Alternative Credit Investor May 2024

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Private credit experts slam claims that sector does not offer higher returns

PRIVATE credit professionals have hit back at a recent report which claimed that private credit does not offer higher returns once fees and risks have been taken into account.

Last month, three academics published a paper, released by the National Bureau of Economic Research (NBER), which found that the risk-adjusted return on $1(£0.80) of capital invested in private credit funds is “indistinguishable from zero”.

The claim was based on an analysis of the risk-adjusted returns of private debt funds originated between 1992 and 2015, using the Burgiss-MSCI database.

However, industry professionals have slammed the research, calling it outdated and incorrect.

One private credit fund manager, who requested anonymity, told Alternative Credit

Investor that the 19922014 sample set “does not reflect the dramatic changes to the private credit market over the last 10 years.”

“Private funds today are much more focused on senior secured debt with lower fees,” the fund manager said. “They also discounted risk using public equity returns.

“In particular, the Cliffwater analysis –

which uses a much more recent sample set (2004 to 2024) and a more conventional risk measurement tool – shows approximately 600 basis points of annual excess return after fees.”

Cliffwater is an alternative investment adviser and fund manager which also conducts its own research. The firm’s chief executive Stephen

Nesbitt published a response to the NBER analysis, claiming that the paper suffers “at least four weaknesses”. These include the outdated time period, a lack of transparency in data collation, and an “inconsistent” approach to risk management.

Nesbitt added that “with a few exceptions, those managing private debt portfolios today are very different

ISSUE 93 | MAY 2024 HOT COMPETITION Flexibility in loan docs on the rise THE SWEET SPOT Opportunities in development finance >> >> 5 12 British Business Investments’ Richard Coldwell on private credit 16 >>
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The private credit industry is going through an evolution this year.

After years of rapid growth, the use of private credit solutions has begun to outstrip bank financing in certain segments of the market.

What was once a last resort for low-grade borrowers has now become an established and mainstream asset class in its own right.

For institutional investors, private debt is likely to be a consideration for most portfolios, while wealth managers and even retail investors are starting to tap into the attractive risk-return profile of the sector.

None of the above statements are unique to 2024, but what’s special about this year is that it is widely feted to be even better for the private credit industry.

A wide array of stakeholders expect fundraising conditions to improve this year – partly due to the decline of last year’s denominator effect.

And other pockets of the market, such as asset-based finance, are forecast to experience strong growth.

Of course, these promising conditions have not escaped unnoticed, and competition is hotting up – among fund managers as well as banks, who unsurprisingly want to claw back a piece of the action.

It will be interesting to see how the private credit industry adapts and flourishes amid improving market conditions and increased competition.


cont. from page 1

from pre-financial crisis managers, who often included public high yield and distressed debt into their private debt funds,” rendering the NBER data inaccurate.

Cliffwater concluded that “fees and expenses for unlevered private debt typically average no more than two per cent, giving a net, riskadjusted excess return equal to approximately four per cent.

“While most private debt funds use leverage to increase return, leverage will generally not change risk-adjusted excess return.”

Claire Madden, managing partner at Connection Capital, agreed that the 19922014 funds sample is “a bit before the maturity of the market”.

“In times of a fully functioning banking system, it may well have been the case that only sub-prime lends were available to private funds,” she added.

“That is absolutely not the case now.”

Other experts criticised the study’s risk-adjustment calculations, stating that private credit is a diverse market which cannot be generalised en masse.

The term private debt covers a range of finance solutions including direct lending, sponsor lending and mezzanine lending, each of which comes with its own unique set of risks and

returns. Furthermore, in the decade since 2014, major innovations have shaped the private credit market, making it more liquid, diverse and transparent than ever before.

“From the global financial crisis to date the industry has matured and lending by private credit funds is much more mainstream,” added Madden.

“The study seemed to suggest that the

One year rolling horizon returns for private debt from December 2019 to June 2023

credits were of lower quality because the debt funds were writing business that banks wouldn’t do.

“Private credit today operates in the same markets as banks – the creditworthiness of the borrower may be strong but the borrower requires something different from the lender such as more flexible amortisation, or a lighter covenant regime.

“Private debt funds are set up to provide this flexibility, banks are not.”

According to the Cliffwater Direct Lending Index, private debt earned 6.19 per cent in annual excess returns, risk-adjusted and gross-of-fee between 30 September 2004 and 31 December 2023.

