European banks bite back mid-market share as funds chase larger deals

The private debt market has grown at a rapid pace in recent years, and is now believed to total roughly $1.5 trillion globally, according to sources. But as debt costs rise and leverage appetite reduces, sponsors are rediscovering an increasingly competitive offering in the European mid-market from bank clubs, which even threatens to take some share back from funds.

Bank lending — which seemed to have been written off in the private credit boom — is now clawing its way back as higher margins and base rates make some private credit funds look expensive and selective, especially for many sectors at the smaller end of the market.

In the European private credit market in the year to June 30, bank clubs (comprising multiple bank lenders on a single deal) accounted for 14% of the lender types on transactions, according to LCD, versus a share of just 2% in full-year 2022. Sole bank lenders on private credit deals have also increased, from 2% of deals last year to 5% in the year to date. Conversely, sole alternative lenders and alternative lender clubs have declined from a combined 72% of transactions last year to 59% this year, as banks grabbed a larger market share.

Funding gaps
Such figures don’t mean the deployment of private credit funds has slowed down. But amid the so-called ‘golden era’ for direct lending, funds have increasingly concentrated on filling funding gaps in the upper echelons of the market, especially given the uncertain bid from syndicated loans over the past year or so.

Indeed, in the last 12 months to the end of June, the total transaction volume for European buyouts — which includes all sources of financing for LBO deals recorded in the syndicated market — fell to €20 billion. This figure is just over half the level recorded in 2022 at €38 billion, and is well below the €96 billion volume generated in 2021, with the market suffering from jitters about deal risk following the outbreak of war in Ukraine.

Meanwhile, private credit has become the route of choice for sponsors on buyouts, at a ratio of 4.7x in favour of private credit over the broadly syndicated approach.

Big tickets
"As mid-market credit firms raise larger funds, their ticket sizes are increasing, and they are therefore looking to do larger deals, as smaller deals involve the same amount of work (if not more), and would require a greater volume to deploy the fund,” said Sophie Pollitt, director, Debt Advisory at Lincoln International. "Due to this, more and more fund managers have shifted their focus to swallow large deals either bilaterally or as part of a club."

As a result, private credit funds have become less reliable, and have also become more selective on the traditional mid-market away from core sectors.

“Unless the borrower can be classified as being in healthcare, critical business services, industrial tech, software or the like, there is much less appetite from mainline credit funds,” said Patrick Schoennagel, managing director at Houlihan Lokey’s Capital markets group and head of sponsor finance, EMEA.  

Schoennagel notes there used to be a time when private credit would do deals that banks wouldn’t. “That’s almost reversed in the current market,” he said, adding that's partly due to existing and potential new LP investors that are being marketed to by credit fund managers as part of their fundraising efforts. “Now, there are many situations where most regular-way credit funds are not interested, and traditional banks are more constructive,” he said, adding that for mid-market borrowers, unless a credit fund has pressure to deploy then it has become much tougher to get lenders in sectors that aren’t seen to be as resilient as others.

Meanwhile, funds are also showing signs of caution amid a step-up of covenant breaches in their portfolios, added another advisor. 

Take, for example, ECM’s investment in One Hiring, which was supported by financing from German savings bank Sparkasse Rhein-Nahe, or the acquisition of Spanish fruit distribution company Frutas Boll, which was financed by a club composed of OLB, BBVA, Caixabank and Novobanco, among others.

Most recently, one of the largest such deals in Italy this year was for non-food discount retailer Acqua & Sapone, which signed a €495 million loan through a club of banks led by Intesa Sanpaolo in a deal that takes out a private credit financing. 

Sweet spot
Following the collapse of SVB in March this year, the deals mentioned indicate a return of risk appetite among banks to underwrite deals from their own books — albeit in smaller sizes. Indeed, market sources say banks via club or bilateral transactions have found their sweet spot at companies with EBITDA of roughly €5-20 million.

A large European debt advisor, which is in the market with 27 deals, expects nearly half of them to feature a debt solution, versus last year when it estimates 85% of such deals would have gone to private credit funds. Sponsors are finding that while direct lenders can offer larger amounts of debt-to-equity in deals, banks are able to compete on price.

Looking at purchase price multiples on LBOs in the broadly syndicated European market, these reached 10.6x on average in the year to June 30, the lowest multiple since 2017, whereas equity accounts for 47.3% of deal structures on average, which is the highest such share since 2020.

As the market is generally taking a more cautious approach to leverage and looking to solve for debt serviceability metrics, the gap between bank and fund structures is narrowing, notes Lincoln International's Pollitt, while adding that sponsors are challenging the benefits of paying another 2%-plus to a fund to get the same or slightly higher leverage in some cases. "A bank club is looking more favorable in today’s market as borrowers have become increasingly focused on the cost of debt," she said.

Banks are pricing their deals at roughly E+425-450 for a term loan A and E+450-475 for a term loan B, market sources suggest, versus pricing for a unitranche at around E+625-700.

Furthermore, banks realise they can be more competitive now because some factors are swinging in their favour. “We are definitely having more bank clubs lined up as potential options on deals now, which may have been just a fund play last year,” said Pollitt.

Active regions
Of the countries that accounted for the bulk of the sponsored broadly syndicated volume in the year through June 30, France, DACH, the Nordics and Italy are among those markets where banks are most active for direct lending, according to debt managers and advisors.

Take for example Italy, where 70% of deals for €5-150 million EBITDA companies are done by banks, while the remaining share is picked up by direct funds, according to an advisor that focuses on that market. “There are about 12-13 commercial banks in the space that are active in LBO financing,” the advisor added.

Another advisor said the UK is starting to see more bank clubs come to the table for deals. “This is partly due to a reduction in leverage appetite from lenders and borrowers, hence bank structures are becoming applicable in more instances,” they noted.

In Germany, meanwhile, there has been a resurgence of bank clubs on smaller deals. “In Germany, both options (banks and credit funds) are still very much accepted,” a German lawyer told LCD.

Rounding up in France, the local press has reported that Agic Capital acquired a majority stake in French packaging specialist PureTrade Worldwide from Sparring Capital, in a deal advised by Rothschild. The company was sold for €140 million, and the financing was provided by a club of banks including Banque Palatine, Caisse d’Epargne d’Ile-de-France, and BRED, as well as private credit players including CIC Private Debt and Muzinich.

Featured image by Mike Hill/Getty Images

This article originally appeared on PitchBook News