Credit investing across Europe – a tailored approach

A flexible offering and established track record remain key in the European lower mid-market, say Investec’s Helen Lucas (co-head of UK origination), Alexandre Neiss (head of Benelux origination) and Kai Stengel (head of DACH origination).

As you look across your key markets of the UK, DACH and Benelux, what differences do you observe in terms of corporate landscape?

Kai Stengel: We are seeing societal changes having a sizeable impact on the corporate landscape. Germany is characterised by family businesses, and generational change has been on the agenda for a while. Where the previous generation of entrepreneurial families could afford a certain level of conservatism and inertia, the younger generation is looking to major topics such as digitalisation and an international focus for their businesses to survive in competitive markets. As a result, there is now an increased desire to partner with private equity, which brings expertise to support businesses through the next stage of development.

Helen Lucas: In the UK, the societal shift is less pronounced, with private equity ownership a well-established part of the lending ecosystem. Instead, the focus from businesses is on streamlining and rationalising operations under the current economic environment to position themselves for future growth. As a result, we expect to see leaner, more robust businesses, which should lead to a much-improved period of growth in the longer term, but we are not there yet.

Alexandre Neiss: The Benelux region is a highly growth orientated entrepreneurial market. We continue to see high volumes of buy-and-builds, evidenced by more than 35 percent of deals over the last three years being in support of add-ons. This suits our breadth of offering at Investec, where we can support the growth of our borrowers through providing a senior product and stretching through the capital structure to stretched senior and uni-tranche products.

Which sectors present the most opportunities for private credit in your core markets?

KS: We have seen higher volumes of strong corporates in the software and technology sectors in the DACH region – sectors we like, given the resilient nature of these businesses, with stable financial track records that can perform through cycles.
In the healthcare sector, there has been some regulatory noise stemming from comments made by the German health minister. However, we still take a positive view on this space and believe there are strong opportunities to continue to support healthcare platform investments. The sustainability space has picked up recently, and we draw on our wider platform credentials to add value to sponsors and management teams.

HL: The story is similar in the UK. In addition, we are seeing a lot of buy-and-build activity in accountancy and legal services, where the critical nature of these businesses provides attractive credit characteristics. There is not the same nuanced political issue around healthcare, however we do approach it with caution as inflationary challenges, particularly relating to personnel costs, have impacted some businesses in the sector. But there are still borrowing opportunities for businesses that can demonstrate resilience and a strong track record in this space.

AN: We find sectoral trends tend to be similar across our key markets, which is a benefit to leverage sector expertise to support the diligence and underwriting process when evaluating transactions. For example, in the Benelux region, we’ve seen platform investments in vets, dental, healthcare services and the current focus is on accountancy – not dissimilar to other regions.

The key read across from all sectors, for us, is embedded in credit fundamentals. We proactively target growth businesses in defensive sectors, deliberately avoiding highly cyclical sectors as well as businesses with high operational gearing and concentration risks embedded in their business models.

How does the competitive landscape differ for direct lenders in each region? What does that mean for terms, pricing and returns?

KS: Things are quite dynamic in the large-cap and mid-market segments. Twelve months ago, with the interest rate uncertainty, leverage reduced, terms improved and pricing increased. Since the start of the year, this trend has started to reverse somewhat, and hot assets have been financed at higher leverage levels and with lower pricing.

In the lower mid-market however, where we focus, the competitive intensity is still much lower as larger players have moved out of this segment and deal volumes are higher. In this segment of the market, sponsors and family owners still shy away from high leverage levels, focusing rather on finding a lending partner that can support their growth ambitions through all conditions.

HL: In the UK, as rates have risen over the last two years, we have seen the reappearance of banking clubs as borrowers became increasingly sensitive to the cost of capital. Like the DACH region, increased competition at the start of this year has impacted pricing and terms.

AN: While the European lending market understands macro themes, localisation across Europe is important for winning mandates. It’s not just about the terms; dedication to the local market and similar-sized businesses is valued. We have been investing in the UK lower mid-market since 2010 and in the Benelux and DACH regions since 2014 and 2016, respectively. We believe our long-term commitment to our key regions differentiates us from competitors.

Finally, how do you see each market developing in relation to private credit?

HL: There is a bifurcation today across Europe with high levels of competition for the strongest assets where the lending is readily available and executed quickly, but with anything more complicated it is taking longer.

Looking forward, we are starting to see borrowers adjusting to operating in a higher rate environment. M&A activity is starting to pick up, although this may not result in a large uptick in completions until the latter part of this year.

AN: Over the last two years, we have seen an adjustment to deal structures with leverage levels reduced, pricing increased and more lender friendly terms. As mentioned, we are already starting to see some of these features erode, predominantly due to the low deal activity and more constructive capital markets for larger corporates. It remains to be seen if leverage will reduce to a more fundamental level when deal volumes increase or if lenders will accept higher gearing ratios in the quest for deployment.

KS: The lower-mid market remains different due to the size of the businesses and where they are in the corporate cycle. This means market indicators are less relevant and each deal needs to be underwritten based on its own merits. We don’t see this changing going forward, even if wider market metrics such as leverage and pricing change.

We have always had a fundamentals-based approach to credit investing. Across our 14-year track record, we have focused on low leverage attachment points and developing a deep understanding of the businesses we support, the motivations of management and the drivers of that sector. We are committed to the lower mid-market across our key regions, where we believe there remain strong opportunities for experienced and dedicated managers.

The first real test for private credit is upon us – as is the strongest vintage potential. Read more in our Challenges and Opportunities series below: