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Josie Shillito

This article is part of our new service, 9fin Private Credit, which will soon require a separate subscription to view. For more info on this product and the accompanying database, contact subscriptions@9fin.com

As 2023 comes to an end — with the last deals signed, chaotic Christmas dinners survived, new years resolutions set (eat healthier, stop smoking etc) — we are looking towards the new year with high hopes.

After what was a rather slow year in terms of M&A activity, the market is united in expectations of a 2024 uptick in M&As, as the dry powder in private equity will need to be spent.

“Buyers and sellers can only wait so long,” said Goldman Sach's Amit Bahri. “They need to return the money to their LPs. We’re now fortunately at the end of the inflation cycle and at the end of the rate hiking cycle.”

This could mean many different things for private credit. Alcentra's Joanna Layton said the optimism means a change in deal terms, with increased leverage, while Clearwater's Chris Smith thinks deal terms will hold, but that a greater variety of companies will come to market. 

As for PIK, almost everyone agreed it will be present in debt structures as interest rates hold.

Layton said: “We will probably see people needing to be a bit creative with PIK tranches or holdco PIK with people being cautious about over leveraging the business from a cashflow perspective.”

Many believe we will see more bank clubs. PWC's Adam Horey said he has seen more interest in bank clubs among sponsors. This began at the tail end of 2023 with the financing of KKR's take-private of Smart Metering Systems, where BNP Paribas, HSBC, NatWest, and Sumitomo Mitsui Banking Corporation underwrote a £1.4bn debt package. 

But others predict the presence of bank clubs will be limited. 

“On the larger end of the spectrum, some originate-to-distribute transactions have burnt certain banks with losses and I cannot see appetite coming back with the same strength as we saw in the last decade,” said Pictet's Andreas Klein. 

Indisputably, there is plenty of dry powder in private credit, which will service the higher demand for financing. 

In the absence of M&As in 2023, there was a rise in GP-led secondary solutions to provide liquidity to LPs. Coller Capital's Michael Schad thinks this will grow, while others, such as Layton, are sceptical.

And what will happen to pricing? Most of the market believes 2024 will not bring any adjustment in pricing, although competition could pressure pricing for the very best deals.

9fin spoke to a selection of debt funds, lawyers and advisors in both primary and secondaries on their expectations for the new year.

“Next year should be a better year for deal activity,” Horey, partner of the debt and capital advisory business at PWC, said, highlighting that the advisory firm have already prepared a number of opportunities, ready to hit the market in the new year.

“Borrowers, in our view, have now accepted the interest rate environment — there seems to be a general acceptance that things aren't going to change any time soon.”

“Leverage multiples have come down and I think they will remain at current levels. One of the dominant focusses for lenders is cash generation and the ability of borrowers to service their debt. We have seen across the board that leverage is down a turn to a turn and a half. The fact that multiples have softened is not a bad thing, the market was very frothy 24 months ago.”

In terms of sectors, Horey doesn't believe much will change, despite the more optimistic outlook. He thinks direct lenders will continue to focus on financial services, business services, healthcare, and TMT. 

“I cannot see that changing in 2024,” he said. “Anything that is consumer focussed or faces off to the consumer market in anyway will remain difficult.”

As for bank clubs, Horey has seen greater appetite from sponsors, suggesting they will become more relevant in the new year. 

“Some wouldn't even entertain a bank club 24 months ago,” he said. “Now, most sponsors we talk to are interested to know what a bank club solution might look like. Banks are also being innovative at the moment and are looking at ways to increase their ticket size to be more relevant to sponsors.”

“I think we will see an uptick in the number of transactions won by banks, in one shape or another. In the US for example, a number of partnerships between banks and investors have been established, to provide larger ticket solutions for borrowers, these are essentially pre-agreed clubs.”

When it comes to pricing, Horey does not think the positive outlook will lead to much change.

“I don’t believe pricing will reduce further in 2024,” he said. “Of course, the strongest credits will continue to attract competitive all in pricing, but I can’t see the direct lending market experience an across the board reduction in margins.”