Date One Year Horizon Return (%) Dec-19 6.4 Dec-20 5.5 Dec-21 32.2 Dec-22 9.3 Jun-23 7.3 Source: Preqin Pro

Lenders introducing more flexibility to loan docs to beat competition



competition amongst private debt funds in Europe is impacting lender protections.

Although cov-lite lending – a common feature of the largercap market – has not become prevalent in the middle market, there has been price erosion as well as an impact on documentation.

“A lot of the documentation changes that were made in 2022 and the early part of 2023 to the benefit of mid-market lenders, are starting to be clawed back by sponsors and borrowers as a result of this increased competitive environment,” said Marc Chowrimootoo, managing director at Hayfin Capital Partners.

He says he has seen competitors expand the list of adjustments and add-backs to EBITDA, with some including revenue synergies, among other things, and others including longer time periods for realisation. Hayfin Capital Partners has been trying to keep that period to 18 to 24 months while others have increased it to 36 months or longer.

In addition, the

percentage of add-backs is also expanding to, around 25 per cent now, with Hayfin fighting to keep it as low as possible.

Add-backs to EBITDA entail removing – or adding – operating expenses to create an accurate view of the business’ historical and future profitability.

“We’re still trying to be very disciplined in making sure for example that EBITDA add-backs are as limited as possible and are capped at an absolute sensible percentage,” Chowrimootoo explained.

“And we are still trying to hold the line on other things we care about, things which are core to the credit thesis, making sure debt incurrence levels are being set at sensible levels, being disciplined around the size of

committed acquisition facilities (CAFs) and the ability to move assets out of the group.”

Chowrimootoo has seen the size of CAFs increase over time, where one deal Hayfin did not participate in had three turns of EBITDA as the size of CAFs.

Another thing Hayfin has been pushing for is covenants that gradually step down to provide credit protection over time, but many of its peers have been offering flat covenants. Headrooms on loans have also moved higher from 25 to 35 per cent in 2022 to 2023, to 35 to 40 per cent this year.

According to Richard Olson, managing director at Lincoln International, given the depressed volumes in new deals there is much more

competition amongst lenders for those. Therefore he has seen more generous covenants, going back to where they were prior to interest rate hikes. While refinancing deals have trended to be slightly tighter, these are also moving closer to what is seen in newer deals, Olson said, as competition from the broadly syndicated loan market increases.

One positive note on the direction of covenants is the increasing prevalence of ESG margin ratchets. Chowrimootoo says he is seeing those more consistently now amongst peers.

“We actually think this is a positive development provided the KPIs selected, their definition and the reporting around those are sufficiently meaningful,” he added.

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P2P platforms report busy IFISA season

PEER-TO-PEER lending platforms and other alternative lenders have reported an uptick in Innovative Finance ISA (IFISA) inflows this year.

In the weeks leading up to the start of the new tax year on 5 April 2024, investors rushed to make the most of their annual tax-free investment allowance by topping up existing IFISAs and opening new accounts.

Rishi Zaveri, chief executive of consumer lending platform Lendwise, said that he saw almost double the number of subscriptions from the previous year.

Meanwhile Jacky Chan, head of investor relations

at Shojin, confirmed that the property lender saw a rise in IFISA investments ahead of the tax year deadline.

Nattalie Weeks, head of portfolio at Kuflink, told Alternative Credit Investor that the platform was “very encouraged by the strong investment flow we have seen coming to us over the last few weeks.”

“An uplift just before

the closure of one tax year is typical,” she added. “However at the start of the next, we would expect IFISAs transfers to level out.”

During the 2024/25 tax year, the IFISA market is expected to become more competitive as P2P lenders will be competing with open-ended property funds and long-term asset funds for IFISA money.

P2P lenders dismiss default concerns

DEFAULT rates will remain stable throughout 2024, despite concerns about the economy, peer-to-peer lending platforms have predicted.

The UK slipped into a recession during the fourth quarter of 2023, sparking concerns that borrowers may be unable to keep up with their payments.

However, a number of P2P leaders have said that default rates should remain relatively stable this year.

“This economic environment is not new,” said Paul Sonabend, executive chairman of

property lender Relendex.

“We have been exercising extreme caution in making loans ever since 2020. As such we anticipated the issues and have considerable headroom to cover delays in construction and sales.

