News Analysis
Direct lending securitisation faces barriers
Lines of credit to European direct lending firms, which borrow from banks and typically lend to middle-market firms, could be ripe for securitisation. However, the securitisation of these funding lines would bring added regulatory scrutiny and rating agency involvement, which would not be welcomed by all corners of the direct lending industry.
David Quirolo, partner at Cadwalader, Wickersham & Taft, explains the rationale for European banks: "The main motivator behind banks looking to securitise the direct lending channels is to more broadly syndicate the facilities to a wider number of investors. If these facilities are securitised and a rating is obtained, this may widen the investor universe. Additionally, they can also free up their balance sheets."
Graeme Delaney-Smith, md at Alcentra, feels that while direct lending securitisation could happen in Europe, it would be more likely to appear first in the US where the direct lending and middle-market sectors are more developed. He says: "I am not saying it will not happen but there are specific issues right now that make it unlikely in the short term."
Delaney-Smith continues: "We are late in the credit cycle and we are in an unstable geopolitical climate. It could perhaps happen once the direct lending sector has more time to mature but this could take 10 years. We have seen banks disposing of balance sheet positions but I am not sure that securitisation is better value at the moment than simply selling their loan books."
Quirolo adds that the process may face certain hurdles, particularly in the pursuit of ratings that go along with securitisation. "Rating agencies have a number of requirements that direct lending funds would have to comply with in order to get certain ratings. This could prove challenging for them and is not necessarily something they want to do."
There are also questions about the liquidity of such a product. Delaney-Smith suggests that middle-market lending benefits from being an illiquid asset class, something that might change due to securitisation.
He adds: "At the moment, if we undertake an investment, nine out of 10 times we are sole owner of the paper. We can sit down with the firm and move quickly and you do not necessarily want to have a large number of buyers on one loan as this adds to the complexity. You can pay a higher price for illiquidity but it works with direct lending."
Additionally, while investor appetite is strong in Europe for middle-market loans, he does not think that investors are seeking this in a structured format. Furthermore, investors may also not welcome the extra scrutiny that is involved in securitisation.
Delaney says: "Investors are looking at investing where they can get cash yield. What they do not want however is for the rating agencies to step in and, due to the restrictions imposed by them in order to get certain ratings, the cash being turned off."
Quirolo agrees that the end product would have to meet the same regulatory standards as a regular securitisation, which may not suit direct lenders. Delaney-Smith adds that direct lending benefits from less regulatory oversight than the CLO sector and this helps ensure the direct lending process is more streamlined.
Regardless of the hurdles to such a direct lending securitisation model emerging, it is generally agreed that it could happen, if not in the short term. Quirolo concludes: "While it is too soon to say about the timing of such a product, broader syndication of these loans is already happening but just not yet in a securitisation format - it is therefore not a huge jump to suggest that the loans could be securitised to open up the investor base further."
12/09/2017 16:07:21
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