Funds struggle to fill bank lending shoes

LONDON (Reuters) - Hopes that investment funds will increase direct lending to companies in 2012 and help fill the gap left by retreating European banks are being dashed as the low returns on offer keep new investors away.

Governments and regulators are keen for companies to increase their use of alternatives to bank loans. This includes tapping the bond market or borrowing directly from fund managers sitting on billions of euros that could flow into the real economy.

This, they hope, will compensate for a drop in lending to customers by European banks forced to hold extra capital. Morgan Stanley analysts estimate the region's banks could slash assets by up to 3 trillion euros in coming years.

Yet as companies prepare for what is expected to be another tough funding year, only a handful of funds are ready with the mandates and teams to begin giving these loans.

"The size of the financing gap is almost unquantifiable given the ongoing credit and banking crisis," Anthony Fobel, head of private lending at BlueBay Asset Management, said.

M&G, an arm of insurer Prudential, has one of the only dedicated private lending funds up and running in Europe, with about 1.5 billion pounds of raised capital. Others like BlueBay are set to follow, but the amounts raised will be dwarfed by the lending shortfall.

Unlike the United States, where the private lending market is developed and 80 percent of total corporate borrowings come from non-bank debt, in Europe this is less than a third.

One alternative source of non-bank finance increasingly used by larger companies is the public bond market, but for most medium and smaller-sized firms with no credit rating this avenue is closed.

A LACK OF TRADITION

BlueBay plans to launch a fund next year providing finance to small and mid-size firms in Europe, and Fobel told Reuters that finding the right people to undertake a rigorous credit analysis was a key challenge. The fund has been hiring from banks.

Martin O'Donovan, deputy policy and technical director at the Association of Corporate Treasurers, pointed to "a mixture of little things" hindering the rise of this funding source in Europe.

"There's a lack of tradition for this kind of market, there are too many other things to invest in, worries about liquidity and credit ratings, documentation and the lack of familiarity with that," O'Donovan said.

"The actual rates on loans may also be a barrier."

Within most banks, loans to larger companies are traditionally run as loss-leaders, or a way into picking up more lucrative business by hooking clients in with cheaper funding.

That is an unattractive prospect for funds focused on the returns of their loans, and they will have to strike a balance to entice customers and meet their own targets.

"Investors tend to separate their activities between illiquid private equity investments and liquid credit investments - this strategy falls between the two," Fobel said.

BlueBay's planned fund, which will lend to European small and mid-size companies, is targeting annual returns in the low to mid-teens across senior and some junior, or riskier, debt.

It is not completely alone in striking out - Aviva Investors is keeping a close eye on the sector too, though the asset manager is yet to launch a fund, a spokesperson said.

M&G's UK Companies Financing Fund, which offers long-term finance to larger UK firms, has lent out some 750 million pounds since its inception in 2009, around half of its raised capital.

"Our view is this market is going to develop. But it takes time to educate borrowers on the benefits of diversification of funding," M&G's Head of Alternative Credit Mark Hutchinson said.

"Our UK system has been built around the banking system...It (the growth of UK alternative lending) is taking longer than we had anticipated."

(Reporting by Tommy Wilkes & Sarah White. Editing by Chris Vellacott and Jodie Ginsberg)