Private credit funds benefit from stricter requirements for banks

Frankfurt. Berenberg bank is one of the most experienced players in germany in the field of private credit funds. Over the years, the business area has developed into a segment worth billions of euros. The latest growth trend: financing through the credit funds in the real estate sector.

"The growth of the private debt asset class is unbroken and will also pick up speed in real estate," predicts tobias bittrich, head of corporate banking at the hamburg-based bank in an interview with handelsblatt. "This will already be ensured by the stricter requirements of bank supervisors in real estate financing, which will be tightened again in 2023 and will now also be partly substituted by loan funds here," explains the expert.

The german banks surveyed tightened their lending guidelines only slightly between april and june, according to the bundesbank. For private home loans, however, the tightening was more severe than at any time since the survey was introduced. For the third quarter, german banks also plan to take an even more restrictive approach.

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Berenberg banker bittrich is confident that institutional investors will remain loyal to private credit funds even with higher interest rates, because many professional investors such as insurance companies and pension funds have meanwhile built up sufficient expertise. "Even if interest rates for government bonds, for example, rise, the interest rate advantage of private loan funds will remain," bittrich says.

Yields between two and six percent

That is for example with flexible products the case: there the interbank rate euribor serves as basis plus a markup of for example four per cent points. "For all of our lending strategies in the different funds, the return is between about three and six percent after all costs. Trend to increase – also due to a rising reference interest rate," explains bittrich.

Today, the alternative real estate financiers also offer loans that map the total financing in one tranche, he says. Providers are very flexible and can go up to loan-to-value (ltv) ratios of 85 percent, for example, he said. The ltv value reflects the ratio of the loan amount to the property value. "We're planning our new real estate debt fund to be in the triple-digit millions by 2023, and it has the potential to be a billion-dollar business," bittrich believes.

The new banking regulations mean that there will be major changes for financial institutions in financing properties that produce little or no income, says david neuhoff, founder and CEO of linus digital finance. Risk provisioning is rising, which means banks will have to deposit more equity capital for real estate loans. This would make such transactions less attractive for the financial institutions or make such financing more expensive.

"In the case of existing properties, investment costs are expected to be high, especially with regard to energy refurbishments. In the office segment in major european cities alone, we expect to invest around 300 billion euros over the next ten years. Much of the gap here is being filled by alternative financiers," neuhoff says.

Fast-growing asset class for institutional investors

The rise of private debt funds for corporate and real estate financing has continued during the corona crisis, and so far there are no signs that the ukraine war will lead to a slowdown in momentum either.

According to TMF group's global private debt insights 2022 report, debt managers globally raised about $191 billion in 2021, up 12.1 percent from the year before. A good two-thirds of lenders to debt funds – mainly from the U.S. – want to increase allocation to private debt, 25 percent want to maintain exposure, and only 5.5 percent want to reduce.

A good two-thirds also expect a return of at least 7.5 percent, and a good 30 percent expect an interest rate of more than ten percent. Art penn, founder of U.S. Middle-market financier pennant park, also expects growing demand for financing from private providers in europe and germany. His company has lent a good 15 billion dollars to small and medium-sized companies in the USA.

"The private credit market away from banks is driven in no small part by high inflows into private debt funds. Their uninvested capital – the so-called dry powder – currently stands at 150 billion dollars worldwide," says randy schwimmer, senior managing director at churchill. The company is the investment specialist for private credit within nuveen – the asset manager of the U.S. Pension fund teachers insurance and annuity association.

More german borrowers

Schwimmer assumes that more and more german companies will also make use of private debt. Last year, for example, the computer retailer caseking and the air-conditioning specialist dantherm received such funds. Maturities of private debt investments would be around six to seven years on average. But typically, companies refinanced in half that time or were already repaying the loans by then.

Schwimmer does not yet see any negative impact from a potential recession. "With hundreds of companies in our portfolios and many billions of dollars invested since 2006, the default risks are widely spread. Even in the past three years, which have been challenging, we haven't had any defaults or losses from covid," says the churchill manager.

Currently, rising inflation is a challenge, and the resulting potential impact on future investments is being analyzed. "In general, we prefer defensive sectors such as business services, technology, software, healthcare and distribution. Historically, we've avoided more consumer-focused companies in retail, apparel and travel and leisure," schwimmer says. And they have never been involved in extremely cyclical sectors such as energy

Churchill can handle financing up to a maximum of $500 million, he said, and keeps a significant portion of it on its own books. Borrowers typically have cash flows between tens of millions and $50 million, he says. "We are very selective in our approach and reject about 95 percent of the investment opportunities that come our way," schwimmer said.