“As house prices have grown over the period our developers have been selling at or above original valuations. We anticipate a small increase in crystallised losses this year. However, ironically these relate to loans made prior to 2020. Overall our loss ratio will have

Many P2P platform chiefs believe that the new IFISA rules will help to bring P2P lending into the mainstream as an investment option for individuals.

“The new rules that came into effect in April could make the IFISA market more dynamic and investor friendly, giving more choice to diversify the allocated allowance of £20,000,” said Kuflink’s Weeks.

“However, there still needs to be more education around the alternative space to encourage investment as most people aren’t aware of the alternatives to cash ISAs, where rates are still low.”

declined as a percentage of our loan book.”

Narinder Khattoare, chief executive of Kuflink, said that the key for lenders is to build strong relationships with their borrowers to get an early understanding of any challenges they are experiencing when moving towards their repayment.

“We encourage our borrowers to start working on their exit no later than three months before their exit date and we have a network of broker contacts we

can share with them if they need assistance with this,” he added.

“Finally, we are clear from the outset that we have a policy of not extending our loans, so our borrowers need to work on their exit with this clearly in mind.”

Rishi Zaveri, chief executive of Lendwise, noted that P2P platforms are well placed to weather the economic storm.

“The expected election does bring an element of the unknown, but defaults should remain stable as long as action to address these is taken promptly," he added.


Corinthia/Barings poaching scandal: Two months on

IT HAS been almost two months since Corintha Global Management poached Barings’ entire private credit team, in what was subsequently called “one of the largest corporate raids at an asset manager in years”.

The move sent shockwaves across the industry, and caused Barings to temporarily pause all new private credit investments while it worked out its next move.

Within a week of the news being announced, Bloomberg was reporting that private credit giants including Ares Management, Carlyle, Hayfin and KKR were

looking for opportunities in Barings’ loan book, and approaching buyout firms to see if they would like to take Barings out of the capital structure of their portfolio companies.

Barings has filed a lawsuit against Nomurabacked Corinthia.

As part of the lawsuit, Barings is seeking to stop Corinthia from poaching more employees and to block it from soliciting Barings customers. It is also claiming damages resulting from the team’s departure.

Additionally, Barings has taken legal action against its former employees Ian Fowler and Kelsey Tucker, who have

been accused of misusing confidential information to recruit Barings employees. Fowler is now co-head of global private finance at Corinthia, while Tucker is the firm’s chief operating officer.

Corinthia formally launched its operations on 15 March 2024, with the aim of generating “attractive risk-adjusted returns for investors by investing in private debt instruments while offering flexible financing for borrowers.”

Meanwhile, since the exodus of its private credit team, Barings has been focused on rebuilding.

In early April, the

company told investors that it plans to hire six new managing directors in North America and Europe to work on loan origination, according to Bloomberg sources. It is also believed to be hiring for two positions in portfolio monitoring. It has made a number of internal promotions to fill some of the vacated roles in its global private finance division, which has approximately $33bn (£26.5bn) in assets under management.

A new permanent investment committee has also been created, covering three key regions: North America, Europe and Asia Pacific.

New AIFMD poses leverage challenge for private credit funds

PRIVATE credit fund managers are adapting open-ended structures to avoid the leverage limits placed on them by the revised Alternative Investment Fund Managers Directive (AIFMD).

The revised EU legislation incorporates rules for loan origination funds for the first time, meaning that private credit fund managers will need to comply with stricter requirements.

Under the new rules, the leverage of closed-ended loan-originating alternative investment

funds will be capped at 300 per cent of their net asset value, while open-ended ones will be capped at 175 per cent.

Legal experts have told Alternative Credit Investor that fund managers are already adapting their open-ended funds to avoid the leverage limit.

Private credit fund managers often aim for 200 per cent leverage, so the 175 per cent limit means they could become uncompetitive in the market as they will be offering lower returns to investors.

Fund managers are currently in talks with lawyers about the ‘grey area’ of what constitutes an open-ended fund.

Some firms are switching to a run-off model rather than offering redemptions so that they do not count as open-ended, the experts said.

And some firms are

buying up CLOs and leveraging them so that they are not technically counted as a loan origination fund.

The European Parliament voted to update the AIFMD on 7 February and the text of the Directive was then adopted by the European Council later that month, before being published in the EU’s official journal. Member states have two years to adopt the rules in national laws and funds then have a further year to meet the additional data reporting requirements.


Are ELTIFs truly opening up to retail?

