German banks lose position to debt funds

Private debt funds have supported the lion’s share of the German mid-market recently, according to research commissioned by GCA Altium. Debt funds supported 56% of German buyout financings with a credit volume of between €20-500m in the first half of 2019, up from 32% in 2017 and 16% in 2016.

The risk-averse nature of banks is the chief driver of this trend, says Beechbrook investment director Peter Gottron: “Over the past 12-24 months, banks have become more risk-averse. They also take a step back and don’t look at more difficult sectors, such as the automotive industry.”

The first-out, second-out unitranche structure has previously allowed banks to offer senior and super-senior tranches, and join forces with private debt funds to bring down the total cost of debt for companies. Unitranche has remained popular in the first half of 2019, making up 15 of the 32 financings in Germany, according to the GCA Altium MidCapMonitor.

However, Investec director Kai Stengel says some banks will avoid involvement in any type of high-leverage transactions completely. “Certain banks that haven’t done many deals don’t want to be in a 6-7x structure, even if their own capital is in at 1-2x,” he says. “They just see things going wrong when there’s too much debt on a business.”

Already notorious for caution, German banks, like all European banks, have high capital adequacy requirements to comply with. The EU regulation package known as Basel III has already put into place increased levels of capital requirements and specified a minimum leverage ratio requirement.

In January 2019, the Basel Committee published minimum capital requirements for market risk, which are expected to increase total market risk capital requirements by 22% against previous requirements for some assets. This indicates the appetite for tightening regulation among EU banking institutions. While private debt funds are regulated by various banking and financial institutions, they are more likely to continue to invest due to the pressure to deploy.

Jürgen Breuer, partner and head of DACH at Pemberton Capital, thinks private debt funds can take on riskier debts because they invest more in risk analysis prior to the deal. “We’ve always given importance to risk processes, infrastructure and staffing,” says Breuer. Pemberton employs nine credit analysts who report to a chief risk officer and are in a different vertical from the origination team, giving them a degree of independence. “If a company isn’t doing so well, through our risk analysis we can collaborate with the management and the sponsor to suggest options to improve the situation. This is something banks aren’t organisationally equipped to do so well,” he says.

Swiss aggression
The situation is not the same in Switzerland, where banks were involved in all the nine senior debt financings in Switzerland in Q2 2019, and GCA Altium recorded one unitranche deal from Q3 2018 to Q2 2019. Breuer says: “In a nutshell, Swiss banks are more aggressive than German banks, so it’s a more difficult market for direct lenders right now.”

Loan terms are loosening as debt continues to pour into the market and different contenders compete for deals. Investec’s Stengel says: “Covenants are getting looser, more adjustments to EBITDA are permitted and the industry is moving away from good documentation. That’s a fact.”

With their ability to tailor loans more than banks, private debt funds can accommodate increasingly aggressive sponsors, while German banks are not as willing; however, in Switzerland, banks are continuing to take a competitive approach to covenants. Breuer says: “The bids the banks come out with can move into higher leverage territory and might offer documentary flexibility as well.”

Gottron agrees that Swiss deals are usually financed by Swiss banks, but thinks the same factors affecting German banks will change the Swiss market soon.

“Unitranche will become just as popular over time there,” says Gottron. “Regulation is having the same impact as in Germany; Swiss banks are also becoming more risk averse. This opens the market and, more often, sponsors turn towards debt funds that can finance transactions.” 

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• Topics
• DACH
• Financing
• Germany
• Switzerland