U.S. investment group Ares has raised € 11bn for one of the world’s largest private debt funds, as lightly regulated alternative lenders step up attempt to supplant traditional banks and bond markets as a result of the pandemic.
The fund will be the largest of its kind in Europe, according to data from Preqin. It will lend money directly to mid-sized businesses in the region that want or need an alternative to the generally cheaper funding avenues of bank loans and bond markets.
This is the latest sign of a shift in power since the financial crisis, from investment banks to private equity groups, which are not subject to the 2008 regulations that have held back bank risk-taking.
The financial crisis and the regulations enacted in its wake “really made the banking sector shrink” and “made this type of credit less profitable for them,” said Blair Jacobson, co-director of European credit at Ares.
“Covid is probably the third step in this, because again, the banking industry will not have the easy task of dealing with Covid-related issues in their own credit books,” he said. “We don’t think they’re quite out of the woods yet either.”
Direct lending funds have attracted a flood of investors from pension funds and sovereign wealth funds seeking higher returns than those available in the public markets. Last year, Apollo Global Management and Abu Dhabi sovereign wealth fund Mubadala unveiled a direct lending joint venture that aims to lend $ 12 billion.
Worldwide, direct lending funds raised $ 82 billion in 2019, up from $ 7 billion in 2007, according to figures from Preqin. This facilitated larger transactions, such as a Refinancing of £ 1.9bn British insurance broker Ardonagh which Ares backed last year.
Direct lenders are free to take risks that banks would not take, often charging higher interest rates. As part of private loans, they are also able to negotiate more personalized financing arrangements with individual companies.
Many were on the verge of increased demand as bond markets froze at the start of the pandemic. However, the Federal Reserve’s decision to intervene directly in bond markets supported the system.
It even allowed some of the hardest hit companies, like cruise ship operator Carnival, to drop talks with direct lenders and tap bond markets rather.
The central bank intervention “took an opportunistic moment to put money to profit in parts of the market that generally did not come to private markets,” said Mike Arougheti, managing director of Ares, based in Los Angeles.
“There was an opportunity that was there for a little while, and that opportunity is gone. But the vast opportunity for lending in the middle market, or lending to companies that are unable to effectively access financial markets or that do not obtain capital from [sources], that has not changed.
The pandemic has prompted some companies to resort to private lenders because “there is a one-counterparty partnership mentality as you work in a tough spot, as opposed to the markets when you go head to head with a syndicate of institutions with agendas, ”said Arougheti.
The total capital of the new fund will be around 15 billion euros as Ares plans to use leverage to increase its firepower, a common practice in the industry.
Ares’ previous European direct loan fund, a € 6.5 billion fund raised in 2018, generated net returns of 5.8% as of December 31 without leverage, according to documents filed by the companies . Its predecessor, high in 2015, achieved a net return of 8.1%, according to the filings.
Like many direct lending groups, Ares has its roots in the 1980s, junk bond king Michael Milken and Drexel Burnham Lambert.
It was founded in 1997 by a group including former Drexel student Tony Ressler, who seven years earlier had co-founded the private equity group Apollo.