Chris Smith, partner at Clearwater International

With a unique view of the many refinancings and LBOs that come to the UK market, founder of the debt advisory business at Clearwater International, Chris Smith, believes we’ll see a 2024 rebound in activity, particularly from the lesser-loved sectors of 2023.

“While in 2023 it was mostly those businesses with high recurring revenue and proven resilient sectors that transacted, in 2024 we’re going to see businesses that aren’t necessarily ‘A-grade’  beginning to get traction,” Smith said. “While 2023 was sector-driven, private equity is now considering good businesses in sectors outside of tech, healthcare and financial services.”

“We’ve seen some leisure businesses now, some travel businesses, gym groups. All these businesses have been incredibly resilient. But what is particularly remarkable is that lenders are again considering consumer deals. Particularly experiential or health-related consumer,” he said, citing holiday parks.

This is buoyed in part by stronger macroeconomic indications, with forward curves on interest rates coming down. However it’s also supported by consumer behaviour. 

“There’s still not a huge amount of personal debt in the UK, and consumers still have money,” he said.

Outside of consumer, Smith is bullish about more recruitment business financing. 

“2023 was an appalling year for recruitment as the tech sector cooled off. But as things start to settle in 2024 resilient recruitment businesses should hopefully be able to refinance. It’s a sector with a lot of buy and build potential.”

With new market confidence, comes the return of absent friends to the market: banks. 

“High street banks have been very busy,” said Smith. “Banks are now doing dividend recaps, which hasn’t been seen for quite a while,” said Smith. “In private equity, no one is looking to financially engineer or overleverage, so they are increasingly looking to bank solutions for lower and mid market.” 

He cited 3.5x as the leverage quantum below which banks would enter.

Despite new market confidence, Smith is not expecting huge changes in pricing and terms.

“Pricing and terms never changed [in 2023] anyway,” he argues. “Instead, the market’s been binary: deals either got done or they didn’t.”

Joanna Layton, co-head of private credit at Alcentra

Layton joins the other in an optimistic outlook for the new year, also expecting to see more M&A deals: 

“A pick-up of M&A is the first thing on everyone's mind for the new year,” she said. “Many transactions have been launched to market, albeit quite softly as private equity wants to be confident in valuations and available financing. We believe there are a lot of assets ready to launch, but it is more likely to at in the end of Q1 to early Q2 than at the turn of the year.

“The back of 2023 saw some increased leverage. Mid 2023 we were firmly saying 4x-5x — probably more towards the 4x level. Coming out of the year, good quality assets are seeing 5x-5.5x. We will probably see people needing to be a bit creative with PIK tranches or holdco PIK with people being cautious about over leveraging the business from a cashflow perspective.”

Layton is seeing lenders providing flexibility through PIK toggles, a feature that has been in the market for a while, but without borrowers needing to use them. 

“With rates staying high, it's starting to be used a bit more.”

On pricing expectations, Layton said: “With large club-style financing I think we'll see margins at around 575bps and done on a cov-lite basis, In the mid-market, it depends on the continued discipline of the market, but so far lenders are not giving up covenants. We're looking at 625-650bps in terms of pricing in the new year I think.”

Continuation funds have received a lot of airtime lately, but Layton has not seen many actually happen: 

“The assets that tend to be left in a fund tend to be a bit more tricky and then the question is is it really a compelling offer to investors to take a discount on those? I believe there's a solution there, but I'm not sure the market has worked out what that is and what is a good result for the underlying investors.”

Michael Schad, head of private credit secondaries at Coller Capital

In contrast, Schad of specialist secondary market investor Coller Capital sees a rise in GP-led solutions such as continuation funds. 

Positively impacted by the dearth of LBOs in the private credit primary market, private credit secondaries have gone from strength to strength in 2023, with a rosy outlook for the coming years. According to Coller Capital, the total addressable market is $2.4trn and volume is expected to reach $50bn by 2026, representing a turnover rate of 1% of the private credit market.

“Liquidity solutions for private credit are an important trend,” said Schad.

With M&A volume low, private equity and private credit funds are under increasing pressure to return money to their LPs, propelling the ascent of GP-led solutions like continuation funds. Moreover, as the asset class develops, “people need liquidity”, Schad noted, referring to evergreen private credit funds that need to maintain liquidity reserves to allow investors to enter and exit, as well as asset durations in private credit now pushing out to as long as eight years.

