BAF Capital provides working capital solutions to South American companies that operate primarily in the agri-food, food and energy industries
Interview with: Ernesto Lienhard, CIO at BAF Capital
25 january 2018
For more than 400 years, the banking sector has dominated the international loan market. Along with governments and mandated leaders, these three groups are traditionally responsible for the vast majority of loans issued. However, over time, their ability to respond to changing market needs has gradually deteriorated. Between increased demands on banks to maintain their capital structure and governments under increasing financial strain, lending has become much more difficult.
As long as the default rate remains low, the volatility of returns is extremely low, thus adding appeal to long-term investors.
To counter this, other forms of lending are beginning to take hold in the market, providing financial resources that many businesses have not been able to access recently. Ernesto Lienhard, CIO of BAF Capital, said direct lending is one of the financial services that have emerged to fill this void.
Based in Switzerland, BAF Capital offers a wide range of financial services, specializing in the Latin America region. Primarily, the company provides working capital solutions to South American companies that operate primarily in the agri-food, food and energy industries. With a team of 120 professionals in five offices (Switzerland, Argentina, Uruguay, Brazil and Paraguay) and a management team with more than 30 years of experience in corporate finance, the company has become one of the players the most active direct credit within the Region.
“What we now call direct lending is a loan provided by private non-bank entities,” Lienhard said. Global finance. “Regulations and limitations aimed at increasing leverage on a bank’s balance sheets have enabled independent non-bank private lenders to fill gaps in the global credit market. Today, direct loans are expected to continue to grow in size and scope, gradually representing a much larger proportion of the market. While the model presents unique challenges, experienced direct lenders now see significant opportunities in the years to come.
The lending market changed dramatically in the aftermath of the global financial crisis of 2008. Many banks around the world were forced to restructure their balance sheets to accommodate the large write-offs that were required. Regulatory changes, such as increased capital requirements, have also taken a toll on banks around the world. Taken together, this has reduced the ability of banks to provide loans, cutting off critical sources of credit for many small and medium-sized businesses.
Lienhard added that while stricter regulations have been responsible for much of the impact on the industry, there have also been additional factors at work: “Although stricter regulations for banks have played a role in reducing their activities, we must not forget that the structures forced them to drastically reduce their ability to hold all loans on their books.
Other factors are still at work behind the boom in direct lending. World trade and the nominal value of the world economy have grown very rapidly, mainly due to the rise in commodity prices over the past 20 years, as well as the continued growth of China. Lienhard explained, “Banks did not have enough capital to keep pace with the growth of the global economy, which allowed other players to fill that space. The current environment of historically low interest rates and excess liquidity is pushing investors to seek new sources of return. These many factors have combined to produce a surge in interest in direct lending.
Find a niche
BAF Capital has been in the market long enough to see how much this has changed the industry. “BAF Capital started business in 1996 as an alternative independent lender,” Lienhard said. “At that time, we were seen as a marginal and exotic player in the financial services industry. Today, BAF Capital retains a larger and more important role in the market.
For BAF Capital’s partner companies, many opportunities may arise. According to Lienhard, reliability, flexibility and quick responses are among the most important: “By having an in-depth knowledge of the business in which these companies are involved, we are able to provide them with liquidity even during difficult times, which is very valuable for any business. In many cases, banks are more reluctant to lend during such times, allowing BAF to build relationships with a wider range of businesses, and with even better returns.
Lienhard added that BAF Capital can also provide financing to a company operating in different jurisdictions at the same time, giving the company another significant advantage over other lenders.
The benefits aren’t limited to businesses looking for credit. Lienhard explained that BAF Capital also provides an excellent opportunity for investors to access a well-diversified and self-created portfolio of private secured loans in South America. “We don’t use leverage and all risk is on our books, so our best interests are fully aligned with our investors.”
As with any loan portfolio, the key is to keep the default rate well below the portfolio’s interest rate. “As long as the default rate remains low, the volatility of returns is extremely low, thus adding appeal to long-term investors, such as insurance companies or pension funds.”
Despite these advantages, Lienhard agreed that the so-called additional leverage of shadow banks can be a risky endeavor, but this in no way suggests that the asset class is worth avoiding altogether. “I don’t recommend having a debt ratio greater than 1: 1 in a credit portfolio. Keep in mind that a bank’s leverage ratio is 10: 1 on average.
Although risks exist, the agri-food sector presents a more stable market than others. “In the markets in which we operate, the financial sector does not cover all the financial needs of companies, thus creating space for alternative sources of financing,” Lienhard explained. “Trading companies, suppliers and non-bank lenders are here to fill the void. At BAF, we are part of the financial structure of the companies in which we are involved.
Lienhard added that a low correlation with traditional fixed income and equity investments is another advantage for an investor’s portfolio: “When it comes to diversification of any investor’s portfolio, private debt offers a superior protection against traditional bonds and a return similar to that of equities ”.
Taking all of these factors into account, the direct lending industry currently sees a bright future. Lienhard said BAF Capital has already seen the direct lending industry generate significant momentum, with further growth on the horizon. “Today almost all asset managers have a strong direct lending division, including KKR, Blackstone and Goldman Sachs. It will be a long time before the banking sector can increase its capital requirements to meet the increased demand. “
Direct lending can also be immune to some of the other forces currently rocking the financial market. Lienhard explained that the disruption caused by the fintech boom is unlikely to have the same effect on the direct lending market: “The world is certainly changing and I don’t see fintech companies as a threat. I think both can benefit from each other, but the regulators’ perspective will be important for that. “
According to Lienhard, banks are particularly vulnerable to fintech challengers, because their nature requires them to offer a generalized product: “Banks have the bulk of customer relationships, both personal and professional. Fintech players can provide them with better technology to improve customer service, serve small businesses much more profitably, and give them access to other customers as well. Plus, I think fintech platforms could even help increase direct lending. They will need funding to develop their business, and this is where we can find synergies.
Tax barriers are also not an immediate difficulty for direct loans. “You cannot stop globalization. With a growing world population, countries with competitive advantages in terms of land and water will certainly benefit over others, ”Lienhard said. BAF Capital also operates in a sector which is not particularly vulnerable to international restrictions, especially in the long term. “South America, especially Argentina and Brazil, will always be a food supplier to the world,” Lienhard said. “There are times when countries can put barriers on certain products to protect their industry, but in the long run South America will still be a net exporter of agricultural products.”
Latin America is also a region with strong growth prospects in terms of direct lending, Lienhard said. “The demand for bonds is strong by the private banking sector because it is a simple and vanilla investment for clients. On the other hand, large sophisticated investors like insurance companies and pension funds seek to invest in private debt because of their low volatility vis-à-vis bonds and their higher yields.
Taken as a whole, the direct lending industry is expected to experience significant growth over a future that has the potential to be filled with consistent returns. As investors search for new solutions, investing in direct credit will soon be a prerequisite for building a balanced portfolio. Lienhard concluded: “For me, diversification remains the key word in any portfolio. “