More and more companies will finance their acquisitions with Private Debt funding. The global economic situation is affecting the conditions for bank balance sheet financing, with fewer and fewer companies receiving funding from banks. Along with rising interest rates, this plays right into the hands of Private Debt investments and boosts their appeal.
The balance sheet problems of medium-sized banks in North America are clearly visible in corporate financing, but bank lending in Europe has also declined significantly. Banks play a big role in the new issuances of bonds and term loans and therefore large corporates are also facing funding challenges as their borrowing is largely based on financing through such debt securities.
In this context, Private Debt has also taken market share as a provider of funding to larger companies. The trend is also visible in the Nordic countries. In this area, the role played by banks as a provider of financing for companies has been very significant, and Nordic banks continue to provide a reasonable level of funding for companies. In recent years, we have seen more and more mergers and acquisitions where Private Debt has been the financier instead of the banks. In the coming years, this trend will continue, and the role of Private Debt financing will also grow in the Nordic countries.
Speed and reliability are of primary importance in the financing of M&A transactions, and Private Debt has been able to meet these requirements. As a result, in the last 12 months, almost 90% of all LBO transactions have been financed with Private Debt. This is a clear indicator that this trend has crept into an increasingly large part of corporate financing.
Rate hikes are boosting interest
A significant proportion of Private Debt investments have floating interest rates, so this has been reflected in higher returns. I expect the trend to continue in the coming quarters, as interest costs gradually rise in connection with interest rate adjustments on loans. In turn, the higher interest rates will improve the coupon return on floating-rate loans, meaning that a larger share of the company's cash flows will go to financiers rather than shareholders. This further adds to the appeal.
General economic uncertainty is supporting fixed income investments and lower economic growth means lower revenue growth for companies. Companies have also increasingly faced challenges in passing on increased labour and raw material costs into the prices of finished products, leading to pressures on profitability. In such an economic environment, fixed income is an attractive option, with loans taking priority in the capital structure, and the return on the loan investment is based on the contractual coupon rate, not on the company's profitability or growth expectations.
The growing interest in Private Debt results also from the fact that it is largely senior-level financing that focuses on non-cyclical sectors. The sector distribution in the Private Debt market is very different from the High Yield market, for example, so Private Debt is an excellent complement to a liquid fixed income portfolio.
Ville Toivakainen
