There are good reasons to have confidence in the European private credit market in the first quarter of 2024. Balance sheets look stronger than anticipated this time last year, private equity sponsors are being proactive - and in some cases creative - with how they’re refinancing deals, and there’s a sense of stability across the markets.  

But be wary of the cracks. Companies with weak business models that have been able to access cheap money in recent years are now beginning to feel the heat from the higher rate environment. Constrained cashflows could contribute to a rise in defaults, though they are likely to be limited. 

A big challenge for the first half of 2024 will be assessing the timing and scale of the coming maturity wall. Companies need to have appropriate equity cushions to support their debt levels if they are to effectively refinance existing loans. The rise in the cost of debt over the past few years may have helped credit investors secure healthy returns but it has also meant companies spending more on servicing those debt costs. Our focus is on enterprise valuations. We anticipate a contraction in multiples across sectors and a fall in valuations overall, raising questions about whether these companies have the valuations to continue to support their financing structures. 

- Michael Curtis, Head of Private Credit Strategies

Senior Secured Loans

• Focus on dismantling the maturity wall as defaults tick up
• Better understanding of valuations needed before secondary buyouts increase
• Pricing in primary market suggests the strong carry experienced in 2023 is set to continue in 2024

Many participants across the European senior secured loan market are entering 2024 with confidence. There’s been significant primary market activity in the fourth quarter of 2023 on the back of a wave of new CLOs. The technical bid that these new vehicles have created, coupled with limited supply, has prompted syndicate desks and sponsors to push through opportunistic transactions. We expect yet more of this supply to come through in the first quarter. In particular, we could see more dividend recapitalisation deals as private equity firms look to give cash back to their partners. The final quarter of 2023 saw payroll and HR software firm Silae price a €650m loan to pay a dividend to its Silver Lake-led shareholder group and proceeds of a €465m facility from CVC-backed travel agency Etraveli were used to refinance existing debt and pay a dividend.

Much of private equity’s focus though will be on the maturity wall and quickly dealing with those facilities that are due to mature in 2026 to 2028. There is a sense, however, that many of the maturing transactions from stronger names have been dealt with already. That leaves the market seeking solutions for the more complex deals, and there is a keen awareness that the window of liquidity could close quickly if geopolitics or economic data take a turn for the worse. 

We anticipate that the pipeline of leveraged buyouts by private equity could pick up in the first quarter given the willingness of markets to fund new acquisitions. We’re likely to see more public to private acquisitions like Cinven’s purchase of medical diagnostics group Synlab, announced early in 2023. However, there’s still a valuation mismatch that may hinder the flow of secondary buyouts. Greater rate certainty in 2024 could see an increase in these sales between private equity firms. 

- Camille McLeod-Salmon, Portfolio Manager

Direct Lending

• Strong pipeline of new deals anticipated for the new year
• Some margin squeeze expected but terms broadly holding up
• Default levels to edge up in the first half, but will remain contained

The start of 2024 marks a highpoint for European direct lending with the pipeline of deals now the strongest since the market came of age. A stabilisation of interest rates and improved visibility on the cost of financing fuelled acquisitions in the final quarter of 2023. The transactions being priced in this same period will generally be funded in the first quarter of 2024. 

Activity has been most pronounced in France, the UK, and the Netherlands. There’s less of a pipeline in Germany, mainly because of the country’s murkier economic outlook. It also has a larger manufacturing base and most of the deals being lined up are from defensive sectors; in particular software and technology, healthcare, and business services.

I’d expect that most of these new deals will be priced north of 600 basis points over Euribor with leverage ratios of 5x or below, with good terms and strong covenants. While we remain staunchly against cov-lite, recently we have seen the occasional cov-lite transaction in our segment priced as low as E+575 bps. Given the strong bank bid in France in particular, we see some appetite for another layer of capital, whether that’s second-lien or a mezzanine facility. 

I do expect to see some evidence of defaults starting to come through in the first quarter of 2024. A year of higher rates and elevated costs for issuers should begin to reveal how exposed people are. I don’t expect the market to crash, but we will see more trouble around the edges, with more deals slipping into distressed territory and a higher level of workouts across the asset class. We could also see more situations where keys will be handed back to lenders.  A worse-case scenario for the next three years would be a default rate close to 6 per cent and recovery rate of 50 per cent. However, our base case is a default rate of 4 per cent and a 75 per cent recovery - a conservative take on what has so far proved to be a resilient direct lending market.

- Marc Preiser, Portfolio Manager

Structured Credit

• Supply likely to remain strong compared to other asset classes
• Bid for triple-A rated paper buoyed by bank arrangers taking holdings
• Refinancings may be on the way as 2022 deals fall out of non-call periods

The end of 2023 has been incredibly busy for new CLO issuance. As of mid-December, new CLO volumes for 2023 stand at €25.8bn, close to the €26bn reported for all of 2022. Some bank research has forecast around the same volumes in 2024 (sell-side research expectations vary, but average around €25bn).

While we expect there to be challenges in 2024, it’s been encouraging to see the CLO market hold up so well in 2023. Demand has remained strong even when there have been big external events, such as the collapse of Credit Suisse, with new deal activity returning after a few weeks. Already there are some managers looking to issue in the first quarter of 2024 so primary market volumes could pick up from the end of January and into February.

Pricing has been impacted by October and November’s jump in supply. Back in September, there were some BBB-rated tranches priced below 500 basis points over Euribor, but early in November triple-B pricing moved above E+600bps. That could change in the new year. Some investors will have renewed their budgets so supply will be more easily absorbed.

The price of AAA-rated tranches has been steadier, remaining around E+170-175 over the fourth quarter for established managers. Interestingly, there’s been an increasing number of CLO arrangers starting to buy AAA-rated paper. The pricing is attractive for these bank buyers (they can find triple-A rated security sitting at the top of the capital structure with the same spread as BBB-rated corporate debt) and it works well for their regulatory capital requirements. Banks’ participation in this area of the market isn’t unprecedented, but it’s certainly becoming more widespread. 

There may be more CLO refinancings in the first half of 2024. Many deals have one-and-a-half year non-call periods, so the CLOs that were priced in late 2022 (when costings were much higher) could return to the market to tap the cheaper levels that are now available.

 - Cyrille Javaux, Portfolio Manager