Spanish Direct Lending Analysis, Opportunity to Expand
Spain is an increasingly attractive market for private debt investors. As the country’s banking sector faces another wave of mergers, direct lenders will have the opportunity to expand on the back of the banks’ reduced capacity to cover the mid-market space. As the economy recovers from Covid, we expect the number of Spanish direct lending deals in 2021 to bounce back to 2019 levels, or even higher. Pemberton opened its Madrid office in 2020 to support all our local clients, and Spain is an important part of our strategy to build pan-European portfolios for investors.
Spain is the fifth-largest economy in Europe and the fourth-largest in the Eurozone. Like most of Western Europe, it has been badly affected by the Covid pandemic, and the growth of Spanish direct lending stalled in 1H 2020 – though only temporarily in our view.
Due to the impact of Covid the Spanish economy contracted -10.8% in 2020. The extent of the pandemic’s impact was partly structural. For example, the tourist sector, a prime victim of anti-Covid measures everywhere, represented about 12% of the pre-pandemic economy. However, the Spanish Government is forecasting 6.8% growth for 2021, which would represent a strong rebound.
However, the political situation over the past few years has not deterred investors from putting their money into investment opportunities in the country, both on the debt and equity side. Part of the reason for this is that Spanish businesses post Global Financial Crisis (GFC) have focused on diversifying their footprint, particularly from a geographical standpoint, thus reducing their reliance on the Spanish economy.
As a result, PE investment in Spain has progressively increased up to its all-time high in 2019 with c. €8.5 billion invested, and international funds representing c. 75-80% of that volume each year. Whilst in 2020, the investment of PE funds in Spain fell by 41.8% to €6.3 billion, in line with the global decline, 1H of 2021 has shown a strong bounce back with €2.1 billion invested, +27% yoy growth.
According to Deloitte’s Alternative Lender Deal Tracker report, Spain recorded 137 direct lending transactions in the last 33 quarters – since January 2012. Although that figure seems small when compared to the 978 transactions recorded in the UK (the cradle of direct lending in Europe), it puts Spain in fifth position, only surpassed by France, Germany and Benelux. Spanish direct lending is a trend that has just begun and which all experts believe will grow exponentially in the future.
Against this mixed backdrop, the level of Spanish direct lending activity during 2020 was – unsurprisingly – lower than in 2019 with 21 deals closed in 2020 compared with 36 in 2019. This gap is mainly explained by the low activity seen in H1, when just four deals were closed as most of the sale or refinancing processes were put on hold given the uncertainty the lockdown brought. However, from June onwards, once lockdown restrictions were lifted, M&A activity resumed, this time very much focused on resilient sectors that coped well through the lockdown or even benefitted from the uncertain environment.
Despite the short-term Covid-driven problems, we take a positive view of the prospects for Spanish direct lending in 2021 and beyond. There will be fewer bank players in the market, creating opportunities for direct lenders to expand their market share from the current 20%.
Spain has traditionally had a strong dependence on bank financing. The consolidation of the Spanish banking system that followed the GFC of 2007-2010 reduced the number of banks and savings banks from 55 in 2009 to just 12 by 2021. After the wave of mergers between 2009 and 2014, in the last six years there were only two deals of note. However, the Spanish banking sector is clearly entering another period of consolidation that is forecast to reduce the number of banks to around five large institutions, plus a few smaller/regional entities. CaixaBank & Bankia and Unicaja & Liberbank have agreed to join forces in 2021, and analysts expect Sabadell to find eventually a partner.
In stark contrast to the situation during the GFC, Spain’s banks now have good levels of liquidity and solvency, but a sustained period of low interest margins has reduced their profitability. These new mergers should help the sector to make the necessary operational savings, but are likely to bring concentration issues, allowing direct lenders to seize the initiative. Bank mergers typically result in lower credit limits for the merged entity, so a reduction in the number of institutions will – on past experience – also mean a reduced size for individual tickets. Banks are also reported to be more cautious about club deals and concerned about their ability to get out of a deal if something goes wrong.
All this will help those direct lenders who can step in and take up the slack. Given that they already have the advantages of flexibility, bigger single tickets and speed of decision-making, continued medium-term growth for the sector looks secure.
So in terms of overall activity – and given that many of the sale or refinancing processes originally expected to take place in 2020 have been delayed to 2021 – we expect Spanish direct lending deals in 2021 to return to 2019 levels, with c.30 deals in total. Looking further ahead, we think that the 20% of the lending market currently taken by direct lenders could grow to 30-40% by 2025.
The speed and lower execution risk – combined with our capacity to provide tailor-made financings – have been highly valued by our clients. As we continue to reinforce our presence in Spain, we look forward to playing a part in growing the region’s private debt market, allowing it to become a real financing alternative for expanding local mid-market companies.
To learn more about the Spanish direct lending as well as news, commentary and analysis on issues affecting the high-yield, stressed and distressed markets in EMEA visit our EMEA Core Credit product page.