A good market
The demand for more CLOs in Europe is rising with both old and new investors looking to join in this part of the market. While there are some concerns about the loosening of deal documents given covenant lite tendencies, there is still foreign investor interest in European CLOs from Asian investors, especially from Japan. Borrowers can enjoy more flexibility, although lower recovery rates may hit lenders when the credit cycle turns.
Why Japanese investors are interested
Japanese buyers have been involved in the US CLO market in recent years but were not in the European market since the financial crisis. With rising costs of swapping dollars to yen and the better rates for yen to euros, investors see the European market as more appealing.
The trend of stepping away from banks and moving towards direct lending is on the rise. Mid-market deals are up because in a world of low yields with traditional fixed income, direct lending funds offer an attractive alternative source of return on a risk-adjusted basis. Investors are showing interest in these less-liquid strategies.
The European direct lending market seems like it is here to stay since it has grown from almost non-existent to raising around US$22bn in 2017.
The trend of direct lending is also growing as regulations across Europe change. It is easier for businesses to source their capital from direct lenders as bank lending activity can be a nightmare of rules.
European banks have been hit with regulatory pressures to retrench and reduce loans to the mid-market. This is good news for CLOs and direct lenders as this will release more of the market share to them. Unlike in the US, direct lenders are not subjects to capital requirement guidelines so they can take on companies with higher leverage resulting in higher returns for investors.
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