Times are a-changing in Europe. The macroeconomic shocks of the past six months – the energy crisis, the inflation spike, rising interest rates and continued supply-chain disruption – are forcing private equity sponsors to re-evaluate their funding options.
“The syndicated loan market and the high-yield market are both effectively shut in Europe right now,” says Luke McDougall, co-chair of the global finance practice at law firm Paul Hastings.
“There are some limited circumstances in which someone would go to market, but generally speaking, as of early September, it is not a feasible option for leveraged buyouts.”
And yet it’s not all doom and gloom – far from it. The shifting landscape has thrown up a set of opportunities for European debt investors that make market participants quietly confident that growth will continue. Here are seven key trends that we identified in European debt market while compiling this report.
Direct lenders are gaining ground
Europe’s direct lenders have profited in the absence of syndicated lenders, and are unlikely to look back, says Adam Wheeler, co-head of global private finance at Barings.
“The syndicated loan markets and the high-yield markets remain basically shut at the moment, which means a lot more transactions are coming to the private markets,” he says.
“Private markets… saw an extraordinary number of deals done and dollars deployed in the second quarter of 2022, in both Europe and the US. In Europe, in particular, we compete against the banks, who remain a large part of the mid-market leveraged finance world, and they have pulled back quite a bit.”
Current conditions could prove favourable
Providing investors make the right investment decisions, today’s market could prove beneficial, says David Hirschmann, Permira Credit’s head of private credit: “The sort of companies that we tend to support have high EBITDA margins on average, a good level of pricing power and high cashflow generation capacity, which positions them well in a more volatile environment.”
Smaller cap deals have come into their own
The lower mid-market, defined as transactions with less than €100 million and more than €15 million of debt, offers compelling opportunities, argues Klaus Petersen, founding partner, at Apera Asset Management.
“The lower mid-market is structurally different from the upper mid-market because the main provider of financing is the banks, who have de-emphasised the space, creating a demand-supply imbalance. There is more demand than private debt providers can supply, which means there are better credits in terms of leverage levels, lower loan-to-value and stronger covenants,” says Petersen.
With around 700 investment opportunities a year, Petersen says the lower mid-market has some tempting traits: “The ability to choose and select the best credits is a massive advantage, as in markets with lower transaction numbers you may be forced to finance marginal deals.”
Credit markets are trying to find their balance
The public markets have been largely shut since March, says Andrew Konopelski, managing partner at Bridgepoint Credit, whose owner Bridgepoint is the owner of Private Debt Investor publisher PEI Media. This has led to new issuance volumes being down 70 percent year-to-date in the leveraged loan and high-yield bond markets. “This has created many different and interesting opportunities for private credit. The clear trends in Europe have been a return of risk premiums, a return of base rates and a very large shift to private markets,” he says.
“Q2 was our busiest quarter ever…everything found its way to private markets: a large M&A pipeline, new credits and many European markets that to date have not favoured private credit all turned to it.”
Opportunistic credit also saw an uptick, which “is proving to be a very good partner and able to deliver attractive financing solutions for sponsors in times like these”.
European debt markets can withstand an economic shock
Private credit, compared with other asset classes, continues to have several advantages that mean it is relatively well positioned for macroeconomic challenges, says Keith Miller, global head of product – private debt at Apex Group.
“Those include the fact that instruments are generally of shorter duration with floating rates, benefit from an amortising position and generate higher yields that offer a bit of a buffer. So, while there are challenges, in the second quarter of this year we have probably seen an uptick in deals getting done, and that is especially true in the core European direct lending markets of the UK, France and Germany,” says Miller.
Southern Europe is a bright spot
Spain and Italy are both seeing record transaction levels, but there are hopes, too, that Portugal is on a growth trajectory for private debt.
“We’ve just been visiting some of the sites that we own in Portugal and it’s hard not to feel optimistic,” says Zach Lewy, CEO and CIO of European fund manager Arrow Global. “In the hospitality sector, there’s a backlog of people who want foreign holidays. That demand is already pushing activity in Portugal beyond pre-pandemic levels.”
John Calvao, fund principal at the firm, is similarly optimistic. “The Portuguese business is one of our more robust businesses. I think we’re approaching a thousand employees in Portugal. We’re a major, major player in that market.”
Nordics remain well-placed
The Nordic region provides a huge market for private debt investors, says Capital Four CEO Sandro Näf. “We are, of course, facing a global slowdown. That means that we’re more selective, and we’re more conservative on leverage,” he says. But Scandinavia has certain advantages which should ensure continued growth: “The Nordic economies are generally less vulnerable to the energy supply crisis because they produce energy domestically and are leaders in renewables.”