Since the financial crisis, changing regulation and a more conservative risk environment mean that banks have been reluctant to make loans of the size that they did prior to the crash in 2008. As a result, small and medium-sized companies have had to look to other financing providers. One, albeit small, source of funding has been institutional investors, which have established pure direct lending funds to service this growing demand. Patrick Marshall, Head of Private Debt & CLOs at Hermes Investment Management, discusses the options for loan origination.
Like all asset classes, this asset class comes with inherent risks. These include credit risk in the form of borrowers’ defaults, which was a significant issue for lenders during the financial crisis. Medium-sized companies have an average default rate of around 3.1% over the past 10 years. However, senior secured loans, which stand at the top of the capital structure, enjoy average recoveries on default in Europe in excess of 75%, which is significantly higher than some other asset classes such as high yield bonds.