Money managers will increase direct lending to Europe’s companies to benefit from higher yields and better guarantees as the region’s banks pull back from keeping debt on their balance sheets, according to Societe Generale SA.
Loans pay investors rates as much as 1.5 percentage points more than equivalent corporate bonds and offer “exceptionally high recovery rates,” Societe Generale analysts including Alain Bokobza wrote in a report. This helps offset the lower liquidity of the debt, meaning pension funds, insurers and other institutional investors may own such investments for long periods of time.
New rules, including Solvency II for insurers and IAS 19 for pension funds, make investors eager for yield at a time when bonds pay low interest rates, the analysts wrote. “Loans appear to be an attractive alternative as they offer a significant yield pick-up compared to equivalent publicly traded securities.”
At the same time, European banks will reduce the amount of corporate debt on their balance sheets and switch to the so-called originate-to-distribute model, partly because of regulatory pressure, it said. This “alleviates capital requirements while securing banks’ commercial relationships and maintaining their ability to generate revenues from transaction fees,” the analysts wrote.
“The asset management industry is about to experience another shake-up, as the investment universe expands to include new asset classes that involve direct loans to the economy rather than financial securities,” Societe Generale said.
Europe’s lenders have begun partnerships with investors to distribute the loans they originate, including a tie-up between Societe Generale and AXA SA, and between Natixis and Ageas. Investors including Rothschild, BlackRock Inc. and Prudential Plc have established loan funds, according to the report.
There are five areas of lending that institutional investors may consider, each of which requires about $100 billion of debt a year, the bank said. These are commercial real estate loans, project finance for energy, transport infrastructure, loans to small and medium-sized enterprises, and debt backed by export finance agencies, Societe Generale said.
Banks provide about 80 percent of the debt borrowed by European companies, the reverse of the situation in the U.S. where banks provide about 20 percent of the total, according to the report. Illiquid assets such as unlisted debt and loans to companies currently comprise about four to eight percent of European insurers’ assets.
A model for institutional investors to lend to Europe’s medium-sized companies is “elusive,” according to a separate report from Standard & Poor’s. “Alternatives, such as the non-bank lending market, private placements, and bond platforms on exchanges, are still in their infancy in Europe. What’s more, they lack cohesion, and operate in different regulatory and accounting environments,” Taron Wade, a London-based analyst at S&P, said in the report.