How funds’ increasing firepower has transformed the European market

Amid record levels of fundraising and an evolving deal market, Proskauer partners Alex Griffith, Faisal Ramzan and Ben Davis examine how private debt's role is shifting on the continent.

Where once European private credit may have been viewed as the poor relation when compared with its US cousin, the past five years has consigned that perception to history. Europe’s private credit market has grown exponentially as funds seize the opportunity to attract capital from institutional investors struggling to find yield in more traditional asset classes.

They have also capitalised on bank constraints driven by tighter post-crisis regulation, taking significant market share in the lower and mid-market leveraged lending space. The flexible, borrower-friendly and often bespoke terms offered by funds have found favour among sponsors and debt advisors, which are now highly familiar with direct lending, having built strong relationships with fund teams.

With significant capital to deploy, direct lenders are refining and diversifying their offerings to appeal to sponsors and borrowers. Today’s funds can offer companies and their private equity backers a menu of options, from preferred equity, revolving facilities, ABL lines and follow-on capex or acquisition facilities or uncommitted facilities, which can be called on as the business grows. Some offer equity co-investment to help sponsors make up a potential equity shortfall in a deal, in a structure that also helps direct lenders benefit from upside and mitigate potentially lower pricing in debt products. Increasingly, funds are hiring specialist teams from banks and other debt providers to grow their product offering and expand their market reach.

Bigger fund sizes are also leading to much larger debt packages being underwritten by the private credit market. The recent £1 billion ($1.3 billion; €1.15 billion) refinancing of UK telecoms and IT business Daisy Group by Ares is an example of how the size of deals being completed by private credit funds in Europe now almost rivals those in the US.

Europe-focused private credit funds are now competing with the European high-yield bond and large-cap Term Loan B markets – something unheard of a few years ago. While almost all funds still require a financial covenant (unlike high-yield and TLB), the certainty of finance and the ease of dealing with a small club of funds are proving highly attractive to sponsors and borrowers.

Yet even with their increased firepower, private credit funds haven’t quite reached the stage where they can hold £1 billion in debt. As a result, we’ve seen funds collaborate on deals to form lending clubs, much as the banks have done in the past, although with significantly higher hold limits than the £20 million to £25 million the clearing banks can currently offer. We’ve also seen, as with the Daisy Group deal, funds underwriting the entire amount and then, again like the banks, sell on parts of the debt to other market participants immediately following closing, in a process similar to syndication.

Conquering Europe

The penetration of credit funds in the European market has been rapid but more is to come. Until recently, the UK accounted for most direct lending in Europe. Now, jurisdictions like Italy, Spain and Germany are welcoming private credit and we are starting to see more direct lending coming from outside of the UK. In the last 12 months included in Deloitte’s Alternative Lender Deal Tracker, 269 out of 425 deals were non-UK.

There is also scope for growth in the non-sponsored private credit market. While there are barriers to overcome, the competitive nature of the sponsored private credit market is leading some houses to ramp up efforts to build relationships with corporate finance directors. If this gains traction, the private credit market could be set for further significant growth.

Private credit has been an exciting market to be involved with during recent times, and the signs are that it could become yet more so over the coming period.