As in the sovereign and corporate bond markets, private debt valuations have risen sharply. “However, by focusing on the lower end of the middle market, we have been able to maintain spreads,” said David Bouchoucha, CIO of Private Debt and Real Assets at BNP Paribas Asset Management, in conversation with Fondsnieuws, Investment Officer Luxembourg’s sister publication.
BNP Paribas AM offers a wide range of solutions in the private debt market. The French asset manager not only finances companies, but also real assets such as infrastructure and real estate. Following the partnership with Dynamic Credit, it is also active in the mortgage market and the assets under management have grown to more than EUR 20 billion.
When it comes to private loans to companies, both the top and the bottom of the market are covered, said Bouchoucha (photo). “For example, we offer leveraged loans to larger companies that typically have an EBITDA of EUR 100 million to EUR 150 million. Here we are a major player in collateralised loan obligations, where we bundle leveraged loans and offer them to our clients.”
Direct lending
BNP Paribas AM is also active in direct lending to small and medium-sized enterprises. “We have a successful direct lending strategy in Europe with senior loans to smaller companies with EBITDA typically between EUR 5 and 15 million. This lower segment offers interesting diversification opportunities for investors, as most private debt funds are focused on the higher end of the market”’ said Bouchoucha.
“Due to our exclusive partnership with BNP Paribas, we have access to attractive industrial companies in France, Belgium and Italy. But we also have relationships with other banks. We also focus on somewhat larger middle market companies with an EBITDA of around EUR 50 million, for example with our US middle market loan strategy.”
Across all direct lending portfolios, the focus is on the lower end of the middle market with an EBITDA of around EUR 10 million. According to Bouchoucha, this does not mean that the risk profile compares unfavourably with an average private debt fund. “On the contrary, in most private lending funds we focus entirely on senior secured loans with a relatively low leverage of usually 3 or 4 times EBITDA. On average, the loans have a BB credit rating, one step below investment grade.”
Defaults
Since the launch of the European SME strategy in 2017, the asset manager has lent to 150 companies. “Among this group, there are no bankruptcies as yet and only a few companies we are monitoring extra closely at the moment. Despite the negative impact of the corona crisis, most companies are holding up well and leverage has not increased, underlining the defensive profile of our investment strategy.”
Given the support from governments and central banks, default rates are historically low. Once that support diminishes, Bouchoucha said he expects more companies to run into financial trouble. “But as the economy is recovering strongly at the same time, we do not see a marked increase in defaults in our portfolios. We also remain cautious on sectors that are vulnerable to lockdown, such as retail, hospitality and leisure. Our focus is on industrials and defensive sectors such as information technology, healthcare and agrifood.”
Profit margins
With inflation currently high, companies’ profit margins risk coming under pressure. The private debt team has therefore been monitoring the inflation-sensitivity of companies for some time and regularly charts this with stress tests. “We see that many smaller companies in our portfolios have a strong market position and therefore the necessary pricing power”, explained Bouchoucha. “A large number of them are active in the acquisition and merger market and are therefore increasing their market share. Of course, there are also companies that cannot raise their prices as easily and will probably see their profits come under pressure. But the drop in profits is not such that the ability to pay is significantly worsening.”
The valuations of most listed liquid investments are on the high side and risk spreads on bond markets have fallen sharply. Valuations in the private debt market have also risen across the board, said Bouchoucha.
“Yet we have been able to maintain spreads thanks to our focus on the lower end of smaller companies. Valuations here are much better than at the top end of the large private loan market, where there is a lot of money from private debt funds chasing scarce investment opportunities. That has pushed down spreads on loans to larger companies.”
Bouchoucha said BNP Paribas AM’s focus segment has less competition. “We are also proactive and responsive to SMEs’ need for long-term financing, so we can generally negotiate higher margins. Moreover, private debt investors still receive an illiquidity premium of 150 basis points on top of the usual yields on comparable listed high yield corporate bonds. This keeps the category an attractive alternative to liquid fixed-income securities.”