The Outlook for U.K. Private Debt

With Europe concerned about the long-term impact of the war in Ukraine as well as the likelihood of recession, the private credit and equity market is wondering what’s next. Globally, transactions are down from 2021 levels, despite nearly $2 trillion in private equity dry powder. Competition is increasing, with banks reported to be developing global private credit strategies.

To find out what this all means for the private debt market in the U.K., Xavier Le Faucheur, GLG’s Head of Strategic Projects, Private Equity, recently sat down with Paul Hatfield, an independent consultant and former Global Chief Investment Officer at Alcentra. Highlights of their conversation, edited for space and clarity, follow.

As an overview, can you tell us some of the trends you have observed so far this year in the private debt market?

To start with, this has been an interesting time in the direct lending private debt markets. A great deal of money has been raised, and private equity players have been massively active. We’ve seen some very large deals, around $2 billion, with firms buying whole deals themselves or teaming up in ways reminiscent of the old club loan market.

With so much demand from investors, and with the power that private equity has, we’re probably going to continue to see pressure on terms. Several private equity houses have said they have struggled to earn decent returns, given some of the recent stratospheric valuations. Some sectors, in fact, have become extremely overbid and less attractive, but the pressure to put their money to work has kept private equity in the market.

Which sectors do you see as providing the greatest opportunities given those macro conditions?

It depends on how you define opportunities. In tech, software remains very popular because it throws off steady cash flow. But valuations have become very stretched, creating challenges to generating the kind of returns investors are looking for.

Sectors that are energy heavy and can’t pass on higher energy costs may as the result provide opportunities for distressed investment. Food, aerospace, and chemicals, for example, are going to be unattractive, unless you’re talking distressed. Then you’ve got the Netflix effect. If people are cutting things like Netflix to manage their cost of living, you’ve got to believe that they’re going to be cutting back on holidays, leisure, and even on things that aren’t luxuries. We haven’t seen much new business in the way of the retail sector, but I think it’s going to be even less attractive as a sector now.

What do you see specifically in the U.K. market?

We’re seeing signs that the U.K. market is reaching maturity. So many deals have been done for such a long period now that it’s getting to be a bit like the U.S. market, where finding any low-hanging fruit is difficult.

While the U.K. is less dependent on Russian oil and gas than other European countries, the price of those globally has gone up anyway, and we also have other issues. Brexit doesn’t seem to be throwing up massive cost savings or benefits, and as you layer on rate rises and other cost increases, we look to be in for a testing time for deals in the U.K. market.

What about the entry of new competitors in the form of banks starting their own private credit businesses?

It does seem that banks see an opportunity in the market. Their biggest problem, according to most investment bank team leaders, is staff retention and staff costs. Even when they offer people all sorts of incentives, they’re still finding people are getting bid away. Of the major banks, Goldman has been the most active. They can do on-balance-sheet deals, and they can invest clients’ money.

Anecdotally, they’ve done some deals at low margins. But they are very active. I haven’t seen or heard much about Barclays, HSBC, Credit Suisse, or Deutsche Bank yet. With aggressive players like Goldman, you’re going to see pressure in terms of deals, margins, fees, and covenants. They’ll be wanting to win deals.

How will that affect the non-bank lending market? Will it stagnate or plateau, at least in the short term?

You would expect that to be the case considering all the talk of banks coming in and packaging deals for the retail market. Getting retail investors into direct lending is tricky. You can do a funds-of-funds type structure for private equity investments, but the debt side is just too illiquid; it’s not really a safe area for retail investors to play in. So, demand is likely to remain more institutionally based and this will support the non-bank market.

What do you see coming for the rest of the year?

We’re at a kind of tipping point. While I don’t believe we’ll see conditions like those in the ’70s, where inflation hit 25% for a brief period and mortgage rates went to 14% and 15%, we are at a point where investors find fixed income less attractive.

The high-yield market continues to suffer from investors taking their money out and from increasing yields. Some of the sectors that have been huge in high yield — such as food, for example — are going to suffer. It’s not going to be a pleasant couple of years in the high-yield sector, which will face pressure in many ways.

That’s why I see rotation out of fixed income into private debt continuing. At the same time, there will be pressure on deals in terms of structures and stress within the deals, which will create opportunities for distressed outside of retail. Overall, the high interest rates that are coming will play into private debt’s hands, given its floating rate nature, if the players have money and their portfolio is strong.

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About Paul Hatfield:

An independent consultant since 2018, Paul Hatfield served as Global Chief Investment Officer at Alcentra from 2003 to 2015. Earlier, he was Senior Analyst at Intermediate Capital Group and Vice President, Leveraged Finance at Deutsche Bank.

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This financial industry article was adapted from the GLG Teleconference “U.K. Private Debt — Market Update and Outlook.” If you would like access to events like this or would like to speak with technology financial experts like Paul Hatfield, or any of our approximately 1 million industry experts, please contact us.

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Questions Asked During the Teleconference:

• What are the drivers for direct lending activity and for the private equity trends driving events so far in 2022?
• Which sectors do you see as providing the greatest opportunities given macro conditions?
• How are energy ties with Russia shaping activity in the U.K. market for the deployment of private equity cash?
• What is the impact of new entrants, including banks, in the private credit business?
• What is your outlook for the non-bank lending market, for new funds and for fundraising?
• What evidence are you seeing for the rotation out of bonds into private credit?
• What’s been happening with margins, fees, and leverage?
• Have covenants changed in the wake of the Russian invasion of Ukraine?
• In which areas are we likely to see defaults in the U.K. over the next 12 months?
• What do you see the likelihood of private equity reducing in its dominance as a driver of direct lending activity?
• What is your outlook for direct lending activity, for distress and high yield?