Deloitte M&A Event

Headline Verdana BoldDeloitte M&A EventThe development of direct lending in Europe and the Benelux13 December 2018

The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium 2

19:30 – 19:35 Welcome address

Speaker: Lieve Creten – Managing Partner Financial Advisory

19:35 – 19:50

19:50 – 20:15

20:15 – 20:45

20:45 – 20:50

Introduction

Speaker: Ivan Van de Cloot – Chief Economist, Itinera Institute

The development of direct lending in Europe and the Benelux

Speakers:

• Floris Hovingh – Head of Alternative Capital Solutions

• Sebastiaan Preckler – Head of Debt and Capital Advisory Belgium

Panel discussion: Relevance of Direct Lending for the Belgian Market

Conclusion

20:50 Walking Dinner

Deloitte M&A Event – The development of direct lending in Europe and the Benelux

Agenda

3The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium

Deloitte Debt & Capital Advisory

Introduction

Ivan Van de ClootChief economist Itinera InstituteProfessor of Economics Antwerp Management School

M&A EVENT13 - 12 - 2018


“ To show, to defend and to build roads for policy reform towards sustained economic growth and social protection, for Belgium and its regions.

”

Itinera Institute

Independent “Think-tank”

Based on facts and figures – international comparisons

Long term


MONETARYPOLICY HYBRIS?


Monetary policy pushed to the limit

Source: Global Financial Data


Mind this concept: excess elasticity

Excess elasticity = the inability to prevent the build-up of financial imbalances, or outsize financial cycles, that lead to serious financial crises and macroeconomic dislocations.

Central banks try to stimulate the economy by lowering rates and QE. Authorities are not able to put a brake on excess credit creation before imbalances and speculative bubbles have developed


Former Fed Chair Janet Yellen just joined the chorus of warnings about $1.6 trillion ‘leveraged loan’ marketHighly leveraged loan deals have grown as a share of new corporate issuance in the United States and Europe…

Lost ProtectionShare of new loans that are covenant lite, giving lenders less control


Low rates have inflated equity valuations


Increasing disintermediation, but corporate funding still heavily bank-reliant in Europe


Pecking order theory (demand side)

Pecking order

• Internal financing

• Debt

• External equity injection

1

Financing cost / control

2

Agency and Asymmetric information

Young/innovative NFC (collateral?): quality assessment

3

The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium 13Source: Deloitte CFO Survey – Outlook 2018 Edition

Debt capacity available to finance further growth

(capex, M&A or working capital) or fund a dividend recap

Bank borrowing is the most favoured funding with

non-bank corporate debt like bonds as a solid

second


Drivers alternative finance

• Restrictions traditional supply

• Awareness too heavy bank reliance, need diversity in ecosystem

• Entrepreneurial economy

• Financial technology

• Complementary role

Macro-prudential side

• Be aware of trigger points (leverage, covlight)

• Need for transparency and literacy

• Monitor what will happen in rising interest environment

Potential

• Strategy of reducing reliance on bank lending in Europe

• Macroprudential perspective

• Supports alternative finance

• More diversification of the financial ecosystem

• Separating the wheat from the chaff

On balance

• Alternative lending in Belgium still underdeveloped

• Valuable potential

• Finding its place (niche): possibly more complex deals, transforming acquisitions, infrastructure, longer term…

• Only complementary to healthy bank lending



Introduction


The Belgian team at a glance


66 funds participating

Over 7,500 recipients

Deloitte AlternativeLender Deal Tracker

Global coverage

DirescoStaple financing

2018

VK GroupStaple finance

2017

Van ReuselStaple financing

2018

Transport VervaeckeAcquistionFinancing

2017

IntersigRefinancing

2017

CheopsAcquistionfinancing

2018

22 dedicated Debt & Capital Professionals

Global resources and execution expertise: 200 professionals in over 30 countries

Track record: over 100 deals closed in the last 12 months with combined value of €10 bn

Over 40 alternative lender transactions in last 24 months

Market leading global team

… which is part of the global Deloitte Centre of Excellence

A strong local Debt & Capital Advisory team …

Ben LeonardConsultant

Alexander OlgersPartner Debt & Capital Advisory EMEA

Sebastiaan PrecklerHead of Debt & Capital Advisory Belgium

Jan BaetensManager

The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium 18Alternative Capital Solutions Event 18

Alternative Capital Solutions focuses on raising non–bank Alternative Debt for private companies

