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Direct lending: tapping Europe’s rich loan pipeline

Despite ongoing disintermediation in the European direct-lending market, strong origination agreements with banks continue to be vital to access high-quality loans – particularly in the mid-market space. Here we explain why.

The European small- and medium-sized enterprise (SME) lending market has traditionally been the preserve of the banks: they have vast networks and strong relationships for originating deals in this sector. The SME funding landscape, however, changed dramatically in the wake of the global financial crisis amid growing regulatory pressure – and investment firms filled a gap left by European banks to provide SME financing.

Today, the market is disintermediating gradually in Europe, but banks still claim the lion’s share of financing for mid-market companies and they tend to be the biggest lenders in their home markets. What’s more, some which exited the market are now re-entering, regaining market share as their balance sheets have improved since the financial crisis. That means companies still source all or part of their financing from banks, as banks have fostered long-term relationships in specific regions where these companies are located, making it difficult for direct lenders to independently generate pipelines of high-quality loans.

Nevertheless, there is an increasing opportunity for direct lenders in Europe: funds based on the continent that run direct lending strategies raised more than €20bn in 2017, up from €9bn the previous year1. Direct lending now accounts for 10% of Europe’s business loan market2.

A fragmented market

Given the prominent role of banks in business lending, direct lenders seeking attractive SME loans must therefore have robust relationships with conventional lenders.  But this can be tricky: direct lenders will never know the borrower as well as the local bank that has provided its loans over the long term. Moreover, there are vast regulatory and cultural differences throughout the continent’s business landscape, which has hindered the pace of disin