A Review of European Direct Lending (Second of a Series)

Burger King isn’t just selling Whoppers any more. Last week the second largest burger giant began serving hot dogs at all its locations year-round. “We’re applying sixty years of flame-grilling expertise,” said Alex Macedo, President of North America. “We also have to chop the onions a little differently,” he added.

The thesis regarding opportunities today in European debt is reminiscent of this fast food story. Why shouldn’t investors think about private credit overseas the same way they think about US loans: isn’t it the same grill, just different meat? Or perhaps there’s a reason there are no national hot dog chains.

Turns out there are fundamental differences between the U.S. and European markets. One is the way each developed alternative lending. The disintermediation of regulated U.S. lenders by non-banks has been going on for twenty years; in Europe that process only restarted immediately post-credit crisis (see Chart of the Week).

“People don’t realize that Europe is the much more efficient bank market for loans compared to the U.S, which is controlled by institutions,” one leading UK credit provider told us. “We’re beginning to see a shift as leverage comes down and regulations go up,” he continued. “But banks still hold sway in many regions.”

This is particularly true for the middle market. “Smaller deals – below €25 million ebitda – are attracting bank attention,” another private fund head reported. “Libor spreads are dropping, and floors are falling away,” he said.