Introduction

The economic outlook remains choppy and uncertain. Inflation is still a challenge, costs of capital continue to rise, while at time of writing there are concerns of contagion in the banking system following the fall of Silicon Valley Bank. 

But despite the gloom we see opportunities here. Across private credit in the medium-term, we expect activity to increase as M&A gradually picks up, as refinancing requirements grow, and with bank retrenchment from corporate lending accelerating there is a lending gap in the mid-market for others to step into. Added to which, as the cost of capital increases across the board – exacerbated by the fallout from the failure of Silicon Valley Bank – banks’ behaviour is only likely to become more risk averse. That will feed through to more attractive risk-reward opportunities for private credit. 

While banks’ increased risk aversion is likely to see them step back further from leveraged lending and other specialised loan products, they are expected to continue to deploy capital in the longer term where there is less credit risk, such as in residential mortgages, consumer loans, and triple-A tranches of CLOs. As some of the biggest buyers of triple-A rated debt in the structured credit market, we believe banks’ appetite here is likely to return over time and continue to drive activity.

With a senior secured position in the capital structure and a floating rate nature that mitigates volatility, private credit provides a noteworthy diversifier for investors. With a more lender-friendly vintage of deals, lower leverage levels, better protections, and more attractive docs available, the coming quarter presents a particularly interesting time for the asset class. 

– Michael Curtis

Senior Secured loans

There are few expectations of a flood of large buyouts, and a limited supply of new paper could continue to overemphasise the technical bid. 

• Market fundamentals have shifted – expect an attractive vintage of deals when they come.
• Defaults will be limited, but ratings downgrades and dispersion will increase.

The European leveraged loan market has chipped away at the worst of the near-term maturity wall. The volume of debt due to expire by 2026 has been reduced to around €47.8 billion[1], of which €19.5 billion is rated B- or lower. Most of the larger or more complicated maturities that had been scheduled to expire imminently have been dealt with through refinancings or extensions. On some of these deals investors were offered higher yields or better terms, while elsewhere third-party equity improved leverage ratios. These terms reflect widespread rising yields currently on offer across the European market, and we believe the upcoming vintage of transactions will be particularly attractive to investors.

The primary markets remained relatively quiet in the first quarter of 2023 with only €6.59 billion of issuance reported in Europe to March 16, down from €18.70 billion in the same period last year. However, the technical bid for paper is still strong as the CLO market remains busy (see structured credit section below), and we anticipate that the flow of opportunistic deals will increase. Already in the first quarter we have seen add-ons and even dividend recapitalisations driven by reverse enquiry. The strong bid is driving performance here: for example, single B-rated Eviosys increased a term loan add-on to €400 million from a planned €350 million as a result of demand for the deal in primary syndication. The transaction was completed at the tightest end of pricing guidance. 

This trend is likely to continue towards the second half of the year, in large part because we do not expect any imminent flood of new paper. There are few large buyouts visible on the horizon because of a mismatch in expectations between private equity buyers and sellers. However, sponsors report that this gap is beginning to diminish as the pressure grows to deploy expanding reserves of dry powder.

We do not foresee a large uptick in default rates, but for the rest of the year downgrades could become more prevalent as corporate and consumer cash flows are squeezed. This will prompt a repricing of risk for those issuers as funding costs rise and operating environments become more complex.

– Camille McLeod-Salmon

Structured Finance

The sustained flow of new CLOs seen in the first quarter of the year is likely to slow in Q2, but there are no signs that issuance will stop. 

• The pricing rally may be at an end but triple-A spreads should remain around E+200bps in the primary market.
• Deals will become more differentiated as downgrades start to impact loans.

The price of triple-A rated liabilities on new European CLOs tightened by a remarkable 70 basis points over the first quarter of the year as the wider market rally finally caught up with structured credit. After deals at the end of December 2022 were seen at around E+235 basis points, the tightest triple-A print to date for a non-static CLO came at E+165bps. Terms have tightened across the entire ratings stack, while some vehicles have even brought back the single-B tranche, which had until recently been deemed too expensive. 

The rally early in the year prompted a number of managers with almost full warehouses to press ahead to price new deals. Overall, some €5.9 billion of issuance from 16 deals was completed in the first quarter to March 13. However, we now believe that there are fewer than 10 well-ramped warehouses ready to be priced heading into the second quarter. While most of the transactions that had been close to completion were printed in the first three months, other warehouses for which the arbitrage no longer worked have been dissolved and assets sold through the secondary loan market. Although we think the pace of issuance will slow, we still expect to see deals come to market in the second quarter. 

Concerns about further rate hikes and ongoing inflation have, however, prompted some softness in the market. Despite this wariness, we do not anticipate AAA spreads in the primary market to cross back very far into E+200bps territory. Rather we expect to see an increasing differential in pricing between vehicles. Already in the primary CLO market, the first quarter has seen triple-B rated tranches price between E+450bps and E+600bps - a 150bps differential that has not been seen over the past two years. Increasingly, as the number of downgrades (or even defaults) of loan assets begins to rise, even more tiering between transactions will emerge. Credit selection will become all the more important, especially at the junior end of the debt. 

– Cyrille Javaux

Direct Lending 

• Some cautiousness is emerging as a result of the weak macroeconomic picture. 
• While the shift to a lender-friendly paradigm should not be overstated, we have seen an improvement in documentation, with the provision of two covenants on deals increasing.
• Competition remains fierce at the large-cap end of the market, with direct lending continuing to be a viable alternative to syndicated lending.

The European direct lending market is heading into the second quarter of the year with some cautiousness. Against an ambiguous macroeconomic backdrop and with questions circling around monetary policy, some direct lenders are feeling less bullish than in 2022, deploying less capital and at a slower rate. 

But this is not to say that appetite for the product has eased: money continues to flow into the market – particularly at the large-cap end – with some big US funds now turning their attention and firepower to Europe. At the top end of the market, we expect direct lenders to continue to encroach on the traditional syndicated lending space. We have already seen several examples of large-cap transactions being taken down by clubs of direct lenders, such as the financing package backing Clayton, Dubilier & Rice's acquisition of British supermarket group Morrisons, and in the US the $5.5 billion unitranche facility supporting Carlyle’s acquisition of healthcare technology firm Cotiviti (the largest deal of its type ever recorded). 

Slowing M&A could hamper supply volumes, although it’s likely we will see more add-on acquisitions that could be happily swallowed by direct lenders. Bank lenders continue to be nervous about underwriting buyout deals – particularly with new European regulation pushing them to tighten their leverage definitions. Direct lenders can provide the certainty financing sponsors will be seeking to get acquisitions done. 

Overall, there is a sense that transaction volumes in the European direct lending market are down over the first quarter, although there are different stories playing out across the region. There is some caution regarding the UK, given the ongoing high inflation levels and risk of recession. And while that region is always going to be one of the largest sources of direct lending deals in Europe given the number of private equity firms operating there, we believe it could shrink relative to its European counterparts over time. In contrast, we’re seeing a growing interest in direct lending across France, Benelux, and the Nordics, where activity is gearing up. There’s also a widening acceptance of the product in Germany, although the regional banking network there remains strong, continuing to provide borrowers with an attractive alternative to direct lenders.

– Marc Preiser

  [1] All data quoted in this piece sourced from Leveraged Commentary & Data (LCD)