When a German direct lender was pitching a debt deal to a £20 million EBITDA company alongside a senior club of other banks, it was outmaneuvered by a large lender offering a single unitranche package. The sole lender then provided the majority of the financing to the firm with loose covenants, no repayment requirements, and no caps on adjustments.
In another instance, an €11 million EBITDA company secured financing from a large direct lender with cov-lite terms. “I was surprised to see those terms, and this isn’t an isolated case — it’s becoming more common in the market,” said an advisor.
Such cases illustrate the new reality of the European leveraged buyout market. While the ‘golden era’ of the private credit asset class — supported by a dislocation in public markets following Russia’s invasion of Ukraine — has led to significantly larger private credit tickets, these bigger transactions in the 'upper market' are now less accessible for many direct lenders. Meanwhile, the resurgence of the broadly syndicated loan (BSL) market has made it that much more difficult for those lenders.
That situation is exacerbated by muted deal flow this year, and many private lenders are now increasingly turning to smaller deals, taking the view that “small is beautiful” as they aim to deploy the plentiful dry powder they’ve raised.
Sharp focus
This pivot has brought the middle market into sharp focus for Europe's lenders and private equity sponsors. In the pursuit of getting deals done, large private credit firms are now extending their terms and pricing to include the lower part of the market. This dynamic is in turn creating challenges for traditional middle market lenders, who find it difficult to compete unless they also compromise on protections. “Private credit managers talk a good game about competition with the broadly syndicated market, but the reality is they’ve lost significant business to the BSL this year,” says a private credit advisor.
Harriet West, private credit partner and member of the Global Finance practice at Proskauer, confirms that private credit managers have faced increased competition in the large-cap space this year, with the BSL and high yield bond markets back in full flow. Due to this competition, she says lenders that had previously gone up the market in terms of deal size in the last 18-24 months are now moving away from that space and setting their sights lower. “This has facilitated the trend of decreased pricing and documentary deal terms creeping into the middle market on the hotter assets, and even to the upper end of the lower middle market,” West adds.
The increased focus on the middle market amid sluggish deal flow has fueled intense competition among Europe's players. “For companies with EBITDA over €10 million, it’s now a completely different world with so much competition,” explains Kirsten Bode, co-head of private debt, pan-Europe at Muzinich & Co., while noting this situation has led to an erosion of both terms and pricing for lenders.
Price point
Indeed, market participants highlight a sharp decline in pricing, with sources indicating that for middle market deals with EBITDA of more than €10 million, spreads have dropped to a 500-575 bps context, representing a roughly 150-200 bps decrease from the levels in play 12-18 months ago — when spreads were often above 650 bps, and sometimes as high as 700 bps or more.
Meanwhile, LCD data shows the median spread for private credit deals has dropped to 569 bps across 2024, from 612.5 bps in 2023.
Markus Geiger, head of private debt at ODDO BHF, adds that while pricing for companies with EBITDA of more than €25 million has fallen, demands for more flexible covenant structures have increased. “The lower mid-market, and particularly the senior space, however, remains protected,” he says.
Increased market competition is also impacting arrangement fees or OIDs. To attract sponsors, for example, arrangement fees have dropped from a 3% to 1.75% context, according to one market source.
Beyond discounts to pricing and fees, large managers are also introducing terms on smaller deals that are more typically seen in the upper middle market. “We’re seeing cov-lite structures now extend to businesses with EBITDA as low as €10 million, with traditional safeguards such as 40% standard headroom, and leverage covenants being eroded,” says an advisor.
Proskauer's West agrees. “Features like wide debt incurrence tests and RP capacity, common in the large-cap markets, are creeping into the mid-market, reflecting a significant shift in deal terms,” she notes.
“Terms don’t matter anymore,” concurs Muzinich's Bode. “Large funds are offering the same terms they give to €50 million EBITDA companies — weak protections and overall weaker structures.”
What's more, this trend isn’t limited only to private credit firms, as PE sponsors that have traditionally focused on larger deals are also moving down in search of opportunities. “Funds with a large-cap strategy are now imposing large-cap documents and terms on the mid-cap segment of the market,” notes Jan Reichenbach, head of private debt for DACH & NL at Pictet Asset Management. “That’s problematic, so we don’t touch those deals.”
Access challenge
Despite the shift, many lenders argue that focusing on the middle market is easier said than done for large managers. “When you get to the middle market, it's very difficult for some large European direct lending funds to access and originate,” said a middle market direct lender. “Take a €20 million EBITDA company in Germany, for example. Unless you have a team on the ground there, it’s very difficult for a large global direct lending fund to access that deal flow. The barriers to entry are higher.”
“There are potential pitfalls for funds turning to the smaller end of the mid-market, especially when dealing with local European sponsors that don’t have access to follow-up capital when things go wrong,” adds another lender.
In addition to these access issues, lenders also have an imperative to put capital to work, as an adviser sums up: “What do you do when you have pressure to deploy money out of the door?”
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