“In credit, by its very nature, a loan, you can’t extend the duration of an asset into infinity,” said Schad.

The growing size of private credit secondaries means the shape and quality of the market is changing. Where once it might have been populated by smaller managers and more concentrated pools of capital, it is now home to larger managers with diversified pools of capital.

As the market grows, so will the product offering.

“In credit secondaries we will see more defined products,” said Schad. “We will also see greater sophistication in how managers approach portfolio construction, what they offer to investors.”

The private credit secondaries market is underpinned by the strength of the asset class. 

“Private credit is attractive as it offers a good return” said Schad. “It’s decoupled from the public markets where you’ll see more stress and volatility.”

Florian Feder, managing director at Rantum Capital

Managing director, Florian Feder, believes 2024 is the year when higher interest rates will be fully reflected in the LTM cashflow numbers of borrowers.

“Combined with stagnation in the economy, debt service coverage ratios will approach or breach 1.0x in many cases,” he said. “New deals will only tolerate modest amounts of cash interest leverage.”

“We expect high demand for our junior PIK loans and pref equity structures in these situations and will transact where underlying business models are fundamentally sound and where we like the risk/return profile. Times will get better eventually.”

Frankfurt-based Rantum capital has three private debt funds, focusing on financing Mittelstand companies in the German-speaking countries.

Amit Bahri, co-head of European direct lending at Goldman Sachs

For Goldman Sachs, the 2024 LBO opportunity is tremendous — in particular for private credit.

“The best crystal ball is Q4 2023 this year,” Amit Bahri, co-head of European direct lending, told 9fin.

In fact, 9fin recorded a €10bn increase in deal volume over the third quarter of 2023 alone — driven by large-cap deals.

Goldman Sachs led or co-led the financing of four of Q4 2023’s largest deals: The €4.5bn debt package backing Permira and Blackstone’s acquisition of online advertiser Adevinta, the €375m unitranche behind Apax Partners’ carve out of consumer insights business WGSN from its parent company, Ascential, the covenant-lite €390m unitranche supporting CVC’s acquisition of French digitalisation services provider Sogelink, and, the most recent: GGW’s €950m financing to back Permira’s acquisition of the German insurance broker, including a €675m covenant-lite unitranche.

“M&A volumes are back up, and private credit is still the go-to source for for all of these LBOs,” said Bahri. “It’s a compelling debt proposition, attractive from a cost of capital perspective and with structural flexibility.”

Bahri cites the “snowball effect” of big deals like Adevinta in encouraging further private credit activity. In addition, a few “structural phenomena” are putting pressure on buyers and sellers. 

“Buyers and sellers can only wait so long,” said Bahri. “They need to return the money to their LPs. We’re now fortunately at the end of the inflation cycle and at the end of the rate hiking cycle.”

Now that the recession is no longer modelled as a downside case, Bahri expects a greater number of deals from cyclical sectors to enter the market.

“In 2023, what we saw was a flight to safety,” he notes. However, Goldman Sachs would avoid these cyclicals. 

“We choose the thematic sectors we are comfortable with and we back the largest players there,” he said. “Credit quality is everything.”

Goldman Sachs’s flagship direct lending strategy starts evaluating assets above €50m EBITDA, with a sweet spot at deals of €100m EBITDA or more. The global investor is putting its money where its mouth is. It plans in the medium term to double the size of its $110m private credit unit.

Andreas Klein, head of private debt at Pictet

This year, Geneva-headquartered private bank, Pictet, announced the very first close of its European lending fund at €200m. The European Direct Lending Fund I will focus on lending to European mid-market private businesses.

Joining Pictet last year to head up its private lending business, Andreas Klein is entering 2024 with optimism and new opportunities awaiting for his fund.

“A key feature of 2023 was lower M&A volume, particularly on the private equity side due to the wide price gap between expectations between bidders and sellers, which has in turn had a drag on credit volumes,” he said.

