It is one of the great unknowns, but one that often acts as a thermometer: the private debt market. When this river dries up they are usually bad omens for the economy. And what happens now in this segment within Europe? Basically, the European private credit sector remains strong in the second half of the year, despite an unstable economic context and continuous rate hikes. However, the weakness of some corners of the market underscores the importance of being prudent, according to the exercises.
Rising interest rates raise the amount that companies have to pay to service their debt. In 2021, private companies dedicated around 23% of their ebitda to debt service, while this year the figure has risen to close to 36%. This not only means companies have less capital to devote to capex and growth, but will also trigger a modest rebound in defaults in the coming year, according to PwC research.
“Although the wall of maturities is coming down, we also anticipate that some companies will have difficulty refinancing with higher yields in the coming years, which will pose more challenges,” they comment from Fidelity.
At present, it is the traditionally more stable sectors (such as telecommunications or software) that bear the greatest leverage, and those that are having the greatest impact from the decline in interest coverage ratios. “Of course, when problems arise, it is unlikely that they will be specific to a specific sector, but will rather affect companies in which there are idiosyncratic credit challenges,” they say from JP Morgan in a report.
The outlook is not bleak everywhere. The same study reveals that more than half of companies are deleveraging, and despite the higher interest burden, most can still access liquidity through their revolving credit facilities (RCF). Only around 15% of these lines are being tapped, suggesting that companies still have plenty of flexibility to weather the storm and even prosper.
“With yields approaching double digits for profitable strategies and conditions becoming more favorable for lenders, we believe that the next 12-18 months could bring a lot of trading for investors”, comments disfidelity
The maturity challenge
In the second half of 2023, VCs look set to focus on managing their upcoming maturities as rising rates increase refinancing costs, a trend we’ve seen in the second with a flurry of change deals and expansion that have extended the term of existing agreements, according to experts.
“We are seeing many organizations take an active approach to managing liquidity and leveraging their portfolio companies through capital injections… For example, in early June we saw SVP inject €150 million into its portfolio company Kloeckner Pentaplast”, recall JP Morgan analysts.
The Issa brothers and TDR Capital are also providing capital to support Asda’s takeover of EG Group stores, along with privately placed debt and sale and leaseback. This transaction should allow EG Group to refinance the huge wall of 2025 maturities that it is currently facing.
On the other hand, it is observed that borrowers go to the market in search of opportunistic corporate operations, either to liquidate RCF or to finance smaller M&As.
A vast majority of these trades are now placed privately, as borrowers prefer the certainty of placing a trade to trying to get an extra 50 basis points on top of the original issue discount if they go public. This has been seen in operations such as those of Socotec, IU Group, Stada and Nemera during the second quarter.
Meanwhile, the extension of the maturity wall in Europe, combined with the improvement of liquidity positions through RCFs and the support of sponsors, offers some optimism for the second half of the year, balancing the increase in defaults that could wait as conditions become more difficult and interest rates continue to rise.
The activity of the European Primary Market during the first half of the year was reduced to 18,300 million euros, compared to 25,800 million in the first half of 2022. with a volume of long-term acquisition financing operations that has fallen to 3,200 million euros so far this year, compared to 13,300 million euros in the same period of the previous year.
“There remains a mismatch between buyer and seller valuation expectations, and while the gap is narrowing, we don’t expect the pace of M&A funding in this space to increase before the end of this year or at the earliest,” Fidelity completes its analysis.
