Sunday, April 06, 2014

US Lenders Seek Interest Rate Arbitrage With Europe SMEs

This WSJ article on US lending to European small and medium-size enterprises (SMEs) caught my eye today.  US funds are exporting the business development company (BDC) model of asset-based lending to the continentals.  These funds are combining a carry trade with interest rate arbitrage.  Hedge funds do that instantaneously but these private funds are lending with much longer durations.

The carry trade is easy money right about now while US interest rates are still at historic lows.  Borrowing in US dollars from US institutions and lending to European businesses that are hungry for capital is a lender's dream.  The euro is lower right now than it's been since late February, so US lenders who need to buy it just to loan it out are getting a decent deal.

It's no mystery why European banks can't fill the lending gap themselves.  Their balance sheets are overstretched with bad debt from the PIIGS and whoever else couldn't figure out how to run a healthy national economy.  European banks applying Basel capital tests have discovered to their chagrin that they can't afford to make more high-risk loans.  Those banks haven't figured out the US trick of moving bad assets into off-balance sheet entities and securitizing their cash flows.

I'm not interested in the details of these trans-Atlantic BDC clones.  They do not appear to be publicly traded (except KKR) so I can't evaluate them.  The news item is noteworthy as a bellwether for the US financial sector.  Funds that chase returns by making loans to European SMEs at double-digit annual interest rates are pretty desperate for yield.  Their investors may be running out of high-yield alternatives here in the US.  I still recall the headlines I read back in 2007 about how a collapse in the US high-yield debt market preceded the collapse of US equities by several months.  I watched it all from the sidelines, in cash.