The UK team at a glance


A dedicated team

Focus

PE Acquisitions

Type of transactions

Corporate Acquisitions

Growth capital

Dividend recap /

Minority take out

Refinancing bank debt for

high levered companies

Floris HovinghHead of Alternative Capital Solutions


The rise of Direct Lending

A brief history of private credit

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Mood's Global Spec. Grade LTM Default Rate US Federal Funds Rate Direct Lending raising Distressed capital raising

18% Fed Fund Rates

Nikkei Crash

Sovereign debt crisis

Black Monday

2nd Real estate crisis

Brady bonds

Asian liquidity

crisis

LTCM Default

Tech/Telecom

Bubble

Enron & Worldcom

Fail

Credit Crunch

Financial crisis

European debt crisis

QE 1,2 & 3

Oil pricecollapse

Chinaslows

ECB QE

Source: Bloomberg/Moody’s


Current European Leverage Loan Debt Markets


,00x

1,00x

2,00x

3,00x

4,00x

5,00x

6,00x

7,00x

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD

9/18

First Lien/EBITDA Second Lien/EBITDA Other Debt/EBITDA

5.38x

1. Leverage multiples continue to increase ..

0%

25%

50%

75%

100%

€0B

€10B

€20B

€30B

€40B

€50B

€60B

€70B

2007 2008-

2011

2012 2013 2014 2015 2016 2017 YTD

9/17

YTD

9/18

Cov-lite volume

YTD -89%

3. ... borrowers are securing more covenant flexibility ...

0%

10%

20%

30%

40%

50%

60%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 LTM

July

'18Retained Equity / Vendor Financing Contributed Equity

4. ... but lenders are securing higher levels of equity

contribution

2. ... institutional pricing remains tight ...

200bps

300bps

400bps

500bps

600bps

okt

05

jul

06

apr

07

jan

08

okt

08

jul

09

apr

10

jan

11

okt

11

jul

12

apr

13

jan

14

okt

14

jul

15

apr

16

jan

17

okt

17

jul

18

The debt markets have returned to pre-crisis levels of aggression, but there is little evidence for overheating impacting appetite of lenders to continue to lend

Headline summary of European debt markets

Source: LCD comps – liquid European transactions


99,

99,2

99,4

99,6

99,8

100,

4Q17 1Q18 2Q18 3Q18

4 6 4 5

33

4 2 17 4

9

3025

19

3038

1

14

48

109

131

0 07

14 13

3643

52

74

133

54

0

25

50

75

100

125

150

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 YTD9/18

Flexed Up Flexed Down

-60%

-40%

-20%

0%

20%

40%

jul/16 sep/16 nov/16 jan/17 mrt/17 mei/17 jul/17 sep/17 nov/17 jan/18 mrt/18 mei/18 jul/18 sep/18

Flex down Flex up

1. Original Issue Discount (OID) is widening …

3. ... and more deals are being flexed4. ... a trend that accelerated in recent months

99.41

3,20%

3,40%

3,60%

3,80%

4,00%

4,20%

4,40%

320

340

360

380

400

420

440

okt/17 dec/17 feb/18 apr/18 jun/18 aug/18

Avg TLB Spread Avg Yield to Maturity for TLB

2. ... and margins increasing …

Early indicators that there is a supply/demand imbalance and deals are being structured to make them attractive

There is evidence that market appetite for pricing may be starting to turn

Source: LCD comps – liquid European transactions


Direct Lenders – why is this relevant for you?


Current competitive bank lending landscape might not be sustainable:

Banks continue to be a key source of funding for strong credits, however, have constraints (Basel IV etc.)1

Financial intermediation outside banking sector (European Capital Markets Union) diversifies your credit supply.2

If you are looking for:

i. Higher leverage

ii. Increased covenant headroom

iii. Bullet debt structure

iv. Speed of execution

v. Deployment in scale

3

Other drivers that will accelerate the change:

i. Foreign buyers (PE) using direct lenders to gain competitive advantage over local buyers

ii. Larger sell side processes will involve direct lenders to maximise price and speed of execution

4

How can you take advantage of direct lenders:

i. Create competitive tension between structures (e.g. bank vs alternative structure)

ii. A partner in buy and build strategy

iii. Funding of unusual or more difficult sectors

5

• “Alternative Lending” / “Direct Lending” / “Private Lending”

• Increasing trend in EU (still moderate in Belgium) yet due to risk appetite and stringent regulation on banks

• Direct Lenders consist of c. 85 non-bank institutions with different strategies

• Funds have structures comparable to PE industry with 3-5 year investment period

• Limited partners in debt funds are typically insurance, pension, private wealth, banks or sovereign wealth funds

WHAT IS IT?


