100 billion of collateralized loan funds, a primary source of funding of European leveraged loans, will wind down by 2015, threatening default on existing debt, Standard and Poor’s said in August.
The hedge funds and private-equity firms are typically lending in instances where banks chose not to lend, or decline to make the capital available at terms or in the time frame wanted by the borrower, executives said.
Firms including New York-based Apollo Global Management LLC (APO) and London-based Intermediate Capital Group Plc (ICP) and 3i Group Plc are among private-equity firms seeking to lend directly to companies.
The firms can typically charge companies interest rates of 9 percent to 12 percent for a blend of senior and junior debt, more than banks, Axa’s Mayer-Levi said. Returns can be boosted with leverage, said Michael Dennis, managing director of Ares Capital Europe, part of Los Angeles-based Ares Management LLC.
“The more risky, the more you have to pay, and some companies may resort to that kind of financing,” said Matthew Sebag-Montefiore, a partner at Oliver Wyman in London. “For typical companies that are not under any kind of pressure, they simply don’t want to pay higher rates. It’s going to remain a niche business.”
Europe’s multiple jurisdictions and political resistance to private equity and hedge funds may also hinder growth in lending, the firms say.
“It will be a very big barrier for entry,” Jason Papastavrou, chief executive officer of New York-based Aris Capital Management LLC, which invests in direct-lending funds, said in an interview. “I would like to see how a hedge fund that operates out of London or New York will try to go to court against a French company seeking collateral when they are screaming ‘Yankees go home!’”
Shadow banking, a generic term used to describe all lending activities not performed by banks, “is one of my top priorities,” Michel Barnier, the European Union’s financial- services chief, said in a Bloomberg TV interview last month, without elaborating.
“The more you raise the costs of banks via regulation, the more you risk pushing activity into shadow banking,” said Mark Weil, head of Europe, the Middle East and Africa at Oliver Wyman Financial Services in London. “That’s bad news for banks, but also for regulators and ultimately taxpayers because there’s a reason why the regulation is there -- to make banking safer.”
In the U.S., most borrowing by medium-sized companies, defined as those whose values range from $100 million to $1 billion, is from companies other than banks, said Ares Capital’s Dennis. In Europe, it’s less than 20 percent, he said. There is little reliable data on the total amount of so-called direct lending by the funds.
‘A Very Good Time’
“The share of institutional investors in the European lending market has been growing in the past few years, and it has accelerated in the past six to nine months because of the worsening of the sovereign debt crisis,” Dennis said. “Now is a very good time to do direct lending in Europe.”
Ares, which manages about $47 billion in assets, started its European direct-lending operations in 2007. It has loaned more than $1 billion to 44 European companies and is raising a new fund for the region, Dennis said. About a fifth of the firms Dennis backed aren’t the subject of a leveraged buyout.
In Europe, the direct-lending capacity built by private equity and hedge funds is about 3.5 billion euros, estimated Jeremy Ghose, head of buyout firm 3i’s debt-management unit. That is dwarfed by the banks, which had 4.7 trillion euros of outstanding loans to European companies at the end of 2011, according to data released last month by the ECB.
Lending by the funds will expand as firms redirect some of their limited partners’ resources toward that strategy, Ghose said in an interview. 3i is considering starting a 300 million- euro to 400 million-euro pool dedicated to direct lending in the next six months, he said.
Apollo Global Management, which is already lending in Europe, is exploring a dedicated pool to offer senior loans to medium-sized companies in the region, said Sanjay Patel, head of the New York-based firm’s international operations.
The lending business could yield 7 percent to 15 percent a year, more than what traditional corporate or government debt delivers, he said in an interview. The strategy could appeal to pension and sovereign funds in search for yields and willing to commit money for five to 10 years, he said.
“The banks and the world in general are moving toward more liquidity,” Patel said. “They tend to lend to bigger companies because it’s viewed as less risky. The vacuum for medium-sized companies is clear.”
Blackstone Group LP (BX), the world’s largest private-equity firm, is also growing direct lending in Europe through its GSO credit unit, a person with knowledge of the operations said. Intermediate Capital, which manages funds providing so-called mezzanine loans, a form of subordinated -- or riskier -- credit to companies, is considering raising money to provide senior loans to European companies, said Benoit Durteste, who heads the firm’s mezzanine lending business in Europe.
“The risk-reward ratio is very attractive,” Durteste said in an interview.
Some companies have turned to non-bank lenders because of the more flexible terms they offer.
Unither Pharmaceuticals SA, a French maker of eyedrops that was acquired by buyout firm Equistone Partners Europe in November, picked Axa Private Equity for a 100 million-euro financing over a group of banks, partly because its loan doesn’t require the company to pay down debt before maturity, saving cash flow for expansion, said Guillaume Jacqueau, Equistone’s managing partner.
“Banks are more cautious and more selective,” he said.
Courtepaille SA, a French restaurant chain acquired by private-equity firm Fondations Capital, chose Intermediate last year for a 160 million-euro debt package because the banks required the debt to be paid down year after year, when the company needed to preserve cash flow for the opening of new restaurants, said Philippe Renauld, a Fondations partner.
“It is a great time for people to be getting into this business because you have high-quality companies with high- quality collateral willing to pay high interest rates,” said Aris Capital’s Papastavrou. “My concern is that investors are idiots. As soon as a few months go by and good returns are generated, then they forget all the problems and you go to the next bubble.”
Firms, Investors Clash
In the U.S., where funds have a longer history lending to businesses, shadow banking hasn’t been without conflict among the firms, their investors and borrowers. The global credit freeze triggered by the 2008 bankruptcy of Lehman Brothers Holdings Inc. caused the failure of several lending firms after clients sought to redeem their investments.
Aris Capital sued a $1 billion direct-lending hedge fund overseen by Quantek Asset Management LLC and one of its managers, Javier Guerra, in 2009 after the firm suspended redemptions because it had made illiquid investments. The fund had lent money to a developer of low-income housing in Mexico, purchased airplanes to lease and bought a stake in a copper mine in Chile.
When Papastavrou made the Quantek investment in 2008, he said he was told his money would be locked up for no more than a year and then the funds could be redeemed in 90 days or less, depending on the share class. Four years later, the portfolio is still being liquidated. After Aris won an arbitration in September of last year, Quantek told investors Guerra had resigned from the board and that plans to sell assets would lead to a “material reduction” to the fund’s net asset value.
‘Sense of Crisis’
“Aris has needlessly created a sense of crisis in what was otherwise an orderly wind down,” Guerra said in a statement. “What this tells hedge-fund managers is that we as an industry should consider doing more extensive due diligence on our investors.”
Plainfield Asset Management LLC, which had $5 billion in assets at its peak, is winding down a hedge fund that made loans to companies with investors suffering losses of about 80 percent, according to U.S. regulatory filings. Plainfield, based in Stamford, Connecticut, has also been sued by borrowers.
All legal cases against Plainfield have been settled, said Elliot Sloane, a spokesman for the company.
Michael Patterson, a partner at New York-based hedge fund Highbridge Capital Management LLC, said investors have learned that lending to businesses only works when firms follow the private-equity model of locking up investor cash for years. He runs a lending fund started in 2009 that raised $1.1 billion from investors and has additional leverage of $500 million.
“In order for limited partners to agree to invest their money for a decently long period of time, you’ve got to be credible and committed,” Patterson said. “You can’t just slide in and out of the market if you are talking about locking up people’s capital for four years or five years. That requirement prevents some of the rush in and rush out behavior.”
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