THE SECOND iteration of the European Long Term Investment Fund (ELTIF) structure has been heralded as a game-changer for the democratisation of long-term asset investing.

But industry experts have suggested that the new vehicle is not being used to target the retail market just yet.

The new EU rules, known as ELTIF 2.0, came into force on 10 January, with an aim of encouraging individual investors to put money into longterm, illiquid assets.

“ELTIF 2.0 is having quite an impact on the industry as there’s the possibility to extend access to private assets, including private credit, to retail investors,” said Mikhaelle Schiappacasse, partner at law firm Dechert.

“However, the challenge is for firms that have historically operated in the institutional investor space to transition to the retail investor space. For example, it’s quite quick in Luxembourg to set up a non-retail ELTIF but there’s a certain overlay

if you’re targeting retail investors which makes the set up process more time consuming.

“If you’re selling to retail investors you need to comply with MiFID requirements around dealing with retail clients and most private fund managers are not set up to do that, as they’re used to the lighter touch requirements of dealing with institutional clients.”

While fund managers may not be using ELTIFs to target retail investors, they still may be using

them to expand their distribution channels, Schiappacasse added.

“I think fund managers without a retail client base are using the ELTIF structure to market these funds to wealth management firm clients, because it allows them to have access to a broader, less institutional investor base,” she said.

ELTIF 2.0 is an update from the original ELTIF structure launched in December 2015, which was not very popular due to a lack of flexibility and limited range of eligible investments.

Recovery expected in development finance market this year


finance market is expected to bounce back this year, property experts have claimed.

Following a turbulent few years for the construction industry, a number of alternative property lenders now believe that the property development market is recovering, thanks to stabilising interest rates and lower inflation.

Daniel Austin, chief executive and co-founder at property lender ASK Partners, believes that a “very gradual” recovery will be seen in the property development market this year.

“It is going to take time for the deals that were done in the 2019-2022

period to get through the system,” he says.

“We have hit the bottom of the market but we need some real drivers to get us off the bottom. The next government needs to capitalise on this, incentivising development, and lifting planning restrictions.”

Meanwhile, Jacky Chan, head of investor relations at Shojin, said that high demand for

new housing and a lack of existing housing stock makes the UK property market particularly attractive for investors.

“We need around 200,000 new homes on top of what we have already,” Chan said. “So the fundamentals are really strong.”

Shojin recently reduced its minimum investment threshold from £5,000 to £1,000 to enable more retail investors to access the investment opportunities in the UK property market this year.

ASK Partners’ Austin added that the property development finance space has changed considerably over the past few years, but he believes that the market is now adjusting to

the new economic norms.

“We are in unprecedented times,” he said. “There are situations where sponsors have used half their dry powder to keep their positions alive but now are at a point where they are considering selling rather than putting good money after bad. They could sell and buy new at a cheaper price.

“No one can afford to sit and wait but we're not yet hearing of major distress stories. I think the market is evolving around the economic situation.

“The way the capital stack is now carved up is very different.”

To read more about property development lending, see page 12.

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The risks and rewards of P2P investing in 2024

Peer-to-peer investing has a more attractive risk-return profile than ever, as the UK’s largest P2P platform Folk2Folk explains…

PEER-TO-PEER investing will celebrate its 20-year anniversary next year, yet the landscape has changed considerably since Zopa launched its P2P offering in 2005. For a start, Zopa – along with many other P2P pioneers – no longer operates in the P2P space. In fact, a large number of P2P brands have fallen away over the past few years, either due to the pressures of enhanced regulation, or the cost of running a compliant business.

The market’s consolidation is just one of the ways in which P2P lending has changed in recent years. Here are just some of the risks and rewards of P2P investing in 2024:

• REWARD: Higher returns

We are still living in a highrate environment. At the time of writing, the UK base rate remained at 5.25 per cent, a 16year high. These higher rates have translated into higher returns for P2P investors. At Folk2Folk, for example, returns start from 8.75 per cent, an increase from 6.5 per cent previously.

• RISK: Possible rise in defaults

These rate rises also apply to borrowers, which means that across the entire P2P industry there is the possibility of a rise in

the default rate. Since the dawn of P2P, the industry average default rate has been around two to three per cent, and investors have been encouraged to diversify their P2P portfolios to minimise the risk of losses. Despite this heightened default risk, Folk2Folk has maintained zero capital losses for investors to date.

