Global credit rating agency Fitch Ratings is anticipating greater competition in the private debt market as a lack of deals forces all credit providers to compete for the same financing opportunities.
Despite this, Fitch expects private debt providers to retain pricing power in the less competitive part of the European leveraged credit market, targeting smaller issuers.
The firm said it was already seeing private debt funds form clubs of lenders among themselves and their limited partners to underwrite large leveraged buyouts.
“We may see collateralised loan obligations (CLOs) of private debt arriving in Europe soon, as they seek funding flexibility, allowing them to use more leverage to compete on lower coupons and meet return expectations,” the firm said.
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Moreover, Fitch said central banks’ rate cuts will represent a challenge for all debt providers, including private debt, which may need to add more leverage on assets with lower coupons, or move out the risk spectrum to garner higher yields.
The firm said that since the fourth quarter of 2023, a reduction in inflationary pressures, peak interest rate sentiment and resilient operating outlooks for most sponsor-owned European businesses have improved the landscape for all types of leveraged credit products.
Fitch said the recent launch of large volumes of highly leveraged CLOs, sustained high-yield bond fund inflows, and record levels of private debt fundraising means financial sponsors will have a wider choice of funding sources than at any time since the private equity industry developed in Europe in the 1990s.
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Fitch recorded only nine primary market LBO transactions in 2023. It said this scarcity partially reflects tighter underwriting standards, although a large gap between the enterprise valuation multiples of what buyers of businesses are willing to pay and sellers willing to accept is still the main reason.
Primary market activity was noted to have increased in early 2024, supported by a recovery in syndicated markets, with the valuation gap narrowing. Fitch expects M&A activity to pick up in the second half of 2024, but the pipeline will still be limited.
Meanwhile, all credit providers will continue to vie for refinancing opportunities. Private debt now appears more expensive than other options.
“While private debt providers may lower coupons, there have already been large private debt covenant-lite unitranche transactions priced at about Euribor + 500bp; however, there is a limit to the spread compression between illiquid unitranche and tradable and less-levered syndicated TLBs,” the firm said.
“We see the decision for borrowers as more likely to be based on a trade-off between price, which will remain higher for private debt, and the more flexible terms these lenders can offer.”
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