Despite claiming a growing share of the leveraged finance market, direct lending could be in for a challenging period as Europe teeters on the brink of recession. This is not necessarily bad news for private debt as a whole.
While private debt deal activity held up strongly throughout the first half of 2022, there were signs of a slowdown towards the end of the year.
According to the most recent edition of Deloitte's Private Debt Deal Tracker, the number of European private debt deals in Q3 2022 fell by 15.7% compared with the same period in 2021, and by 11.1% compared with Q2 2022. Market participants agree that activity in the final quarter was lower still.
In part, this has been driven by managers approaching full deployment on existing funds, making them more selective about where they place their remaining capital.
This has been exacerbated by a tough fundraising landscape. Managers including Bridgepoint, MV Credit, Permira and Eurazeo, for example, have taken longer to raise their new flagship direct lending funds than anticipated.
Yet the wider macroeconomic picture suggests market conditions could be ideal for alternative forms of private debt, namely opportunistic strategies and distressed debt. Inflation was running at more than 10% in both the euro area and the UK in November, according to official figures.
Central banks' base rates are also much higher than they have been for some time. Hard times are surely on the horizon for some portfolio businesses with floating rate loans.
A number of managers appear to have been preparing accordingly. In August, London-based manager Zetland held a €620m final close for its second pan-European distressed debt fund.
Other managers including Carlyle, Arrow Global, Monroe Capital, Incus and Stafford Capital Partners have launched or held closes for opportunistic or distressed vehicles.
For those that have timed the market correctly, the impending challenging economic conditions should provide ample opportunities for strong returns.