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Liquid credit refis become next frontier for direct lenders as public markets remain in limbo

Private credit funds are eyeing up the refinancing of liquid securities, such as syndicated term loans and high-yields bonds, as the next avenue for the direct lending industry’s expansion. With public markets having a limited capacity to provide financing amid heighted market volatility, some argue that private credit can become a major new source of capital to refinance.

Private markets taking financings out of the public sphere is no new phenomena, with private credit funds focusing predominantly on new debt issuance backing LBOs, as reported by this news service last week. But with some USD 16.8bn-equivalent of broadly syndicated European leveraged loans with due dates in 2023 and a further USD 58.4bn maturing in 2024, as well as EUR 48.8bn and EUR 55.5bn of European high-yield bonds maturing in 2023 and 2024, respectively, according to Dealogic data – and choppy secondary markets making the job of syndicating banks increasingly difficult – some private credit investors see a new role for themselves developing.

“There will be space for private markets to take share, in terms of refinancing larger companies,” said Michael Dennis, Partner and Co-Head of European Credit at Ares Management, one of Europe’s largest direct lending funds.

“You have started to see the emergence of direct lenders of sufficient scale to provide relevant financing solutions to these larger borrowers, and in some instances provide attractive alternatives to what capital markets have to offer,” he added.

Whether or not private credit will become a serious player in refinancing liquid debt largely hinges on how open public markets are next year. Borrowers will typically look to refinance maturities 12 to 18 months ahead of time, although the timeline has been increasing as refinancing conditions have deteriorated.

“I think as we see shorter-term maturities approaching we might see more [borrowers turning to private credit funds], and there is clearly liquidity with direct lenders,” said one senior leveraged finance banker.

Activity in the primary market already suggests that a number of borrowers believe access to syndicated funding may be intermittent next year. The Luxembourg-headquartered telecom group Altice International, the UK sports betting business Entain and the French medical diagnostic firm Sebia have all recently closed amend-and-extend exercises, targeting maturities between 2024 and 2026.

“An important question is, what is the underlying appetite among the existing investors in the institutional space to amend and extend? Whether that appetite will take some of the refinancings out of the system is to be seen. I think it will account for some of it, but not all,” said Ares’ Dennis.

Some borrowers have already taken the decision to remove public securities from their capital structure for fear that refinancing costs will be too burdensome. AS Roma, the Italian football club, announced in October that it was redeeming its EUR 275m 5.125% August 2024 senior secured notes, raising the financing for the redemption outside of public markets.

A question of cost and quality

Despite the favourable market conditions for private credit, its offering may not be for everyone when it comes to syndicated debt refinancings. While borrowers might prefer the greater certainty of execution entailed by the private nature of direct lending, pricing could be an impediment in the months ahead.

Private credit funds had previously been happy to finance buyouts with pricing in the 6%-7% territory, but given the decreased supply of bank debt, the margins for private credit have shot up by at least 2%, making the instrument less accessible, a debt advisor and a high-yield investor said.

Just a year ago, there was little-to-no gap in pricing between liquid and private debt markets. But with unitranche pricing stretching to nearly 10%, public markets, when open, still remain the cheaper go-to option, especially among cost-conscious corporates, the debt advisor said. Therefore, if refinancing with a bank isn’t an option, the company would first look to amend and extend.

Borrowers unable to amend and extend, if not refinance, are likely to spark concerns over the quality of the credit and the outlook for the business. If public markets are not willing to take the risk, there is no certainty that private investors would.

“I'd be particularly cautious if you don't get A&E,” said one direct lender, who argued that with a potentially onerous interest rate from a debt fund, the financing might not be economical. “You really need to see what the equity portion is, and leverage will have to come down.”

Although some are now comparing private credit funds to lenders of last resort, they are naturally becoming more selective when it comes to deploying.

Only substance will make the cut

Unlike the pandemic outbreak two years ago, inflationary pressures on consumer spending and the energy crisis precipitated by the ongoing war in Ukraine, means governments can’t step in as easily. With little hope for state support, direct lenders need to scrutinise any potential refinancings of liquid credit even more.

