Private Debt Investor: Junior Debt Opportunities Set to Shine

Over the past few months, the European syndicated loan market has roared back to life, and private credit’s junior debt segment is reaping the rewards. Robin Doumar, managing partner at Park Square Capital, tells us that the market’s revival creates exciting opportunities for junior debt lenders to be part of financing solutions alongside syndicated senior loans.

However, Doumar warns that managers need to be disciplined to succeed in junior debt lending in the face of a volatile macroeconomic environment.

How is the reopening of syndicated markets affecting the private debt market in Europe generally, and the junior debt market in particular?

From a junior debt perspective, we have been through a slow period after the syndicated loan market became dislocated a couple of years ago. Sponsors knew it was not the right time to sell most assets, so the amount of new issuance was limited, and the pace of deployment
was slow.

Now that the syndicated loan market has recovered, it is white hot, with margins compressing. With a number of CLOs ramping up their portfolios, they have bid the secondary loan market to very aggressive levels. As a result, the combination of a low-cost syndicated
senior loan and junior debt has become very attractive. The junior debt opportunity, mathematically, is much more appealing today than it was 18 months ago.

Typically, Park Square is part of a comprehensive solution where there is a senior component and a thinner, junior component. With the market where it is now, it makes much more sense to undertake a large transaction with a very attractively priced syndicated senior
loan that has junior debt behind it.

The simple explanation is just maths: the market has reopened and we are at least back to a historically normal level in terms of syndicated loan market pricing. There is more M&A activity, which is very positive, and the pricing dynamic has changed dramatically. Overall, the syndicated senior loan market’s snap back to health is absolutely fantastic for junior debt.

How are refinancing and deleveraging activities affecting the junior debt market?

As base rates have moved dramatically in the past couple of years, there are a lot of high-quality businesses dealing with a cash paying interest burden that is higher than the businesses and their private equity backers would like. Therefore, we are being called on to provide a solution to deleverage the debt with junior capital. While some might think of this as rescue financing, it’s actually about optimising the capital structures to create more cash pay headroom.

Another theme we are seeing driving the junior debt business in this volatile environment is that private equity firms are holding assets for longer. However, in many cases, their LPs want a faster return on their capital. So, private equity firms are coming to us and asking
if we can help them to recapitalise their business to allow them to pay a dividend and keep their LPs happy, while continuing to hold the assets.

To what extent is the risk of defaulting increasing?

We are seeing relatively healthy performance in Europe and, in general, the quality of European borrowers tends to be higher than their counterparts in the US. Private equity tends to operate in sectors such as high-quality industrials, software, business services and healthcare, where there are many examples of stable and predictable business models. On the other hand, sectors that are more cyclical are going to see a fair amount of pain; managers who have exposure to consumer-facing sectors such as restaurants or gym chains are going to have issues.

Of course, we are in a higher interest rate, slower growth environment, and after a couple of years, inevitably, things are starting to bite. Our portfolio has performed very well, but in this environment, it is more difficult for management teams across the board to execute on basic things. To address this, we’re seeing private equity firms changing out management teams more frequently, and where perhaps complacency has crept in, they have not moved quickly enough to rein in costs, or they have not passed through price increases quickly enough.

May 2024