• REWARD: More lending opportunities

Banks have been pulling back from the lending market in recent years, which has created a funding gap for many business borrowers and property developers. This gap has been effectively filled by alternative lenders such as P2P lending platforms, resulting in more choice for investors seeking to back interesting British projects.

• RISK: Enhanced regulation

Overall, regulation is good for investors as it provides safety nets

and risk management tools that can help to avoid certain losses. But in the world of P2P, regulation often results in more administration for investors and platforms alike. New P2P investors are now required to fill out an appropriateness test to confirm that they understand the risks involved in alternative lending. These tests are unique to each platform, and can seem a little bit daunting to novice investors. If an investor continues to fail this test, they may not be allowed to use the P2P platform of their choice, so it is important to be well educated on the nuances of P2P investing before taking the plunge.

• REWARD: Supporting British businesses

This is a difficult time for the UK economy, and many British businesses are struggling to access the finance that they need to innovate and grow. Over the past few years, P2P lenders have been extremely supportive of these businesses, offering finance to business owners who would have otherwise struggled to find funding. Folk2Folk is particularly proud of the support that they have offered to the farming community over the years, thanks to their dedicated investor base who have provided an essential lifeline to this key market.


Filling the gaps

Is this the best possible time to invest in property development? Private credit funds and alternative lenders certainly seem to think so. Kathryn Gaw reports


development sector has been through the wringer in recent years. The global financial crisis of 2008-2009 upended the market, then a few years later Brexit came along to disrupt supply chains and slow progress on existing developments. In 2020, construction equipment was left to rust on incomplete building sites for months on end, until lockdown restrictions were eventually eased.

Since then, property developers have been battling with some of the highest interest rates that the market has ever seen, while bank funding has become increasingly hard to come by.

This has left a substantial funding gap in the landscape, which is quickly being filled by private debt funds and alternative lenders who are offering a different type of financing and reshaping the market in the process.

“With the retrenchment by traditional lenders and tighter restrictions, [property development] lending has become a more attractive proposition to the credit funds,” says Matthew Archer, director at finance broker Tapton Capital.

“Development loans secured by underlying assets have emerged as a more attractive opportunity. This trend, combined with the

competitive returns offered by such loans, has made lending a viable and profitable option for private credit funds, and it's been great working with them on some of our more unique projects.”

Private credit funds have deep pockets, and they are constantly seeking opportunities to invest their capital in suitable projects. According to Preqin data, the proportion of LPs targeting real estate debt – including property development debt – grew from 18 per cent in the first quarter of 2022, to 38 per cent a year later.

Gerard Minjoot, an analyst in research insights at Preqin explained that “real estate debt helps to hedge a portfolio’s downside risk while generating a steady income.”

Much of the focus on real estate debt funds to date has been around commercial property opportunities. But increasingly, private credit fund managers are turning their attention towards property development. This is due to a number of factors, including the quality of projects, rising investor

“ This is the sweet spot right now to deploy capital”

demand, and the possibility of cheaper financing on the horizon.

“Slowing inflation will help to manage costs and curb the trend of contractor insolvencies that we have seen over the last year,” says Laura Bretherton, finance partner at Macfarlanes.

“Real estate debt funds have seen the opportunity here as banks are even more cautious than previously in funding real estate development.

“Managing development facilities requires more active asset

“ Developers are bundling different properties or development projects together to create a more diversified and attractive investment opportunity for lenders and investors”

management of the loan from a lender, and certain managers are not set up and do not have the resources to manage the financing of large scale developments.

“Those managers that do are continuing to see an opportunity

to provide financing solutions for real estate development where bank finance is not available.”

Property developments are high-yielding investments secured against real assets, which makes them appealing

to many institutional and highnet-worth investors. However, development financing has always been considered more risky, and many traditional lenders have shied away from funding these projects, or have limited their


exposure in a way which manages their risk. This has only just started to shift in the past year.

“Over the last 12 months, we have seen appetite from debt funds for residential development (both for sale and private rented accommodation), logistics development and life sciences,” notes Bretherton.

These are just a few of the bright spots which have been identified by private credit funds in recent months. The prospect of lower interest rates in the near future has also stirred up excitement among investors.

The average construction project takes 18 months to two years to complete. In two years’ time, the general consensus is that interest rates will have fallen, and bank lending will have ramped up again, making it easier to refinance and exit certain investments. This has led many industry experts to conclude that this is the ideal time to allocate funds to this sector.

