The first quarter of the year has been a positive one for European private credit markets. Falling inflation, a benign growth environment, and expectations of upcoming rate cuts have all contributed to improved market sentiment. 

For investors though, prices across private credit remain robust. In the European senior secured loan and collateralised loan obligation (CLO) markets, spreads are at or above the median figures of the last decade, at levels that suggest that the returns on offer would more than compensate for even the worst historical level of defaults. Meanwhile on core direct lending deals, prices have compressed a lot less than in public markets, showing a stability supported by a diminished sensitivity to market technicals, and falling competition from banks. 

The resilience in the economic backdrop and improving visibility about the start of the rate cutting cycle is building business confidence, and we believe that this will lead to an increase in M&A activity by the end of the year. The ratio of private equity buyers’ investments to exits is at the highest level it has been for 15 years[1], and sponsors are under pressure to return capital to investors. As the macroeconomic backdrop settles and as confidence in the availability of financing through capital markets grows, the gap between the valuation expectations of buyers and sellers is narrowing, allowing for more deal-making activity to resume - whether that’s for M&A, leveraged buyouts, or IPOs. 

Fresh buyout deals in particular are essential to provide a new supply of paper for a healthy CLO market, while in the direct lending market there’s still a lot of capital being raised that needs to be deployed on new transactions. Already we’re seeing the pace of buyouts pick up slightly, but we’re expecting to see a much healthier pipeline in the second half of the year.

However, there remain certain areas we’re watching closely. If rates stay higher for longer and inflation continues to be sticky, although credit investors will benefit from a yield perspective, the environment will continue to pile pressure on borrowers with overleveraged and unsustainable capital structures. To date, most borrowers across the private credit universe have shown resilience, but we have seen weaker credits struggle. Already there have been some default situations, especially in the US where so-called “creditor on creditor violence” has resulted in lower recovery rates than the historical average. 

Similarly, geopolitical risk remains a threat, and there is a possibility that the elections coming later this year could prompt volatility, pushing up the price of liquidity, and causing spreads to widen. Although the market has traditionally recovered from these episodic shocks quite quickly, it’s worth keeping an eye on such events as we move through the second quarter.

- Michael Curtis, Head of Private Credit Strategies

Senior Secured Loans

• Primary market pricing remained disciplined throughout a busy first quarter
• Issuers are refinancing direct loans and high-yield bonds into the senior secured market
• Dynamic expected to continue until buyouts return to market in strength, which is likely to happen in the second half of the year

There has been huge demand from new CLOs in the first quarter of the year that has been met with a robust supply of senior secured loan deals launching to the primary market. In the year to March 20 new primary market loan issuance jumped to around €23.6bn, compared to €6.6bn in the same period in 2023[2]. 

What’s interesting is that throughout this period of strong issuance, investors have shown discipline on pricing. For B2-rated issuers looking to reprice existing facilities, margins seem to have settled at Euribor plus 400 basis points, while for B3 names margins are at E+425-450bps. One B/B2 company tried to tighten pricing on a deal to E+375, for example, but the market held firm. It was completed at E+400. 

While we do anticipate some leveraged buyouts coming through, we do not expect buyout activity to pick up in earnest until the second half of the year. There are already headlines about potential auctions however, with suggestions that valuations are lower than just a few years ago. If a couple of deals get completed at those lower multiples it could set a precedent and open the floodgates. 

For now though, we expect that most of the new money supply coming through the primary market will be from borrowers looking to refinance existing high-yield bonds or direct loans into floating-rate senior loans. In particular, there are a lot of companies that turned to the direct lending markets two years ago when the volatility that followed Russia’s invasion of Ukraine closed the senior loan market. Those direct deals are now coming out of the two-year non-call periods in which they could not be refinanced, and there’s a decent cost saving on offer for borrowers to switch to a senior syndicated loan. 

One example of this theme was seen in a €1.1bn deal from Ingenico, which illustrates how strong appetite in the senior loan market has become. Two years ago, Ingenico was unable to syndicate its original deal (which financed Apollo’s carve-out of the company from Worldline) and so took out a direct loan instead. But demand in the primary loan market is now so strong that not only has the company been able to replace the unitranche deal with a broadly syndicated senior loan, it has also been able to raise additional funds to pay a dividend to its sponsor.

We do not expect every borrower will enjoy this sort of appetite, and there are still challenges around individual companies and specific sectors that investors should be aware of. Already the first defaults are emerging, especially from those credits that have had weaker performances for some time or where there have been underlying structural issues. However, we do not believe that defaults will become unmanageable. Rather they will remain contained to those distressed names that have already been flagged, and in Europe the default rate will be far lower than in the US.