“You’ll need to look to see if there is substance in this company,” the debt advisor said. “If you’re willing to bet on that, come in on a super senior basis and believe that you’ll be out of the woods once the company turns the corner, then you can invest. But how many of those we will see?”

Another question is whether borrowers want to refinance maturities entirely with private credit funds, or through a mix of public and private securities. This in turn affects which funds would consider the financing. “We would be slightly nervous [to share a credit with other lenders], in that we would want to be able to control the capital structure of the companies,” said Dennis. “Our strategy is to be sole or the controlling lender to the companies in which we invest.”

Ultimately, the extent to which private markets are able to offer cost-effective solutions, or greater certainty of execution and more flexibility, in comparison to syndicated financing will determine the extent to which further deal flow will be diverted away from Europe’s leverage loan and high-yield bonds markets.

“If you want certainty and deliverability of financing, then you go to private markets because you are speaking to the institutions that are holding the asset, not an intermediary,” said Dennis. “The capital markets will come back - whether that is early 2023 or late 2023. But irrespective of that, companies are now choosing private markets, not just because of price, but because of certainty of execution or confidentiality.”

Mid-market picks

In the UK, Oxford International Education Group’s owner THI Investments is working with Marlborough Partners on a refinancing of the UK-based pathway provider. The sponsor is seeking to reduce its cash commitment after acquiring the business in an all-equity buyout.

Clyde Munro’s private equity backer Synova has mandated Investec to guide an auction of the UK-based dental group. The asset is expected to be marketed off annual EBITDA of up to GBP 10m with informal discussions taking place with prospective suitors ahead of a formal auction process.

Ireland’s MCR Group, the facilities management provider, saw prospective direct lenders present sponsors with initial leverage indications of 3.5x–4x ahead of non-binding offers that were collected in November.

In France, MediaSchool’s backers Florac Investissements, 123 Investment Managers and Golda Darty Partners have hired Eurvad Finance to guide an auction of the for-profit higher education provider in 1H23, which is expected to be marketed off annual EBITDA in the region of EUR 20m–EUR 25m.

Carlyle and CNP are among sponsors admitted to the second round of bidding for Vespa-owned Cleeven, the France-based engineering and technological consulting firm. With an enterprise value in the region of EUR 400m, prospective lenders are questioning the extent to which it should be levered – suggesting a sizeable equity cushion could be required.

The sale of French Piercan, a protection gloves manufacturer for the nuclear and pharmaceutical sectors, saw multiple sponsors preparing indicative offers which were due at the end of last month. The business is marketed off around EUR 11m EBITDA.

Meanwhile, potential lenders have been pitching leverage of between 4.25x and 5x for Netherlands-based traffic construction safety specialist Buko. Scheybeeck Investments-backed Buko is being marketed off circa EUR 20m of EBITDA in the Lincoln International-run auction process.

In the German-speaking region sponsor Partners Group will stick with incumbent financier BlackRock to support its buyout of German digital transformation services specialist Cloudflight. Opening leverage on the business was 5.5x on around EUR 25m EBITDA implying a debt quantum of close to EUR 140m to support the buyout.

The first round of bids for DPE-backed VTU Group is expected to be collected before year-end. Financiers have submitted indications for the Austrian engineering services business, and leverage on the business is hovering around 4.5x, with both banks and funds pitching. VTU is being marketed off EUR 20m to EUR 25m in an auction run by Houlihan Lokey.

Just kicking off is the sale of Flexim, a German industrial ultrasonic flow meter specialist with marketing materials circulating among private equity and trade buyers. Commerzbank is guiding an auction process for the privately-held business which generates between EUR 15m and EUR 20m EBITDA annually.

Meanwhile, Germany’s Findos has mandated Carnegie to exit its portfolio company FFW, a Danish digital consultancy. The sale should commence in the early part of 2023.