Debt funds making inroads in DACH amid Covid-19, says GCA

Bank financing accounted for 29% of LBOs recorded in the period, while debt funds made up the remaining 71%. This shows a market increase from H1 2020, when debt fund financing accounted for 52% of leveraged deals.

Norbert Schmitz, a managing director in the firm's debt advisory and restructuring team, says the figures appear to reflect direct lenders' view of their role in the market: "Debt funds have always said they would be there in a more difficult market, it's one of the reasons why they started in the first place in 2011/12, when things were difficult after the last crisis – they thought they would be there when the banks were not."

Schmitz adds that banks have had more on their plates during the crisis, which likely hindered their ability to take on new deals. "The banks have a much bigger portfolio than most of the debt funds, so they had many more workout deals in Q2, and they had the KfW programme on the table as well. A debt fund with five assets, for example, would not have such a difficult time."

Bank on it
However, banks did continue to back certain deals in Germany, says Schmitz. "If you are a strong sponsor and have shown that you care for your portfolio in the last three months, you can still get bank financing. The banks are there, but they are selective."

This trend appears to be continuing into H2 2020; Unquote sister publication Debtwire reported that Waterland's buyout of Leupold, which took place in July 2020, was backed by a senior club deal, while Lea Partners secured bank financing for the acquisition of Prosoft by its portfolio company Landwehr, as reported by Debtwire.

The report also shows a sharp drop during H1 2020 in the number of buyouts completed with leverage: it recorded 23 LBOs with credit volumes of €20-500m in Q1 2020, compared with 11 in Q2. The survey excludes all-equity buyouts. Schmitz notes that this is important to bear in mind when considering the dominance of direct lenders during this period. "In general we would have expected this, but one has to keep in mind that the number of deals in this period was limited – and they were also more cautious and there was not actually a huge amount of competition – in the end, there were generally one or two funds still there for each deal, and the more experienced ones were able to deliver a commitment in these difficult times."

Unitranche-backed deals announced in H1 2020 included Paragon's acquisition of Weka, as reported by Debtwire. EQT's acquisition of hygiene products producer Schülke was also financed by unitranche, Debtwire reported.

Around 59% of the deals that took place in the German market were for add-ons and refinancings, compared with 44% in H1 2019. "We have seen add-ons and refinancings increasing, since lenders feel more comfortable if they know the asset, even if it is trading with some difficulty," says Schmitz.

A swift recovery
Schmitz notes that the market is likely to remain split when it comes to which deals will lenders likely finance, since some parts of the market are largely unaffected by the crisis. "A bifurcation is already happening – our thinking here is that deals will go through for the quality assets not hit by coronavirus, or companies who were hit initially but now are trading at pre-coronavirus levels. People are really focusing on IT/software, certain parts of healthcare, and other resilient businesses. This will continue on the lending side and we don't think the enterprise values will come down massively for high-quality assets. For the remainder of this year, it will be very difficult to finance or sell automotive and retail companies, especially if they have covenant breaches already."

Unlike in the global financial crisis, debt funds will likely play a significant role in Germany in potential restructurings that are likely to come in the next few months. Says Schmitz: "In the last two months, we have seen an increase in covenant breaches and restructurings – we knew there would be more restructurings, especially in automotive, due to the structural changes happening within the industry even before coronavirus. However, the pandemic is now intensifying the negative effects. When Q2 results come out in August, there will be more covenant issues. It's too early to say, but it will be interesting to see how the debt funds behave and handle the restructurings and covenant issues in Q3 and Q4, and how aggressive they will be."

On a European level, and in the DACH region, Schmitz expects that the market will pick up in Q4 for both M&A and refinancings. "As long as things remain as they are at the moment, and there is no massive second wave, M&A processes for high quality assets are getting going and people are thinking about selling or bringing assets to market. We expect more activity in September and Q4 2020, but you always need a seller willing to sell and a buyer who is willing to take a view on EBITDA. You need them to believe it and agree, although there are mechanics such as earn-outs and vendor loans."

He adds: "We believe Q4 will be more active on the add-on, refinancing and M&A side. But on dividend recaps, I am not very optimistic for Q4."

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• Topics
• Financing
• DACH
• Germany
• GCA Altium
• coronavirus
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