UK Trends and Developments Contributed by: Fergus Wheeler, Paul Yin, Tracy Liu and Medha Vikram, Latham & Watkins
Growth of junior and hybrid capital The growth of junior and hybrid capital has become a notable feature of the European private credit market, particularly in an environment where the difficult pri - vate equity exit market is piling pressure on sponsors to return capital to investors. Hybrid capital structures have emerged as critical solutions for private equity sponsors, generating returns comparable to upper- quartile private equity with superior downside protec - tion. The newer cohort of hybrid funds tend to focus on highly structured financing, combining contractual cashflows – often fixed-rate – with warrants or pre - ferred equity. Some funds use a blend of senior debt plus equity to produce a similar overall return profile in the mid-teens. This contractual cashflow element offers an attractive feature for allocators concerned about relatively low distributions in buyout funds, while warrants or holdco preferred equity offer the potential for equity upside. The seven largest junior capital funds in the market are targeting over USD50 billion between them – 30% more than the fundrais - ing total for junior debt funds in 2023 and 2024 com - bined – indicating robust demand for this segment. The increase in capital allocated to junior and hybrid products reflects a broader rebalancing across private credit. Structures include 45–50% preferred equity stakes, minority common positions, secured debt with equity warrants, preferred equity with participation rights and PIK/OID instruments. Sponsors and pri - vate credit funds are deploying sophisticated capital structures across Europe that reconcile balance sheet reduction with the need to preserve upside incentives for stakeholders. For investors, the shift from focusing on absolute returns to prioritising risk-adjusted perfor - mance has favoured the downside protection offered by hybrid capital.
Recent trends in liability management exercises Liability management exercises (LMEs) have become increasingly prevalent in European private credit and leveraged loan markets, as stressed borrowers and their sponsors seek to restructure debt without formal insolvency proceedings. While headline default rates in private credit have remained below 2% for several years, once selective defaults and LMEs are taken into account, the “true” default rate approaches 5%. The increasing use of payment-in-kind facilities and LMEs suggests that more borrowers are struggling with interest burdens. LMEs involve a range of techniques, including debt exchanges, tender offers, transferring assets to secure new financing and other modifications to existing debt agreements – almost always to the disadvantage of lenders with minority positions. While LMEs have played a large role in the US debt market for over a decade, they have had less traction in Europe and the UK. However, this has begun to change in recent years, with deals involving companies such as Victo - ria, Hunkemöller, Selecta and Hurtigruten illustrating how swiftly US-style techniques are being adapted to local legal frameworks. Market participants expect further growth in LME-related activity and associated litigation as the credit cycle matures and more bor - rowers seek creative solutions to address their capital structures. The UK and European private credit market is poised to continue its rapid growth, with opportunities aris - ing from regulatory change, competitive dynamics and innovation in fund structures and capital sources. With increasing demand for flexible, customised financing, coupled with a broader range of lending strategies, private credit will play a central role in the leveraged finance market and beyond for years to come.
274 CHAMBERS.COM
Powered by FlippingBook