The Direct Lending market


4. Drivers of Direct Lending growth

Increased regulation (e.g. Basel III)

Increased focus by commercial banks on larger clients

with strong track record

Low yield environment attracts pension/insurance funds

to this asset class

1. Thesis (US leveraged mid-market)

0%

20%

40%

60%

80%

100%

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Bank funding Non Bank fundingSource: S&P CapitalIQ - LCD

3. Direct Lending Deal Completion

145

231

271 277

376

188

0

100

200

300

400

2013 2014 2015 2016 2017 H1 2018

Deals

Source: Alternative Lender Deal Tracker

2. European Fund raising (c. $40bn raised in 3 years)

$14,2 bn $18,3 bn

$6,8 bn

$29,1 bn

$8,5 bn

19 21

17

33

16

0

10

20

30

40

0

10

20

30

40

2014 2015 2016 2017 2018

Q1 Q2 Q3 Q4 Number of funds

Source: Alternative Lender Deal Tracker


Senior Direct Lending fund raising focused on the European market


• Structurally the market is increasing, however fund raising dependent on macro-economic events

• Increasing number of funds

• Increasing size of funds across the board and introduction of mega-funds (+€5bn)

Senior: How much funding has been raised by which Direct Lending managers?

ICGSDP1

€1.7bn

ICGSDP2

€3.0bn

ICGSDP3

€5.2bn

The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium 27The development of direct lending in Europe and the Benelux 27

What are the private debt strategies?


Current Private Debt Strategies:

1. Mid-cap Private Placements

2. Traditional senior debt

3. Unitranche

4. ‘Story credit’ unitranche

5. Subordinated (mezzanine/PIK)

6. Growth capital

7. Structured equity

1

2

3

4

5

6

7

1

2

Marg

in

2%

0%

4%

6%

8%

10%

12%

14%

16%

18%

20%

€50m €250m €300m€0m

Growthcapital

Structured

Equity

HoldcoPIK

Mezzanine

‘Story credit’unitranche

Unitranche

Traditional senior debt

Mid-cap private placements

€100m €200m

Scarcity of Financial Solutions

Debt size

3

4

5

7

6Scarcity of FinancialSolutions

New senior products approach the gap at 5%:

1) Targeting larger senior deals with lower risk return

2) Direct lending asset class becoming mainstream and

seeing significant in flow from fixed income investors

with lower yield requirements

3) Leverage applied at fund level reduces borrowing cost

1

2

3

The development of direct lending in Europe and the Benelux© 2018 Deloitte Belgium 28The development of direct lending in Europe and the Benelux 28

Who are the Direct Lenders?


Trends

Different backgrounds of Direct Lenders:

• PE

• Mezzanine

• Distressed

• Fixed income investors

• Pension funds

Melting pot of backgrounds resulting in different products & strategies

Criteria for success:

• Strong origination capabilities

• Expertise in credit

• Portfolio management

Speed of adoption varies across countries

581

14

35

10

65

38249

162

19

73

21

2418

11

Other European jurisdictions: 29

17


Typical debt structures in the mid-market


Note: the structures and pricing presented are indicative and only for illustrative purposes

E + 50-300bps E + 375bps (excl. mezz)

E + 581bps E + 675bps E + 815bpsE + 513bps

Weighted Average Cost of Debt (WACD) – Based on mid-point average range

Stretched leverage Flexible covenants Greater role for bank Reach more liquid part

of unitranche market

Higher pricing Intercreditor/AAL

Stretched leverage Flexible covenants Lower equity

contribution No Intercreditor

Higher pricing

Increased leverage Club of relationship

banks

Low leverage Shorter tenor

(3-5 years)

Lowest pricing Relationship bank Bullet RCF Modest fees

Restrictive terms 2-4 covenants c. 30%-40% amortising Relatively high fees

Stretched leverage Only Leverage Cov. Lower execution risk Bullet debt Buy-and-build friendly

Higher pricing Need RCF lender

Pros & Cons per structure

Stretched leverage Flexible covenants One-stop shop solution Speed of execution Relationship lender

Higher pricing

Note: In the Belgian Mid-Market, pricing can even be more aggresive (<300 bps)

Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity

Mezzanine(5-6% cash + 5-6% PIK)

Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity


Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity


Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity


Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity


Senior debt (Bank)

Unitranche (Fund)

HoldcoPIK

Equity



Zooming in on Belgium


Raising concerns on “shadow banking"

... Zooming in on Belgium

Source: De Tijd / L’Echo – 2017 & 2018


Belgian authorities started to monitor the risks related to shadow banking

.. Zooming in on Belgium

Findings on risks related to shadow banking, as reflected in the Report on Asset management and Shadow banking”, are relatively comforting:

• Total BE “shadow banking” activity is limited to €147 bn at the end of 2017 (+15%);

• Systematic risks are observed to be mitigated by several lines of defense;

• Interconnectedness to other financial sectors is mitigated by risk management and supervision at the level of the financial group.

