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Synne Johnsson

The first half of 2024 has been a tale of economic uncertainty, political turmoil, and a continued sluggish M&A market.

With the return of the syndicated markets this year, combined with the scarcity of new deals, there is fierce competition for the few good credits coming to market.

Adding to the difficult deployment market, elections across the globe leave the political future of a number of major economies unknown. In the UK, on Thursday, Labour is expected to win and to regain the power it lost back in 2010.

How would Keir Starmer's expected premiership affect the market? How have the economic challenges impacted private credit? And when will the M&A market finally come back?

Stuart Brinkworth, European head of leveraged finance at Mayer Brown, answered to some of these questions sitting with 9fin over a glass of Chassagne-Montrachet in London, talking elections, distress and — as a sommelier — his favourite wines.

1. What three words would you use to describe the first half of the year for the private credit market?

In no particular order, cautious, innovative and under deployed.

The market has been cautious for a while and it remains so. Geopolitical issues, elections, political instability, tax uncertainty… It's a difficult market to deploy in, especially because interest rates haven't come down as we expected. Clearly the inflationary pressures are lessening, so the environment is improving, but it has a way to go to be a bull market.

In this kind of market, you have to be innovative. Both sponsors and funds are being much more innovative about how they deploy. We're seeing funds take small amounts of equity in deals and trying to offer flexibility within the products they offer. They're not necessarily coming in with a straight term loan B unitranche, they're coming with some kind of PIK tranche option, some kind of quasi-equity.

We're also seeing PE funds giving guarantees for portions of the debt, like the RCF for example. There's still a lot of equity commitment-type letters as well. Sometimes the cap structure needs some underlying help to get it away.

2. UK elections are coming up. How do you think the results will affect the market?

In the short-term, I don't think there will be many changes. I think we're going to end up with a government with a big majority, so at least that brings certainty. Whether it's a certainty a lot of people want is another thing.

At the moment, there is a lot of mood music around private equity and carried interest, but that seems to be softening. It seems like Labour has some appreciation for the importance of the industry to the economy and so hopefully any changes will not harm the industry.

Longer term challenges are going to be around the degree of public spending, government debt and taxation. Whatever Labour currently says, I think it's still an unknown in the longer term how that will play out. It's clear that there is a funding gap in the economy, whoever wins the election.

To me, growth — or lack of it — will drive policy in the next Parliament. It's a challenge for whoever wins the election. If a Labour government can't achieve growth quickly, how will they then achieve a high spending budget environment? Especially given their policy on energy transition. It will only mean one thing and that is that taxation will have to start going up. That will then not be conductive to growth.

3. What are the main trends you are seeing right now?

The bottom line is that there's less leverage available and cost of debt remains an issue. Sponsors also don't want to have as much leverage because debt is twice as expensive as it was two years ago. Therefore, they have to be much more creative around their capital structures in order to be competitive in transactions.

It often isn't as simple as writing bigger equity checks. Clearly they can do that, but in terms of achieving return, that isn't the way of doing it over an entire portfolio. So they have to be much more flexible and much more creative as to how they raise money.

As I mentioned earlier, we are seeing more complex capital structures, different blends of tranches, different types of debt and quasi equity. PIK and similar products are becoming more popular as means of achieving the same equity check as you would have, but without borrowing 7x through TLB at the start of the transaction.

4. Why haven't we seen a lot of dividend recaps?

Dividend recaps rely on maximisation of leverage as an alternative exit. If you can't achieve maximum leverage, then there's probably not much to be gained in refinancing if you're not paying out much of a dividend, but incurring fees and resetting non-call — unless you extend maturity.

The business where we have seen dividend recaps are businesses that have actually de-levered and are at 2 to 2.5x, therefore a 5x deal seems worth it in terms of the money you can take out and the fees you incur for doing it.

A lot of businesses can't recap because they are over-levered and haven't been able to de-lever through cash or EBITDA growth. We just aren't seeing those dynamics in play because of inflation, interest rates, cost of living et cetera.

The lack of recaps is mostly sponsor-driven. If it's a good credit, it's a good credit, so from a lender perspective why not do it?

After the financial crisis dividend recaps were off the table for a while, mainly because it was banks, not funds, lending at that point. Banks took a very strict view that they didn't see sponsors taking money off the table. Funds are much more pragmatic in their views. They want to deploy and if it's a good business and if it's the right capital structure, they will — if it means there's a dividend going out, they don't really mind.

