Ares closed the new fund last week. With €4bn of leverage on top of the limited partner capital, its €15bn of firepower towers above the largest incumbent funds from the likes of Alcentra, BlueBay, Pemberton and Ares itself, which have so far topped out at €6.5bn.
At first glance, Ares’s success appears to be a vote of confidence for the nascent asset class. European direct lending only truly emerged in 2011 and 2012, years after its older sibling in the US showed how the market could eat into bank lending.
As much as $200bn has been raised by Europe-focused credit funds since then. But while US direct lending faced a financial crisis in 2007 and 2008, European direct lenders accrued all that capital without having witnessed a full credit cycle.
When the coronavirus pandemic struck Europe in March last year, there were fears about how the market would cope — the middle market being precisely where crises are usually expected to hit hardest.
The Covid-19 crisis was different to the financial meltdowns that had gone before it. On the one hand, governments were better prepared to roll out generous stimulus packages, which have proved to be a massive help to European mid-caps. But on the other hand, rapid lockdowns and travel restrictions meant that some firms’ earnings dropped to zero overnight.
Portfolios that were exposed to retail, travel or hospitality fell into the deepest difficulties. In some cases, injecting fresh capital into a business or giving a debtor a lengthy covenant holiday allowed them to muddle through.
In some instances, private debt funds took ownership of struggling borrowers. Partners Group, for example, converted its £100m-plus unitranche creditor position in restaurant business Côte Brasserie into equity in September, as Côte’s former owner, BC Partners, exited the business.
Sometimes, the problems have been overwhelming. In the UK, direct lenders such as Alcentra and Permira are licking their wounds after having to write off investments in retail chains like Debenhams, Caffè Nero and Paperchase, which have either gone through insolvency proceedings or are being liquidated.
This does not point to a systemic problem in direct lending. In fact, most direct lenders say this has been their busiest period to date, with the pandemic prompting a renewed retreat of banks away from making middle market loans.
What the crisis has done is give would-be LPs a new way to differentiate between direct lenders on the basis of their track record of running a fund through a crisis. While no major fund has ended up in existential difficulties, portfolio managers that sidestepped debt-for-equity swaps and insolvencies may well benefit from enhanced demand, while the others might have some explaining to do.
As one prominent European direct lender, who did not want to be named, told GlobalCapital: “There are some investors who came into the asset class years ago and picked three managers from different funds. Will they continue to back them? That’s a big question mark.”