Debt managers call for tough conversations with PE sponsors

Private debt managers are encouraging private equity sponsors to take a more considered approach to leverage in 2023.

Speaking on the opening panel of the Private Debt Investor Seoul Forum on Monday, Christine Vanden Beukel, managing director and head of European credit markets at Crescent Credit Europe, told delegates that the firm was having more open discussions with sponsors about appropriate levels of leverage in a high interest rate-environment.

“What we’re doing now is we’re actually stepping down the amount of leverage we’re allowing them to borrow, particularly if they are dollar or sterling-based lenders,” Vanden Beukel said.

“Sometimes the sponsors are quite surprised, but we literally sometimes have to do the math for them and say, ‘Look, when we underwrote you, you were at two-and-a-half and now you’re at one-and-a-half, so maybe you shouldn’t borrow at five times anymore.’ Unless you have that open discussion, of course you don’t have that opportunity to step it down.”

US leveraged loans had an average debt/EBITDA ratio of 4.7x in Q1 2023, based on pro forma adjusted EBITDA, according to LCD and PitchBook, matching 2015 as the lowest reading in the last 10 years.

Vanden Beukel said Crescent Capital was placing greater focus on underlying portfolio liquidity this year.

“And I think that a lot of people are surprised when I say this, that oftentimes we’re far more focused on liquidity than the underlying sponsors,” she added.

“Believe it or not, several times we’ve had to point out to the PE sponsors based upon what’s happening [that in] two quarters, you’re going to have an issue with cash and they’re like, ‘No we’re not.’ So being able to project what’s happening, have that conversation early, flag it to people so that you’re not surprised when these things occur – I think it’s another thing that as an active credit manager, you can help mitigate some of these factors.”

The price ain’t right

Besides leverage levels, panellists expressed concern over whether private equity sponsors are prepared for a correction in purchase prices and the resulting impact on existing portfolios.

“We like sponsor-backed deals because of the alignment of interest between us and the sponsors, but now that we’ve moved away from a zero-interest-rate world where money is free and it’s easy to solve issues with credit by taking out a capital structure or doing some form of refinancing and kicking the can down the road, I don’t think we’re returning to that type of an environment from a sponsor’s perspective,” Sean O’Keefe, managing director at Audax Private Debt, said.

“We’ve seen positive support thus far, but we still have not seen that rationalisation of purchase price multiples. So if I bought a business in 2019 at 15 times, I still as a sponsor want to sell that business for 15 times… When that rationalisation does in fact take place and maybe the market moves down to a 10-times market or an 11-times market, what is the sponsor going to do? Are they going to put money into a business they paid for 15 times just to pay us as lenders, or are they going to buy a new platform company at 10 times to try to help hit the returns that they need to hit within their private equity portfolio?”

Average private equity EBITDA purchase price multiples in the US climbed to 11.9x for buyouts last year, the highest on record, according to Bain & Co. Conversely, European multiples fell to 10.7x – around the same level as in 2017.

“We’re being very deliberate about how we approach the market given all this uncertainty and I think that we are facing a market that ought to be a little bit chaotic – I don’t expect it to be perfectly smooth,” Marc Preiser, portfolio manager for European direct lending at Fidelity International, told delegates on Monday’s panel.

“I think that the purchase price multiple question is a big one… We still see fairly punchy leverage sometimes, especially when it comes around a company that looks somewhat pristine, has the right characters, has the right cashflows, in the right sector… So there’s still a fair amount of enthusiasm in the market, just not, I think, the economic factors to match it.”

Weathering the storm

Proactivity could prove key to weathering this challenging environment.

“I do observe that among the private equity sponsor communities, a lot of the partners who are dealing with situations today don’t necessarily have that workout experience,” Vanden Beukel said.

“So what I worry about a little bit is that if the sponsor is not proactive enough or sort of savvy enough to see what’s coming, oftentimes that’s a challenge for us as a credit investor, because it’s almost like we have to sit down with them and say, ‘Look… this is how this is going to play out.’ And sometimes people get it immediately, and then sometimes if they’ve never seen it before and they’ve been super successful, they almost can’t believe what’s happening and… that they actually have to do something about it.”

Similarly, private debt managers that have passed through at least one cycle may be in a better position to do so again.

“There’ll be many firms that will come in but those that have been doing it for a while and those which have a track record, I think you’re going to be rewarded for trusting those managers that have that experience,” Mark Glengarry, senior managing director at Blackstone Credit, said on the panel.

“We will see a lot of credit being created – you’ll start to see that in the US. With returns being where they are, that’s not a surprise, but I would encourage people to look through track records and things, because it’s not a market where you want to be a first-time player.”