“Now is the time for investors to deploy capital,” says Jacky Chan, head of investor relations at Shojin.

“Over the past two to three months things have stabilised. Costs are not rising as quickly and inflation has normalised. For developers this is very helpful because they can accurately price in their bills cost.”

Chan has already seen a rise in the number of transactions taking place.

“People are buying homes again,” he says. “This is the sweet spot right now to deploy capital because

property prices have bottomed yet demand is still robust.”

Shojin operates in the midmarket space, funding property projects which are valued at under £60m. This is a key market for property developers, Chan

Alternative lenders have the opportunity to uncover the deals where there is growth potential”

says, as “the big private equity and private credit players are not interested in this segment because the deal sizes are too small so the fees don’t justify it.”

Private credit funds typically back developments worth £100m or more, leaving the small-to-mediumsized projects to alternative lenders such as Shojin, and peer-to-peer property development lenders such as CrowdProperty. As well as working with under-served borrowers, these platforms are

“ Smaller bridge lenders pick up the smaller end of the market and banks take the £100m plus, leaving the mid-range underserved”

unique in that they welcome retail money with minimum investment thresholds as low as £500.

By contrast, private credit funds work at a much larger scale, funded by multi-billion dollar institutions who might allocate £50m or more to a single project. By offering a range of options to a variety of investors, these non-traditional lenders are taking a growing share of the property development market, and they are already leaving their mark. In the absence of traditional

bank funding, these alternative lenders are innovating by offering more flexible solutions for borrowers, and grouping together similar types of deals to add diversity to their portfolios.

“Developers are bundling different properties or development projects together to create a more diversified and attractive investment opportunity for lenders and investors,” says Archer.

“This approach not only spreads the risk but also enables developers to leverage the combined value of their assets to secure financing on more favourable terms.”

Daniel Austin, chief executive and co-founder at property finance specialists ASK Partners, said that the rise in private credit-funded property development is not only due to bank retrenchment. Austin believes that borrowers truly appreciate the flexibility and holistic solutions that these alternative lenders can offer.

“We are seeing more core plus and value add opportunities which represent a higher return, which aligns with the risk,” says Austin.

“Many of the funds we work with are looking towards distressed debt and assets that can be secured at lower acquisition prices due to commercial landlords struggling with revaluations and margin calls.”

One of the key trends in property development financing this year is the rise of creative capital solutions spurred by increasing land values, development costs and the slower movement of legacy banks who take a very conservative approach to risk. This has made space for alternative finance providers to segment the market in new ways, in response to market demand.

For example, Tapton Capital has seen a number of transactions

across Europe within the prime serviced accommodation and the later living spaces.

“Developers are looking into innovative ways to fund their projects, such as joint ventures, mezzanine financing, or crowdfunding,” says Tapton’s Archer.

“Additionally, there is a growing trend of exploring different capital providers beyond traditional banks, including private equity firms, family offices, and even individual investors seeking to diversify their portfolios.”

Archer notes that banks do not generally lend against sites with speculative change of use plans, whereas alternative lenders tend to be much more open minded.

“Alternative lenders have the opportunity to uncover the deals where there is growth potential,” he says.

“But it takes time and specialist knowledge and it doesn't scale so easily which is why the banks aren't interested. We have found a sweet spot for loans between the £50-100m mark. Smaller bridge lenders pick up the smaller end of the market and banks take the £100m plus, leaving the mid-range underserved.”

For developers, these alternative lenders can offer a lifeline amid a challenging economic environment. Their cost of capital has increased, valuations have been in flux, and an uncertain macro-economic environment prevails.

If alternative lenders can offer flexible and affordable financing packages to these developers, they could carve out a profitable niche and tap into a lucrative lending market which is crying out for funding.


Addressing the SME funding gap

British Business Investments’ Richard Coldwell talks to Hannah Gannage-Stewart about supporting SMEs through the investor’s private credit portfolio

AS THE MAN AT THE helm of British Business Investments’ (BBI) debt fund portfolio, Richard Coldwell has a unique insight into debt finance for small- and mediumsized enterprises (SMEs).

Coldwell was there at the outset in 2012, when the global financial crisis prompted the coalition government of the time, led by the Conservatives' David Cameron and Liberal Democrats' Nick Clegg, to carve out an initial £100m for investment in small businesses.