,0

50,0

100,0

150,0

201720152014 2016

Source: NBB calculations based on NAI data.

Belgian shadow banking sector according to the narrow concept of the FSB (in €bn)

• Wider diversification of funding sources

• Increased loss absorption capacity of the economy

• Potential efficiency gains in capital allocation

• Opaque financing flows;

• Increased liquidity risks; and

• More extreme leverage positions

Concerns Value added

The Belgian shadow banking sector is delineated by the FSB definition as “credit intermediation that involves entities and activities outside the regular banking system”

FSMA and NBB provide joint effort to monitor non-bank intermediary developments

Source: FSMA – “Rapport over asset management en schaduwbankieren” – 25/10/2018


Moderate increased activity is driven by flexibility, higher leverage and longer tenors


Cumulative number of deals per country

0

50

100

150

200

250

300

350

400

Q4 12 Q2 13 Q4 13 Q2 14 Q4 14 Q2 15 Q4 15 Q2 16 Q4 16 Q2 17 Q4 17 Q22018

Belgium Netherlands Luxembourg France Germany

Direct Lending in Belgium

• Belgium does not reflect the same deal growth over the last quarters compared to surrounding countries.

• Corporate lending in Belgium is still dominated by attractive bank lending.

• Nevertheless, direct lending is observed in LBO, real estate and infrastructure financing.

• Deal types benefit from cov-lite structures, higher leverage and longer tenors.

• Increased amount of active players on Belgian territory, with attractive offers of local players.

Source: Deloitte Alternative Deal Tracker Autumn 2018 | Trends – “De schaduw over het nancieel systeem” – 28/11/2018


Examples of alternative capital

providers active in Belgium

The increased activity is driven by an growing range of active players


Direct lending in BelgiumA cumulative of 21 direct lending deals were executed in the region

21Funds presence increaseNotable deal in Belgium are:

Belgium


Conclusions


Conclusions


Direct lending in Belgium is expected to gradually catch-up with the rest of Europe1

Banks’ approach to working with direct lenders varies by situation they compete, work together or distribute2

Despite the recent increase in institutional pricing it is still a borrowers market and for sure in Belgium with domestic banks still competing heavily for LBO lending opportunities.

However, pendulum expected to shift driven by higher central interest rates, reduction in quantative easing, geo-political uncertainty and changing lending of Belgian banks

3

Direct lenders do not follow the same rules as banks in relation to capital requirements

Although Direct Lending is still small compared to the Belgian banking sector, there are increased concerns on “shadow banking”

However, studies show that:

i. Direct lending funds fall under the Alternative Investment Fund Managers Directive (Directive 2011/61/EU)

ii. Systematic risks are mitigated by several liquidity management tools such as closed ended funds (c. 70%) types, lock-up periods and asset eligibility rules.

iii. Direct lenders use no to limited leverage (up to 1.5x and 55% do not use leverage at all)

4

Expected approach to next phase of restructurings with direct lenders during the next downturn:

i. Likely to be supportive through difficulties because any loan write-down impact portfolio returns in a concentrated loan book

ii. When in default will price risk on market terms

iii. The mainstream direct lenders will look for consensual restructurings so as not to tarnish brand and therefore jeopardise their business model

5


Panel Discussion


Deloitte M&A Event – The development of direct lending in Europe and the Benelux

Panel discussion

Floris Hovingh

Deloitte UK

Head of Alternative Capital Solutions

Sebastiaan Preckler

Deloitte Belgium

Head of Debt and Capital Advisory Belgium

Filip Lacquet

PMV

Group Manager Corporate Finance

Mattis Poetter

BlueBay AM

Partner Private Debt Group

Moderator

Ivan Van de Cloot

Itinera Institute

Chief Economist

Event Panel


Conclusions

Deloitte M&A Event

Documents

Transcript of Deloitte M&A Event