5. How is the stressed/distressed situation in private credit right now?

There's definitely more distress around this year than there was last year.

With the ongoing high interest rate environment, we've seen the consumer/retail sector continue to struggle in particular.

But we're seeing distress across the board, whether it's lower, mid or upper mid market, and across multiple sectors. You still have businesses that maybe two or three years ago took a lot of debt on, which are now struggling because of that combination of debt, interest rates and increasing costs — so there's just a lot of over-levered businesses out there.

We are still seeing a lot of amend and pretend where people are saying “OK, we'll give you some relief for a year in the hope of economic environment changes and improves, alongside you making some changes to the business and putting some money in to support the business.” I think it works, but only for deals that still have a fair bit of runway to maturity.

For deals that are closer to maturity, it is much harder to take that approach, so we are seeing funds taking ownership of businesses, particularly where the sponsor is not necessarily willing to continue supporting the business.

Maturity is going to be as big of a challenge to sponsors as distress is, particularly as we go through the next two to three years and if the credit market remains quite tight.

Credit funds are equipped to deal with stress in their portfolios and are in a much better place to than banks. Banks only have one way to deal with distress, which is to write down to zero straight away and see what they can recover in the immediate term. But that approach is actually quite value-destructive. Funds come at it from a very different perspective, it's much more about retaining value in the business over a longer term and they are much more flexible in how they achieve that, including through ownership or additional equity.

6. What are covenants like in the private credit mid-market now?

In some deals we are occasionally seeing cash flow cover creeping back into deals in addition to leverage. Headroom is definitely tighter than it was. Lenders are trying hard on documentation to limit add-backs, but we are still mainly seeing sponsor-friendly documentation.

Overall covenants haven't changed much other than around the edges in terms of things like add-backs and pro-forma — lenders are more cautious around that, but again: on a good credit where there's intense competition, sponsors are in a good position to push better terms.

Lenders would rather do a good deal on bad docs, than a bad deal with good docs.

I don't really think covenants are getting too loose. We are seeing stress where covenants are having the desired impact. I think we've seen enough breaches and enough covenant resets to indicate at least that covenants are having the effect they're designed to have.

7. With the return of the syndicated markets, are you seeing more competition in the mid-market?

We have seen a lot of lenders who were mid-market lenders step into doing much larger private credit deals, but I think they have to come back now. They were doing that opportunistically, particularly when the secondary markets were trading as low as they were — there was just a great opportunity to deploy capital with massive discount to par, so why wouldn't you take that opportunity?

But I think that was only ever going to be a temporary gap-filling and we're now seeing people coming back to what they traditionally did before, which is mid-market lending.

There is certainty more available liquidity in the mid-market now, but the reality has been that because there's a lack of really good quality credits, whenever a good credit does come to the market, there's just massive competition for it. That's just inevitable.

There has definitely been an increase in M&A activity and we are busier with new money deals than we have been for a while. However, I think it will continue to be a challenging environment because of the backdrop of two elections, ongoing war, and the political situation. We now have this volatile political situation in Europe to add to the mix. I don't think we're suddenly going to see an explosion in the market this year, especially with the interest rate environment not being as favourable as everyone had hoped it would be.

So I think it will continue to be an improving market, but a bull market is still some way off.

If Labour were going to come down hard on private equity and change capital gains tax, we might see a flurry of deals before the end of the tax year for people to crystallise gains. Although on current rhetoric that looks unlikely.

9. As a certified sommelier, what is the best bottle of wine you've had?

One is a bottle of Domaine Romanée-Conti, which lived up to its billing as the world's most expensive wine and an utterly phenomenal Burgundy. I'm not a massive Burgundy enthusiast, but that one completely blew my mind. It wasn't even a top Romanée-Conti, it was an entry level wine — although still relative in terms of price.

Then secondly was a bottle I had on holiday. You often remember the wine because of where you had it and who you had it with. I had this wine in Sicily in a village called Erice. I loved the place, it was a very high point with amazing views over the coastline.

The wine was called Mille e una Notte 2015, and is produced by Donnafugata, one of my favourite wine producers.

It was just a beautiful wine with a beautiful steak, and it was a beautiful sunset and a romantic dinner. Idyllic. Whenever I see a bottle of that wine, it takes me straight back to where I first had it.

Sicilian wines are amazing. It's an amazing place to grow wine, with a really unique terroir, and they are often great value.

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