Welcome to Taking the Credit, 9fin’s weekly observations on the issues affecting the European private credit market. To get these updates in your inbox each week, sign up here.

Let’s open with a facetious comment: if European private credit is a market where some firms can raise €30bn through a classic private equity-style vehicle, then why bother with raising capital in any other format?

If it’s not broke, why fix it? There’s a valid argument to be made that private credit funds should stay exactly as they are in drawdown structures offering investors extremely limited liquidity (reflecting the nature of the private credit asset class).

But there is an alternative in the shape of private credit CLOs. Granted it’s just a speck on the private credit AUM landscape, with Barings so far the only firm to reach the milestone of issuing a European private credit CLO, having done so in November.

But, as pointed out by speakers on 9fin’s private credit webinar this week, the private credit market is going mainstream and CLOs could play a key role in that evolution.

“It’s another source of financing that will enhance the liquidity and depth of the private credit market,” said Tikehau Capital’s head of private debt, Cécile Mayer-Levi.

That means that it might be worth all the time and resources that goes along with raising private credit CLOs. And to be clear, there is a lot of hard graft involved…

Portfolio dilemma

One of the issues that CLO managers have to wrap their head around is how to create portfolios that are diverse enough to satisfy rating agency criteria. Mayer-Levi felt there is enough depth in the European private credit market to overcome this hurdle and create CLOs with exposure to 50-60 underlying names.

She pointed out that, in this respect, evolution has been underway for some time, with early private credit funds investing in roughly 30 names, whereas now we are seeing deployment into 60-80 names from a particular vehicle.

Barings Euro Middle Market CLO 2024-1 had targeted exposure to 61 unique obligors, according to an S&P ratings report.

There are other levers to pull in order to create granular and diversified portfolios, such as a bucket for broadly syndicated loans, and even creating space for sterling-denominated assets.

Of the 61 credits Barings had outlined in its target collateral obligations, 16 were classified as broadly syndicated loans. “Syndicated loans can help,” said Nicholas Nedelec, partner at Eurazeo. “The question is how small can we go in terms of company size, because that would be a way to improve diversity.”

Those smaller company loans would also support a CLO’s weighted average spread. The balancing act CLO managers face is whether this has too much of an impact on the CLO’s liabilities and, therefore, their ability to execute such a transaction.

A CLO component for sterling loans would open up a vast market, but Mayer-Levi described this as a “currency paradox”, pointing out the UK market is one of most active in private credit, but the BSL and private credit CLO market is, and will naturally be, euro-denominated.

There will be a need to solve for this, but currency hedges within a CLO construct are difficult to put together, and quite costly.

Perhaps another paradox created by CLOs is that of flexibility. CLOs are rules-based products, but private credit has prided itself on being able to provide borrowers with flexible financing options.

“It is an important part of private credit,” said Nedelec. “We’re supporting companies over the long haul. You don’t want CLOs to become rigid to the point you are losing all the benefits of having a direct lender on board.”

He pointed towards private credit lenders being able to provide acquisition facilities and delayed draw loans, with these instruments not being snug fits within a CLO construct. (In small portions such assets could be digested by CLOs given the advent of delayed-draw CLO tranches that have emerged in the last couple of years.)

What lies ahead?

The next set of private credit CLOs that follow Barings will likely attempt to add upgrades and reinvestment flexibility is an obvious area to target (the Barings CLO is static).

Andreas Botterbusch, senior credit officer at Moody’s Ratings, said on the webinar that outright trading of private credit loans in a secondary market is likely some way in the distance, but there should be scope for private credit CLO managers to make changes to their portfolios.

“Deals might gain flexibility to replace assets that are maturing, perhaps by adding another loan from the same borrower,” he said. “It might be a while before we see enough liquidity to see active trading of loans.”

European private credit loans have been tagged as buy-and-hold assets, but it needn’t be that way. In fact, CLOs can be the agents of change. A benefit of CLOs becoming a more prominent part of the private credit machine is that these vehicles can drive liquidity in private credit loans. Before you know it, there might even be a vibrant private credit secondary loan market.

There will be some flaws to iron out no doubt — Mayer-Levi warned that “you cannot have a growing market if there is not some form of harmonisation in terms of valuations” — but these are the sorts of growing pains that the industry should expect to face as a consequence of entering the mainstream.

How big of an opportunity is this?

That’s the golden question. Some rough arithmetic led our panellists to conclude that, conservatively, at least 10 private credit lenders having the capability to be repeat CLO issuers in Europe.

Nedelec pointed out that if these 10 were to issue one €400m private credit European CLO a year, suddenly that’s a €4bn a year market.

In the US, private credit CLOs (or middle-market CLOs) have built a ton of momentum in recent years. In 2024, 9fin data shows that 35 US managers priced new private credit CLOs with volumes reaching $38.3bn. That’s about 19.1% of overall US CLO new issuance figures with BSL CLO issuance amounting to $161.2bn courtesy of 105 managers.

But for context, our data shows that in 2011, US private credit CLOs accounted for only 4.1% of overall US CLO issuance with $540m in volumes (two managers) while there was $12.4bn of US BSL issuance (27 managers).

European private credit pipeline

This week at 9fin towers we reported on Blackstone looking to sell its 30% stake in HH Global with three private equity firms circling.

We also uncovered a special sit with Netceed looking to carve-out parts of its subsidiary Amadys. Netceed, a TLB issuer, had been in focus this week after its loans dropped 20 points into the mid-40s as one of its lenders sold its position.

And Ares, fresh from announcing its mega private credit fund, has put forth a debt package as part of the carve-out of DCC Healthcare in a deal which could have been at risk of landing in the syndicated loan market.

You can read our weekly updated pipeline of new and in-market deals here.

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