13.04.18

Snapshots was listening to the excellent song “Blind Faith” by British drum and bass duo Chase and Status. It reminded us of the blind faith structured credit teams put into their pricing models in the run up to the financial crisis.

Direct Lending

It is hard not to think there is some blind faith evident in the direct lending market.  Direct lending is a topic that seems to come up in nearly every client meeting we have.   Huge amounts of capital are being raised in this sector.  The reason is obvious.  New Basel regulations mean that corporate lending is now a capital heavy lending activity for banks.  Funds are being set up at a record pace to disintermediate the banks and lend to mid-market corporates that do not have access to the capital markets.

However, we question the integrity of some of this lending.  Direct lending is a post crisis asset class with little historic default and recovery data and smaller corporates can have very volatile EBITDA streams.  Some direct lending portfolios have lumpy exposures and do not benefit from diversity.  Enforcement of security across European jurisdictions can be an expensive and a long drawn out process.  Ultimately, it is very easy to lend money; it is more difficult to recover it.  We also note that some listed direct lending firms are starting to trade at discounts to NAV which is driven by a lack of transparency and impaired investments.

For the moment, we see more compelling opportunities in providing risk transfer solutions in respect of lending books of banks where those banks have long track records in corporate lending.

Discounts

We note that UK listed real estate investment trusts are also trading at large discounts to NAV (in some cases over 30%!).  We think these discounts are reflective of the fact that the market sees the potential for a decline in property values in the short to medium term due to a combination of increasing interest rates, rising cap rates and a period of low rental growth

Discounts in both of these sectors are a further sign of healthy dispersion and volatility increasing.

Good luck.

Asif Godall
Co-Chief Investment Officer



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