Loan Note: European deals in the doldrums; weak covenants could impact recoveries

Latest Deloitte survey shows Europe's deal market weakening further in H1. Plus: Covenant specialist warns on likely recovery rates; and some European pension funds' key priorities. Here’s today’s brief for our valued subscribers only.

They said it

“The consumer has been really robust. That I would say is a difference with what you read in the press sometimes about concerns on the consumer. You just haven’t seen it yet”

Madelaine Jones, portfolio manager of Oaktree Capital Management’s European high-yield bond and senior loan strategies, in a transcript of Oaktree’s The Insight: Conversations – European Credit at a Turning Point

First look

Illustration of a businessman riding a snail

Europe deal market slowed in H1

Europe’s private debt deal market continued to decline in the second quarter of this year, down 23.4 percent on the previous quarter and 47.9 percent down on the same quarter of last year, according to the latest Deloitte Private Debt Deal Tracker.

The first half of the year saw 256 deals completed, down 36.2 percent on the first half of last year. Dealflow from the M&A market continued to be sluggish and there also continued to be a wide difference in price expectations between buyers and sellers. But while financings have become more conservative, Deloitte reports that appetite to put capital to work remains strong.

The UK market saw drops of 26.1 percent compared with the second half of last year and 41.4 percent compared with the first half of 2022. UK leveraged buyouts saw a particularly notable decline, with only 18 completed – the lowest number in the equivalent period since 2016. As a proportion of total European deals, the UK’s share has dropped from 34.8 percent to 26.2 percent between 2021 and 2023-to-date. Over the same period, Benelux has risen from 10.1 percent to 14.1 percent.

One clear trend that has emerged is a decrease in the amount of leverage supporting deals. The four most popular sectors – business/infrastructure/professional services, TMT, financial services, and healthcare/life sciences – saw the proportion of deals with 4x leverage or more fall from 71 percent to 61 percent between Q2 2022 and Q2 2023. Over the same period, leverage below 3x increased from 14 percent to 19 percent.

Paper highlights covenant weaknesses

One of the characteristics of a more challenging financing environment has been borrowers reportedly forced to make more concessions to lenders in their contractual negotiations. However, it appears to be the case that these concessions are only around the margins and don’t make up for the big swing in favour of borrowers in recent years.

Indeed, new analysis by Fox Legal Training – a covenant training programme headed by European Leveraged Finance Association chief executive officer Sabrina Fox – indicates just how much lenders have conceded over the last decade. “Provisions… originally engineered to protect lenders have since become tailor-made to afford borrowers increased flexibility,” says a press release from Fox Legal Training.

Features of the leveraged finance market highlighted by the analysis included:

  • Seventy percent of collateral packages immediately post-GFC included real assets and structural collateral, while in the modern vintage only 20 percent include hard collateral;
  • The capacity to incur debt that would dilute lenders’ collateral (as a proportion of EBITDA) increased from 25 percent post-GFC to 44 percent in the modern vintage;
  • Over the same period, the capacity to incur certain priming debt doubled from 17 percent to 34 percent.

Fox notes that changes such as these could result in lower recovery rates, “particularly given the steep refinancing wall coming up in 2025 and 2026”. A recent report from JPMorgan indicates that this is already happening. Recoveries for high-yield bonds and leveraged loans over the last 12 months were 19.6 percent and 39.7 percent respectively, down on the 25- and 24-year averages of 40.2 percent and 64.3 percent respectively.

Index-linked income target for pensions

Long-dated index-linked income and real estate are allocation priorities for European pension funds, according to the European Fund Survey from real assets manager AlphaReal.

The survey of European pension fund professionals, representing €324 billion in assets, found that more than half expect to increase their allocations to long-dated index-linked income, and a quarter expect to increase those allocations dramatically.

Three-quarters of investors expect a yield of 2.5 to 3.0 percent from long-lease index-linked real estate assets, while a further 20 percent expect yields of 3.0 percent to 3.5 percent. Secure income real assets such as commercial ground rents were cited as an attractive option for European pension funds.

The same survey found that 46 percent of European pensions say their main strategic allocation priority is to increase diversification in the portfolio, while 28 percent say it’s to increase expected returns and 18 percent cite increased portfolio income.

The main risk management priorities are to reduce the absolute volatility of the portfolio, cut volatility versus liabilities (liability matching) and meet liability cashflows as they fall due.

The funds said they allocated to illiquid assets to earn a premium above more liquid assets. Nearly all (98 percent) said they had an allocation to illiquids, with nearly half of pensions allocating more than 10 percent of their portfolios.

A call to LPs

Our LP Perspectives 2024 Survey is now live, and we would greatly appreciate your participation as we seek to understand investor sentiment in the private markets today. Here’s the survey link.

Some pointers on this year’s survey:

LP Perspectives is PEI Group’s annual study of institutional investors’ approach to private market asset classes over the coming year. The survey gathers insight on investors’ asset allocations, propensity to invest, performance predictions and views on the wider market.

The results will be published across all our titles.

Respondents will receive the results of the asset class of their choice as a thank you for completing the survey. PEI Group will also donate $5 to UNICEF for each completed response.

The survey takes no longer than 10 minutes to complete, and all submissions will remain anonymous.

The deadline for submissions is Friday 6 October.


TAP hires restructuring specialist

TAP Advisors, a New York- and London-based investment banking boutique, announced that Andrew Kramer has joined the firm’s New York office as a managing director.

Kramer will focus on building out the restructuring and capital advisory arms of the business, a new product offering for the firm. Prior to joining TAP, Kramer was a managing director at UBS focused on restructuring, capital advisory and liability management. Prior to UBS, he held similar roles at Greenhill, Credit Suisse and Donaldson, Lufkin & Jenrette.

Kramer has advised a variety of stakeholders in complex restructuring and capital markets transactions, including companies, creditors and equity constituents. His experience includes engagements across a wide range of industries including energy, power, healthcare, media, technology, gaming and leisure, and general industrial concerns.

Scott boosts structured credit at M&G

M&G Investments has appointed Rob Scott to its 20-strong structured credit team as director. He will report to James King, head of structured credit at M&G, and will be based in London.

With more than 20 years’ experience in structured finance transactions, Scott will focus on the origination, structuring, analysis and execution of investment opportunities for the speciality finance strategy, and the mortgage and consumer income strategy, managed by the investment team.

He joins from PIMCO, where he was executive vice-president, leading the European loan portfolio asset management team. Prior to this, he held several senior roles at Barclays, including managing director within the bank’s securitised products division.

LP watch

Institution: Ohio Police & Fire Pension Fund
Headquarters: Columbus, US
AUM: $17.2 billion
Allocation to private debt: 3%

Ohio Police & Fire Pension Fund announced a $50 million commitment to Barings North American Private Loan Fund III during its August investment committee meeting.

The fund offers direct lending within the central US mid-market and primarily targets loans for private companies, many of which have private equity backing.

For 2023, OP&F’s private credit plan has set a target allocation of $235 million-$285 million. The Barings investment represents its first commitment of the year towards this goal.

Currently, OP&F’s private credit portfolio is valued at $531 million, accounting for 3 percent of its overall portfolio. The goal is to increase this allocation to reach a target of 3.5 percent.

Today’s letter was prepared by Andy Thomson, with John Bakie, Christopher Faille and Robin Blumenthal contributing