The SME leveraged finance market is celebrating the comeback seen in the second quarter. After a disappointing first quarter with only 21 deals, transaction activity in Germany increased by 76% to 37 transactions in the second quarter. This is the finding of the new Midcap Monitor from the investment bank boutique Houlihan Lokey, which is exclusively available to Börsen-Zeitung. The research records all mid-cap private equity deals financed by banks or private debt funds with a transaction volume of between 20 and 500 million euros. In addition to LBOs, the statistics also include smaller add-on financings, refinancings and debt-financed dividend distributions (recapitalisations) in Europe.

The German market grew even more strongly than the European market as a whole, particularly with regard to deal activity from private debt funds. With 135 transactions, the second quarter in Europe recorded 67% more transactions than in the first quarter. In Germany, debt fund deals increased by 110%. The only other country to record triple-digit growth rates was France.

„The first quarter came as a negative surprise in terms of the number of transactions,“ says financing consultant Thorsten Weber from Houlihan Lokey. However, the figures for the first half of 2024, especially the second quarter, show that the market has stabilised and become more active.

Extrapolated for the year as a whole, Weber believes that the market should perform better than in the previous year, and could even come close to the record figures of 2021 and 2022. Back then, just under 160 transactions were recorded before the ECB unsettled LBO bankers and fund managers with the interest rate turnaround. However, the market has since become accustomed to the higher interest rates, according to the research report.

There were also signs of a trend reversal in the second quarter. The leveraged finance market was able to somewhat reduce its high dependence on add-ons. For the first time since 2021, add-on transactions were not the dominant segment of financings by banks and private debt funds (31%). At the same time, the share of primary transactions increased again (29%). This suggests that private equity investors are once again venturing more into new platform deals, instead of mainly connecting smaller companies to existing portfolio companies.

However, this does not mean that the deal crisis in the private equity sector is over. After all, the most common financings for banks and debt funds involved refinancing and recapitalisations. At 34%, their share in the second quarter was the highest since 2017, which is a strong indication that private equity investors need to hold on to their portfolio companies longer than planned, and are therefore replacing their original LBO financing.

In addition, private equity is no longer buying companies from their competitors. At 5%, the proportion of so-called secondary deals in the second quarter was the lowest since the Midcap Monitor was established. These deals involve one private equity investor selling a company to another financial investor. In the second quarter, the focus remained clearly on working with the existing portfolio: 65% of all deals were either add-ons or refinancings.

However, there is another explanation for the large number of refinancing deals: attractive financing conditions. „Both in terms of pricing and contractual arrangements, we see flexibility in selected deals that would not have been feasible a year ago,“ says Weber, referring to interest rate, fee and covenant structures.

According to Weber, private debt funds have reduced both their structuring fees (arrangement fees) and their margins. Whereas the funds used to charge an average fee of between 2.75 and 3.25 per cent, they now charge 0.5 to 1 percentage point less. This means that debt funds „are sometimes even cheaper“ than the bank debt, says Weber. This is quite unusual, as the debt fund bears the higher risk in this financing structure.

Debt funds also favour borrowers when it comes to margins. Whereas last year they were still charging an average of between 6 and 7%, Weber says that this is currently half a percentage point to 1 percentage point less for comparable deals. This means that debt funds can currently offer their private equity clients even better conditions than in the record year. And debt funds currently have more room for negotiation when it comes to margins.