The $10.5 billion University of Michigan endowment is making
a big bet on small business lenders worldwide.
In an expanded strategy to access the global private lending
market, the endowment has added new managers who would account for 30% of all
the endowment’s managers specializing in private credit, distressed and other
forms of debt. In total, the new managers would receive $400 million. The
endowment did not release how many new managers were hired or their names.
The private debt strategy comes at a time when endowments are looking
to boost returns in a low-return, global environment, while avoiding excessive
risk. A Preqin
study found that the alternative financing market is “progressively
expanding throughout Europe to become one of the mainstream options offered to corporates
and private equity ﬁrms to access long-term debt ﬁnancing.” The study also
noted that 46% of investors plan to increase their private debt allocations in
2016, while there is $523 billion in total assets under management in the
private debt industry as of June 2015, an increase of $40 billion from year-end
The Michigan endowment is the 10th-largest
college endowment and uses about 250 managers as of June 30, 2016. Since then,
the university regents approved additional hiring, including investing up to
$70 million in a pair
of Asia special situations group credit funds, according to Bloomberg.
In addition, records show the endowment invested in nine
credit managers since June 30, 2016, including Black Toro Capital Fund II
(about $53 million) that operates in Spain; Abax Global
Capital ($40 million) that lends to small- and medium-sized companies in
China; and, Emet Capital Management ($50 million) that invests in distressed
municipal bonds collateralized by student and senior housing in New York.
Fills a Void Created by Dodd-Frank
Renewed activity in the private lending and credit markets
to small- and medium sized US companies is the result of capital requirement
rules in the Dodd-Frank Wall Street Reform and Consumer Protection Act passed
in 2010. Under Title I rules,
banks with more than $50 billion in assets must cap credit exposures to a single counterparty with assets over $50 billion
at 25% of a bank holding company’s total capital. Commercial loans are covered
under Title VI.
While Dodd-Frank is in effect, the credit market is open to
non-bank lenders. However, the Trump administration has vowed to repeal all or
sections of Dodd-Frank, so this marketplace could look different if these
changes are made.
In Europe, banks are under more stress. A recent report from
Altficredit found that banks have been shrinking their balance sheets since the 2007 recession. In
2008, the total assets of European banks stood at about $35 trillion and
declined to $29 trillion by 2015, according to the European Central Bank data
as of 2016.
As a focused asset class, private lending can add
incremental return for a large, diversified portfolio, such as the University
of Michigan endowment, but these returns could be short-lived, according to
Richard Steinberg, president and CIO of Steinberg Global Asset Management, Boca
Raton, Fla. The current situation is similar to mezzanine financing in the early-2000s,
when returns went from 12% to almost zero due to cross-collateralization,
Steinberg said. As an alternative,
he suggested that since the European central banks are following a similar
playbook to the US Federal Reserve, it could make sense to invest in banks
directly as regulations evolve.
Yet with more stress on balance sheets, a low-rate
environment and higher capital requirements, the lending business
model in Europe is changing. “I see strong evidence that the conviction among key decision
and policy makers in Europe is leaning towards increased lending via
alternative sources. Over-reliance on banks made us too vulnerable and
constrained our economic development and we need to increase resilience via
diversifying funding sources towards the European economy,” Gabriella
Kindert of Altficredit said in a report.
While this market is expected to grow this year,
especially in financial technology-related firms, institutional investors
should temper their expectations of high returns, Kindert said.
to have high return expectations from private debt instruments that need to be
managed,” she said. “At the moment, a high percentage of investments are going
to the highest-risk basket in private debt (e.g., direct lending with return
exceptions of 6%-10%). The potential private debt universe is a lot larger than
lending at 6%-10% to sub-investment-grade companies.”
Kindert said European
banks have about 1.5% net interest margin and lend at an average interest rate
of 2.5%. However, “the bulk of the traditional banking products are safer
assets and can be an excellent alternative to traditional fixed-income
products. Some of these new assets classes [like Dutch mortgages] have been
favored by many institutional investors recently and a lot of similar product
initiatives are likely to come.”
By Chuck Epstein