On the back of COVID, transactions in the European middle market are showing decreased leverage levels, stronger documentation and improvements in pricing—suggesting a rebasing of the market from where it has been for the past several years.
The private credit market that has emerged in the wake of COVID looks somewhat different, and in some ways more attractive, than that which preceded the pandemic. Specifically, in the months following the initial shock, the quality of deals coming through, broadly speaking, has improved, with many exhibiting lower leverage levels, tighter documentation and better pricing. In our opinion, these are encouraging signs for how the market may continue to develop in a post-COVID world, and suggest that we may continue to see higher quality opportunities going forward. However, with a number of uncertainties on the horizon—including around the pandemic itself—we believe a disciplined investment approach, with a focus on capital preservation, will be crucial.
Key Market Movers
There are a number of key drivers shaping the opportunity in private credit today. Many of these have been apparent in the market for a number of years, but have been exacerbated or enhanced as a result of the pandemic.
Over the last decade, increased financial regulation in Europe has continued to limit the lending activity of banks, creating a gap in the market for direct lenders to fill the shortage of capital. As a result, non-bank lenders have continued to grow their market share—from roughly 40% two years ago to just over 60% today.1 And we do not expect this to wane anytime soon. In fact, institutional market share in Europe remains well below that in the U.S., where it is closer to 90%, suggesting there is further room to grow as banks continue to pull back from middle market lending.2
At the same time that supply has been decreasing, demand for private financing—particularly to support buyouts—has continued to grow. Indeed, as of August, dry powder in Europe had reached a record €194 billion.3 This suggests that even as regulatory pressure and challenging market conditions on the back of COVID have impacted banks and other lenders, borrowers and private equity sponsors continue to seek financing solutions and certainty of execution from non-bank providers.
1. Source: AlixPartners Mid-Market Debt Report. As of December 31, 2019.
2. Source: S&P LCD. As of Q1 2020.
3. Source: Preqin.