- Ellie Piper, Assistant Portfolio Manager

Direct lending

• The market is normalising from a price perspective, especially on the larger end of direct lending, with syndicated loans becoming a more viable option in competition with direct lending solutions
• While pricing is compressing across the direct lending market, this is from toppy highs so current returns remain quite strong
• Terms remain conservative, but private equity buyers are beginning to push for higher leverage levels on certain transactions – especially those with stronger cash flow profiles, particularly technology and business services

The direct lending market continued to normalise across the first quarter with a hint of more refinancings, especially on the larger side. Now as the cycle turns and the syndicated loan market stabilises while rates even out, we’re seeing some issuers that went to direct lenders when times were difficult replacing those facilities with syndicated deals.

We are also now seeing a regular flow of new M&A coming to market. Private equity buyers are more comfortable buying and selling assets as the gap in buyers’ and sellers’ expectations begin to converge. That trend is fuelling activity in the core middle markets where the pipeline has grown substantially. There are noticeably more transactions being announced and a much larger pipeline – so a brighter outlook compared to where we were at the end of 2023. 

Given trends in the loan market, I would expect pricing to tighten in the direct lending market over the next several quarters, although a healthy illiquidity premium will remain. As of the first quarter, average yields have tightened from 7 per cent over Euribor to 650 or 625 basis points over Euribor. By the end of the year or early 2025, I’d expect to see some deals coming at Euribor plus 600 basis points or below. This shift in pricing is really a normalisation of terms after a particularly toppy few years. Even now, all in yields (including Euribor) are close to 11 per cent, and that’s on the higher side compared to historical levels. For those who have invested capital in the market across several cycles, it has been difficult to understand how the market could stay at these levels long term, so it’s reassuring to see a return to normality. 

We’re also seeing some sponsors try to push on terms, particularly leverage levels as they move to put dry powder to work. We now regularly see bids asking for starting leverage ratios of five times senior debt to ebitda and above. For the moment lenders appear to be holding strong, but with the pressure on to put capital to work, that could change. 

- Marc Preiser, Portfolio Manager

Structured credit

• Strong figures prompt bank research desks to increase annual issuance forecasts 
• Pipeline of deals remains robust going into second quarter as returns stay relatively attractive
• Concern that some CLO investors will fill up on deals early in the year, pushing down the technical bid

The first quarter of the year saw high issuance volumes in the CLO primary market. To March 18, there had been 19 new European deals – including new vehicles and resets - totalling just over €8bn. Full year 2023 activity reached €26.2bn[3], and many investment banks’ research desks had forecast volumes of €25bn for the whole of 2024. But given how busy it’s been in the first quarter – traditionally one of the quieter parts of the year – already we’ve seen some banks' forecasts increase to around €30bn. 

The flurry of supply is unlikely to slow down in the second quarter. One arranging bank estimated there were 69 warehouses from 47 managers open at the end of March. Not all of these prospective situations will result in issuance, but it’s a good sign for the pipeline of activity.

There are a few dynamics that I believe are driving this surge of issuance. Firstly, although pricing has become tighter – triple-A spreads have come in from around 170 basis points over Euribor last year to 150 basis points over now – they are still quite attractive on a relative basis, while the arbitrage on equity tranches works well too. 

We’ve also seen renewed interest in the equity of deals from traditional third-party buyers that had been inactive for quite some time due to the recent volatility. While the floodgates have not completely opened, I’m now cautiously optimistic about their return, and how they could drive new deal supply. 

Finally, of course, the ongoing flow of deals in the senior secured loan market is supporting the strength of new CLO issuance in Europe. With more direct lending deals being refinanced into the broadly syndicated market, and with more private equity-backed leveraged buyouts expected in the second half of the year, there should be more paper available for these new CLOs to buy. The improved macroeconomic outlook and general tightening of credit spreads have also helped the flow of CLO issuance. 

What about risks to CLO activity? It’s important to remember that this is a very technically-driven market. CLO buyers might fill up on this glut of early supply. In portions of the market where there tends to be more of a reliance on a few large investors – I'm thinking of the AA and A-rated tranches – we could start seeing some weakness in demand with certain deals having to price wider to attract interest.

- Cyrille Javaux, Portfolio Manager

[1] European Private Equity Breakdown, Pitchbook, January 2024

[2] According to data from LCD Pitchbook

[3] According to data from Pitchbook LCD