After a year and a half of rate hikes, the private credit market is holding up relatively well. The floating rate nature of the market means absolute returns have strengthened with every rate rise from central banks, and a greater share of corporate cashflows are now flowing to lenders.

There are two main paths that central banks could take from here – each with challenges for the market. In the first case, a higher-for-longer strategy would start causing problems for borrowers as rising debt costs push interest coverage ratios lower. On the other hand, central banks could pivot to cutting rates – but this would imply a weakening economic backdrop, bringing troubles of its own to borrowers in this space. 

In either scenario, we expect to see more credits across the leveraged finance space being downgraded to CCC – or even dipping into distressed territory. Already, the default rate in the European loan market is rising, albeit from record-low levels. As of August, the European leveraged loan trailing 12-month par default rate was 1.27 per cent[1]. This is up from 0.41 per cent in January but still far below 2.92 per cent averaged since 2007. 

Nevertheless, private credit remains resilient. Despite these looming pressures, we believe there are several reasons to be optimistic. For starters, private equity sponsors are sitting on record amounts of dry powder – estimated at $2.72 trillion globally as of early September[2]. Many general partners in Europe have demonstrated their willingness and ability to use this cash to support their portfolio companies in increasingly creative ways. 

Moreover, investors can take comfort in the positioning of senior secured loans at the very top of the capital structure. Even though fewer companies now include junior (or subordinated) debt in their funding stacks, equity cheques remain solid and the average leverage ratio on transactions has stepped down.

Whichever route central banks take from here, default rates may well pick up from historic lows. But Europe’s private credit markets look positioned for resilience. 

- Michael Curtis, Head of Private Credit Strategies 

Senior Secured Loans

• Technical bid drives secondary market to tightest levels seen in over a year 
• More LBO supply on the way, albeit bulk unlikely to be seen before Q1 or Q2
• Amend and extends continue to dominate the primary market

Moving through the third quarter, the surge in demand we have seen from new and ramping collateralised loan obligation (CLO) vehicles (see structured credit section) has not been matched by new money supply in the European primary loan market, which has pushed the technical bid to focus on the secondary sector. Here, demand has pushed prices to the highest levels we’ve seen all year – the Morningstar European Leveraged Loan Index in September topped 96 for the first time since May 2022. 

As of mid-September, there has been little sign of any flood of new-money paper to satiate this demand. An $8.4 billion debt financing package backing the acquisition of global payments technology firm Worldpay by GTCR has launched, while PAI Partners is soon expected to finance its takeover of Infra Group with a €500 million loan. But, for the year to date, leveraged buyout volumes have slowed. In the year to September 14, there have only been €5.16 billion of European loans supporting new buyouts, down from €16.76 billion in the same period in 2022 and €30.53 billion in 2021[3]. 

There are signs that more new money buyout supply could be on the way – we believe that private equity buyers’ and sellers’ expectations over valuation multiples are now beginning to converge, paving the way for a more effective acquisitions market. Meanwhile there are headlines about some potential public-to-private takeovers in the pipeline. However, any financing transactions to support deals now under discussion are unlikely to emerge in the loan primary market before the first quarter of next year at the earliest. 

In the meantime, though, supply through the end of the year is likely to continue to be dominated by amend-and-extend transactions, continuing the trend seen across most of 2023. Although most of the 2024 maturities have now been dealt with, around 40 per cent of deals in the European market are due to expire by the end of 2026, meaning there is still ample room for more amend-and-extends before the end of the year.

-Ellie Piper, Assistant Portfolio Manager

Structured Credit

• Supply has been choppy, but CLO volumes on track to match 2022
• Prices creeping down after some volatility, and primary market new issue premiums missing in some cases
• Refi and reset deals may re-emerge in the final quarter of the year

After a quarter in which the supply of new CLOs ebbed and flowed (only two deals were completed between June 10 and July 23), the European primary market stands resilient with year-to-date volumes of €17. 05 billion as of September 14, and the full year should fall in line with expectations from the start of the year, slightly below the €26 billion reported in 2022[4]. Issuance remains on track to match the €22 billion reported in the whole of 2022. More managers are now lining up, and a flurry of issuance is anticipated over the coming months.

It’s difficult though to see how all these new deals will get absorbed by the market. Headwinds include the slower pace of new loans coming through from the primary market to stock new CLOs, while CLO pricing has become ever tighter. As of September, the price of triple-A tranches coming through the primary market has reached around Euribor plus 170 basis points, far inside the Euribor+185bps to 190bps range typical of early June. In the first half of the year, one of the tightest deals came in February (before the turmoil prompted by the Credit Suisse crisis) and was priced with a BBB tranche at E+500 – this was matched by a deal in early August, and in September a CLO was completed with its triple-B tranche at E+480.

Elsewhere, some single-A rated tranches in the primary markets have been priced at tighter levels than those on offer in the secondary market. Deals completed in primary usually offer a new issue premium, given the settlement period following pricing in which no interest is paid, so it’s both unusual and notable that new deals are coming inside where secondary is offered. 

So far this year, we haven’t seen any refinancing or resetting of previously completed deals, but these could emerge in the fourth quarter. While prices in the market are still wider than those seen in 2021, issuers that completed deals in 2022 with one-year call-protection periods could soon return to investors to reset terms. 

 -Cyrille Javaux, Portfolio Manager

Direct Lending

• Q3 activity seasonally slower over summer months, but busier than expected
• Bank and loan retrenchment continues to support healthy direct lending volumes
• Valuations expected to begin to normalise in the fourth quarter, prompting an increase in transactions in the first half of 2024

While the European direct lending market is typically quieter over the summer months, there was more activity than we expected this year. Partly, this was due to pent-up demand from investors after a slower start to the year. But we’re also seeing increasing numbers of issuers tap into the market, as more traditional lenders curtail their corporate lending activity and fund managers generally take a more conservative approach to advancing credit. Some European banks, for instance, have been concerned about the economic outlook for the coming year, and so we’re seeing some significant retrenchment there. 

Elsewhere, we continue to see examples of deals coming to the direct lending market rather than using broadly syndicated loans. Payments firm Finastra (formerly known as Misys) raised a $4.8 billion unitranche credit facility – a record for the global market – in a refinancing deal that once would most likely have been done as a broadly syndicated transaction. 

But the real pick-up in issuance will emerge once the disconnect in valuations between buying and selling sponsors’ expectations has been sorted. Private equity firms are still valuing their existing portfolio assets at historically high marks: valuations are overstated due in part to the sponsors’ previous ability in more robust markets to finance these investments with richer debt multiples.

This revaluations cycle has not yet come full circle, although we’re three-quarters of the way there. I would expect to see more acquisitions processes kick off in the fourth quarter of this year, but the real increase will come in the first half of 2024 once that gulf in multiple expectations between buyers and sellers narrows. 

- Marc Preiser, Portfolio Manager

[1] Data from Pitchbook Leveraged Commentary & Data (LCD) 

[2] According to data from Preqin

[3] Data from Pitchbook LCD

[4] Data from Pitchbook LCD