That gap is narrowing as the macro outlook is increasingly converging with a view towards a softer landing and a mild — if any — recession, he added. That brings a level of comfort to unlock a bit more M&A activity, a key driver of private credit demand.

“Fundraising in 2023 has been hit by a bit of a 'let's wait and see' stance,” he said. “Rates rises of this magnitude have not been seen since the 80s, so the market seemed to be waiting to see what knock-on effect they were going to have on the wider economy. However, it feels like a convergence of view in 2024 might compel some investors to move more money into risk assets like private credit where the downside protection is still high.”

With regards to PIK notes, Klein struggles to see the value for both lenders and borrowers. 

“With PIK pricing at 15%+ it has a strong drag on returns for the equity but does not offer a material yield premium to lenders,” he said. “Do you really want to subordinate yourself in a levered structure with few control rights for an extra 3-400 basis points?”

Unlike Horey, Klein believes bank clubs will remain difficult. Firstly due to the continuous capitalisation pressure on banks' balance sheet, especially with the new Basel regulations coming through, and with the amount of dry powder for credit funds in need to be deployed.

“On the larger end of the spectrum, some originate to distribute transactions have burnt certain banks with losses and I cannot see appetite coming back with the same strength as we saw in the last decade. So although bank clubs will always exist to some extent, I personally see private solutions continuing to take market share.”

When it comes to dividend recaps, we will likely not see an increase. 

“I think we will see a lot of refinancing of over leveraged balance sheets that will need some sort of equity injections or subordinated debt to plug the gap,” he said. “Taking capital off the table will be the exception rather than the norm.”

“Continuation funds on the other hand, I do think we will see more of,” he continued. “The investment cycle has clearly lengthened and sponsors need to think how to extract the best value of those assets. It might take longer to extract that value, so the increasing use of continuation funds and financial solutions such as holdco NAV financing is definitely something I can see.”

Luis Felipe Castellanos, private debt managing partner at Alantra

Castellanos, who heads private debt at advisory services business Alantra, believes 2024 will depend on two variables: interest rates and investors-interest in illiquid assets.

“While 2023 has provided the perfect storm, 2024 seems to offer more opportunities for private credit fundraising,” he said. “Bond prices are falling and so LPs are returning to the alternative market. Many PE funds will need to sell company portfolios and show performance in order to raise capital.” 

2024 is going to be a year of transition and of improvement, he continued, adding he hopes activity will truly take off in 2025.

“All in all, I think we have reached rock bottom and the only direction from here is upward — I expect an increase in activity in 2024, marking the gradual climb out of this downturn.”

“The rise in interest rates has caused that the debt servicing that companies can afford is lower than two years ago, thus leverage has gone down. Consequently, debt structures have become more secure since 2021. In Spain, we have always tended towards structured operations with covenants, guarantees, board observer seats, and similar measures, that were not often seen in the broader European market.”

In terms of pricing, Castellanos believes the market it normalising and rates stabilising after having fallen around 50bps, now standing at around 650bps. 

“I believe we will see pre-crisis pricing in 2024 as investors achieve additional profitability due to the increase in the Euribor.”

Richard Kitchen, partner at King & Spalding

Calls for a soft landing are growing in volume, but Kitchen, based in London for international law firm King & Spalding, is circumspect about the way the markets will head. 

“In the US, everyone is calling for a soft landing right now, so the market is racing ahead and rate cuts are priced in for as early as March next year,” he said. “Inflation has come down meaningfully, labour markets aren’t showing much weakness, and corporate earnings are ticking along just fine — so the market seems to think the unicorn of a soft landing is going to be the most probable outcome.”

However, Kitchen said he remains slightly pessimistic given the severity of interest rate hikes, knowing the effects can take a while to filter through to the wider economy. 

“There is still room for some unknown, hidden gremlins in the system to show up,” he said.

“But if the soft landing materialises, and there’s no guarantee that Europe will follow, but if Europe does I think M&A activity will increase as the valuation gap continues to narrow and deal certainty improves. The capacity of banks and direct lenders to finance deals will definitely be there, they’re sat on plenty of money and are ready, willing, and able to deploy.”

“The best crystal ball is fourth quarter 2023” — 2024 private credit outlook

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