“A single person falls in love through Parship once every 11 minutes.” Thanks to extensive marketing, this advertising slogan for the online dating site is now familiar to Germans nationwide.
But very few singles are aware of the owner of Parship, the financial investor Oakley Capital. Even less well known is the Permira lending fund, which financed the acquisition of Parship by the U.S. investor. But funds like these, known as debt funds, have been sharply on the rise in the last 12 months.
It’s the attack of the shadow banks. Debt funds, which are expanding rapidly, exploit the problems of traditional banks and are increasingly challenging them for their business with small- and mid-sized companies, collectively known as the Mittelstand.
Unlike banks, debt funds operate beyond the scope of public perception and with significantly fewer legal constraints. This has enabled these funds to achieve the kind of growth that is now rare in an industry largely in crisis mode, as evidenced by the almost daily reports about major German lenders like Commerzbank and Deutsche Bank.
The numbers are impressive. According to an analysis by the Alternative Credit Council (ACC) and consulting firm Deloitte, the market for financing outside the banking world had grown to a mind-boggling $560 billion (€502 billion) by the end of July, compared to $440 billion for all of 2015.
“In addition to acquisition financing, credit funds are diversifying into new areas, such as real estate financing or classic financing of corporate investment projects.”
The United States is the single largest market. But the business in alternative loans is also enjoying wild growth in Europe. Between 2013 and 2015, these specialized funds collected about €31 billion in Europe, and credit funds now offer €38 billion in available funds in the European market. This is roughly half the volume of the European market for over-the-counter venture capital, according to calculations by financial data provider Prequin.
Credit funds have grown massively in the last three to four years, not just in Europe as a whole but also in Germany, where more and more providers are crowding into the market. “In addition to acquisition financing, credit funds are diversifying into new areas, such as real estate financing or classic financing of corporate investment projects,” said Frank Jung, managing director of DC Advisory.
Firms with especially ambitious plans include Blue Bay, Hayfin, Highbridge, ICG, Ares and Alcentra, analysts said. “These companies are all but unknown to outsiders, but we’ll be hearing their names more and more often now,” said one market player.
In addition, a growing number of well-known companies like financial investors EQT, Permira and KKR are capturing the market, lured by growth opportunities.
The boom was triggered by an expanded legal framework for debt funds. German financial regulator Bafin brought about deep-seated changes last year with an unwieldy administrative decision. The most important change is that credit funds can now lend directly to the so-called Mittelstand sector of small and medium-sized companies.
The banking lobby is horrified by the new competition. The managing director of the Association of German Banks, Michael Kemmer, said: “From our perspective, and in light of European regulation, the important thing is to formulate lending rules for credit funds that adequately account for risk, and that are comparable to the rules that regulate banks.”
Banks, he added, play “an important role as middlemen in corporate financing and allow for a holistic and ongoing customer relationship, which credit funds cannot provide to a comparable extent.”
A third of the assets of these anti-banks come from pension funds. The two next-biggest contributors are insurance companies and foundations, at 13 and 9 percent, respectively.
But this doesn’t interest the major investors behind credit funds. They are desperately seeking profitable investment opportunities for their customers, but there isn’t much to choose from these days.
There are growing fears that German stocks could be facing a downward correction after the leading index, the DAX, has been reaching record highs almost daily. At the same time, bonds are hardly offering professional investors any yield at all. In fact, investing in 10-year federal bonds actually costs them money. This is why pension funds, in particular, love credit funds and are investing money in them.
A third of the assets of these anti-banks come from pension funds, according to Prequin. The two next-biggest contributors are insurance companies and foundations, at 13 and 9 percent, respectively.
Private credit funds also play a key role in takeovers. In the first half of the year, they financed about 15 percent of the medium-sized deals of financial investors. Their share is likely to double in the medium term, estimates Dominik Spanier, Managing Director at Lincoln International, who also expects to see debt funds gain a growing share of the corporate lending market.
“Credit funds are especially likely to play a role either when the aim is to maximize leverage or the banks lack sufficient appetite for the risk involved in financing more complex transactions. In those cases, the higher costs of about 3 to 3.5 percent are justifiable, compared to a traditional takeover loan,” said Mr. Spanier.
The majority of funds active in Germany are still from the English-speaking world. But German financial institutions are also discovering the benefits of debt funds. “Examples include vehicles of banks like IKB or Lampe Bank, as well as non-bank funds like Rantum Capital,” said Mr. Spanier. Even Dekabank, as a fund service provider for German savings banks, has gotten involved and now has five debt funds, which have already exceeded the billion-euro level with €1.1 billion in assets. In addition to takeover loans and corporate financing, credit funds also offer loans for real estate, infrastructure and transportation.
The majority of funds active in Germany are still from the English-speaking world. But German financial institutions are also discovering the benefits of credit funds
Observers expect the market to develop in Germany the way it has developed in Britain, where credit funds are established players. “About 80 percent financing provided by credit funds relates to takeovers, but 20 percent already consists of direct corporate financing, such as for expanding business operations or investing in production,” said Janine Harion, Investment Director at Permira Debt Managers.
Her company uses credit funds to finance companies with earnings before interest, tax, depreciation and amortization (EBITDA)of €10-50 billion. Well-known companies are using the service. In addition to Parship, the Permira debt fund has issued loans to luggage manufacturer Delsey and popcorn maker Savoury & Sweet.
In the increasingly tough battle for customers, lenders are no longer sitting on their hands as credit funds make inroads into their business. Banks, including some in Germany, have started to fight back. “A number of banks have reacted to the growing competition with significantly more flexible financing structures, so as to protect their market share in the transactions business,” said Lincoln Managing Director Spanier. For instance, they are requiring smaller payments than usual and lowering their credit requirements.
But despite these efforts, Mr. Spanier believes that the rise of credit funds is unstoppable. Still, they will probably never become as well known in Germany as Parship.
Peter Köhler is a Handelsblatt editor in Frankfurt, reporting on banks, private equity firms, venture capital and corporate funding. Robert Landgraf is Handelsblatt’s chief correspondent for the financial markets. To contact the authors: email@example.com, firstname.lastname@example.org.