After some successful early projects, BBI was established in 2014 as one of the commercial subsidiaries of the UK’s first development bank, the British Business Bank (BBB), which was primarily focused on investing in debt structures.

It brought together around £1.5bn of existing programmes and presented a solution for businesses that could not otherwise attract investment.

Then, much as now, private banks were retrenching from lending in what came to characterise the whole era as ‘the credit crunch’. The objective was to support alternative lending in a bid to plug the sudden bank lending gap.

“Our portfolio has broadly reflected the growth in the private credit market in the UK,” Coldwell says. “We invested in some first-round mid-market direct lending funds and some

of these teams are now raising their sixth and seventh funds.”

Back when those initial investments were made, the government accepted there was a need for investment in midmarket funds, but as time went on the feedback from politicians was that there was an additional need; to support smaller companies.

BBI was established to meet that need. It begun by funding asset finance providers, a couple of debt funds focused on smaller companies, and a £20m investment in Funding Circle, which is now a commercial lender but started in 2010 as a peer-to-peer lending

utilising international capital. At the smaller end, capital continues to flow less easily to structures that are supporting SMEs and lower mid-market companies.”

Now, the largest part of the BBI portfolio is credit funds. “We also provide structured capital where we provide capital to smaller lenders and we invest in some of the challenger banks, as well as investing on a small number of fintech platforms, but the largest part of what we do is in funds,” Coldwell explains. Those funds make up around 70 per cent of BBI’s balance sheet, with structured finance and platform

“ Our portfolio has broadly reflected the growth in the private credit market in the UK”

marketplace that enabled the public to lend directly to SMEs.

12 years on, BBI still has a £1.5bn portfolio and remains focused on SMEs. Coldwell says the business still has some exposure in the mid-market due to those early investments but does not make new investments there. “We continue to invest in a range of structures that support alternative lending, the nuance is that we are focused on the smaller end,” he says.

“While the broader alternative market has become established, and larger managers are now raising multi-billion funds and successfully

lending occupying the remaining 25 per cent. “It’s interesting that the mix of the initial £100m is still broadly the same as the portfolio that exists now”, he says, reflecting on an initial £100m allocation of capital that pre-dated the formal establishment of BBI.

While the BBI’s portfolio mirrors the mix of investments it started out with, Coldwell is clear that the variety of lenders within that has evolved. “'Funds' is a very glib description,” he says. “The only constant within that is that the fund is taking institutional capital on one hand, and lending in some


way to a company on the other.

“Alternative credit has prospered due to the bank retrenchment process, which is a structural issue. This seems likely to drive further growth in future years.”

Other parts of the BBB, he says, are primarily focused on policy issues, supporting businesses during the pandemic for example, or funnelling money to the regions.

“What BBI is trying to do is to deliver an appropriate riskadjusted return for government,” Coldwell explains.

“We are mindful that we are ultimately government owned, and we are only operating in parts of the market where capital doesn’t flow freely to companies. We seek to highlight the opportunities that exist for investors at the smaller end of the market. We are prepared to support first time funds for example but only where we are comfortable that we can get an appropriate return for that risk.”

Perhaps partly because the BBB, and its subsidiaries, were born out of the financial crisis,

Coldwell says it does not make investment decisions based on macro trends. Asked whether the protracted hike in interest rates or relative uncertainty relating to this year’s election influences BBI’s operation, he highlights the longterm nature of BBI’s investments, which are generally anything between three and 10 years.

“We have been an investor in private credit for a number of years now and so we are looking to maintain a steady investment pace, because we feel that that will give us the appropriate diversification across the different years of the economic cycle,” he says.

That said, Coldwell acknowledges that a key theme to emerge since the high interest rates that followed the pandemic is greater difficulty in fundraising across the board. With a balance sheet of approximately £1.5bn, BBI is a modest player in the context of the broader market but, among its target market of SMEs, Coldwell emphasises that it remains a significant and much needed entity.

It is an environment in which SMEs are likely to remain underserved, as fund managers building assets under management are unlikely to favour multiple small investments to smaller companies when the economies of scale are more favourable in the mid-market.

Does he worry that an incoming Labour government might curb operations? Coldwell’s sense is that, given markets don’t always work as efficiently as is ideal, governments of all persuasions will want to support the economy. And as the BBI has the ability to generate a commercial return while also achieving policy outcomes, it should be something that will continue to have cross party support.


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