HSBC expects dealflow uptick and higher returns with second direct lending vintage

“We have moved into a slightly different time from when we launched the direct lending strategy amid the Covid-19 pandemic, into an era of higher inflation and rising interest rates, and yet we see that our lower risk proposition continues to resonate with investors who are thinking more carefully about not just the return but also the risk they’re taking in their portfolios,” he said.

The firm announced the launch of the second vintage of its senior UK direct lending strategy earlier in June, as reported, with more than USD 580m in client commitments. It raised USD 1.1bn for the first vintage of the strategy and associated mandates in May 2022.

The second vintage will follow the strategy of its predecessor, making senior secured loans for mid-market private equity backed companies in partnership with HSBC UK bank, said Green. It will, however, have the ability to look at non-sponsored deals, although these are likely to make up a relatively small proportion of the overall deployment. The vintage will also be able to do slightly larger transactions, while remaining focused on the mid-market segment, he added.

The firm is able to get mandates and craft bespoke approaches for clients, giving them exposure to specific types of deals and businesses, head of institutional sales for the UK and Nordics Maria Ryan told Unquote.

Differentiated sourcing
Looking ahead, the direct lending team largely expects private credit investing to see good momentum against the current macro backdrop due to the combination of lower leverage, better economics and more lender friendly documentation, said Green.

The team is working in partnership with HSBC UK’s mid-market leveraged finance team benefitting from its established origination platform covering several regions across the UK, and therefore generating a differentiated level of dealflow for investors, he said.
The strategy is lower risk and defensive but targets high-growth businesses, which is an attractive proposition for investors, Ryan argues.

The second vintage will be offering GBP 30m to 120m in debt per deal, largely in the form of senior secured loans, said Green. It will focus on companies with EBITDA of GBP 10m-GBP 20m, although it has the ability to do deals for smaller and larger businesses where appropriate.

The strategy will continue to focus on the UK, while ensuring that portfolio remains diversified across the country. The regional bias in the portfolio is around 65% to 70% outside of London, said Green.

The strategy is sector agnostic but favours market segments with repeatable demand, as opposed to those displaying cyclicality in their revenues and profitability.

“That often means that we are being focused on certain sectors, perhaps more than others,” he said – namely, business services, IT services and software, as well as healthcare businesses and specialist manufacturing. “If a deal is attractive in terms of our general screening criteria, we'll still look at it and because our attachment point in terms of risk and leverage is lower than the general market, this opens out other opportunities for us,” he added.

With the first vintage now more than 80% deployed and a number of transactions set to close over the next couple of months, the firm is seeing strong dealflow into its pipeline and expects to start deploying capital from its second vintage in July. The firm is expecting to see dealflow pick up in H2 2023.

The first vintage will likely finish its deployment with around 40 deals in its portfolio, with a similar amount of transactions expected for the second vintage, said Green, to ensure diversification.

Structuring transactions “conservatively” will remain a priority for the second vintage, he added. The firm will typically offer between a third and a half less leverage than the wider private credit market.

Looking ahead, HSBC AM’s direct lending team is positive about the market environment and bullish that the businesses already in its portfolio should stand up reasonably well, thanks to its conservative approach, with lower leverage relative to the broader direct lending market.

Investor base expansion
The firm is at the early stage of the fundraising process for the second vintage and expects to grow its commitments going forward, said Ryan, without commenting further on the vintage’s target.

The amount secured so far for the second vintage has largely been committed by existing institutional investors in HSBC AM’s strategy, said Ryan.

Its LPs base is “quite diversified”, with UK-based insurance companies and pension schemes, while currently receiving a lot of interest from investors based in Asia, she said.

The firm has been having “very positive” engagement with existing and new clients both in the UK and Asia, and is expecting it to broaden its outreach into Europe in the second vintage, she added.

This development is consistent with the strategy’s first vintage and is in line with its expectations for its second vintage, she added. “We now have a track record and a wider addressable investor base and we’re starting to be much more proactive about broadening our investor base.”

As markets have evolved, “given where [interest] rates are, expectations for returns in the second vintage are higher than the first”, particularly in the short term, said Ryan, noting that the first vintage has delivered above expectations.

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