The refinancing of private debt with public debt was a notable new trend over the first half of 2024.

Why it matters:  Issuers that refinanced private debt with public debt during that period typically improved their credit metrics, securing a median 138 bps to 150 bps improvement in interest expenses based on our estimates.

What we think and why:  Public debt will continue to be used to refinance private debt so long as interest rate spreads remain at their currently tight levels. However, private debt markets will remain important providers of interim financing for temporarily stressed issuers that would struggle to find financing in the public market. It is notable that the credit quality of BSL issuers that refinanced private debt in the public market was comparable to their publicly rated peers.

A New Trend In Refinancing

The first half of 2024 witnessed the emergence of a new trend in European debt markets and more specifically in the BSL market, when a handful of leveraged buyout structures refinanced private debt in the public markets. S&P Global Ratings assigned new ratings for nine such issuers (which we will call Group 1) over the first six months of 2024. That is in marked contrast to the previous two to three years, when private lenders were tapped to refinance debt previously placed in the public credit market.

Group 1 refinanced almost €4.5 billion with new term debt. That is a relatively small volume compared to the total of about €130 billion issued in the European BSL market--where demand has benefited from favorable market conditions, increasing investor demand, and tighter interest spreads. Yet, the amount rises to a more meaningful €10.5 billion if we include the refinancing of €6 billion of privately financed debt that was held by eight entities already present in the BSL and high yield bond markets (Group 2).

The general trend to public refinancing of private issuance appears to be a reflection of prevailing stability in debt markets--following two years of higher and more volatile spreads. During periods where debt markets are tighter and more turbulent private lenders are sometimes preferred because they typically offer greater certainty of execution compared to public markets. That is particularly the case for borrowers with greater indebtedness, which often characterizes issuers that turn to private debt markets.

The uptick of private debt refinancing in the public market warrants examination, not least to ascertain if it might continue, the extent of its possible benefits for issuers, and to understand the credit risk taken on by the public markets. To that end, we studied the identity, creditworthiness, and credit metrics of the refinancing issuers and the interest savings they achieved.

Sectors Involved In Refinancing Matched Primary Public Market Activity

Issuers in Group 1 were predominantly from the business services sector, though the healthcare sector was also well represented. That is perhaps unsurprising given that:

• Both sectors are popular among private lenders, who appreciate their typically low earnings volatility and stable growth.
• Both sectors accounted for significant portions of total European debt issuance in the BSL market during the first-half of 2024 (though there was also strong activity in the consumer products sector).

With the inclusion of Group 2 in our analysis, activity notably expands to include issuers from the technology and software sector. Indeed, that sector then emerges as the second most active group, behind business services (see chart 1).

Chart 1

The Creditworthiness of Refinancing Issuers Reflects Their Rated Peers

Two-thirds of Group 1 (private debt issuers that completely refinanced in the BSL market in 2024) were rated 'B', with the remainder rated 'B-' (see chart 2). This roughly matches the spread of ratings on other leveraged buyouts (LBOs) with similar debt profiles that we rated in Europe over the same period.

Chart 2

We note that no issuer that refinanced previously privately placed LBOs in the BSL market this year was rated above 'B'. LBOs rated above 'B' are rare among the entities we rate, although they exist.

While new LBOs are typically not rated lower than 'B-', existing ratings occasionally erode in subsequent years. Yet the probability that a 'B' rated issuer will fall into the 'CCC' category (indicative of a capital structure we consider unsustainable) within three years is low at only about 6.1% in Europe (based on rating data since 1981). It remains to be seen if the new BSL issuers will track this statistical rate of decline.

Half of the issuers in Group 2 were rated 'B'. This was broadly in line with all new issuers in Europe over the first half of 2024. Three issuers in Group 2 were rated in the 'B-' category and one issuer was rated 'B+' (interestingly that was one of the biggest deals by value).

We consider that market participants' increased willingness to lend and a greater confidence in positive economic developments has led to a higher risk tolerance, resulting in more issuers with ratings lower than 'B' refinancing in the BSL market, compared to a year ago. This is a significant departure from the trends observed in recent years, when BSL liquidity decreased due to higher interest rates and credit concerns.

There Are Notable Credit Metric Differences Between The Two Groups

The median credit metrics of Group 1 support 'B' ratings. Median expected debt to EBITDA for 2025 (the first year after the refinancing) is equivalent to those of 'B' and 'B-' rated existing issuers, while the funds from operations (FFO) to interest expenses (the interest coverage ratio) is more in line with 'B-' rated issuers. We think the interest coverage comparison is somewhat misleading given that the new issuers in the public market have refinanced in a higher interest rate environment, while the comparison pool includes fixed interest rate issuers that placed debt in a low interest rate environment.

We also note that the cash generation of the new issuers is comparably strong, as shown by their median free operating cash flow (FOCF) to debt of 6%, which is above the median of 'B' rated issuers in our portfolio (which consists of corporate issuers we rate in Europe). We consider that this outperformance is likely also supported by the generally lower capital expenditure intensity of the business services and healthcare sectors, which account for the majority of issuers in Group 1.

Chart 3

In comparison, the median credit metrics of Group 2 align to 'B' and lower ratings levels, though they do not neatly match a specific rating category. Group 2's expected FOCF to debt for 2025 is closer to that of existing issuers with a 'B-' rating, while the FFO interest cover is more aligned to issuers in the 'B' rating category (due in part to interest rates that are still relatively high). Group 2's median debt to EBITDA is equidistant between that of a typical 'B' and 'B-' rating. In theory, it could be valuable to assess the credit metrics of refinancing issuers across different rating categories, but we have not split them in this way because the number of issuers is so small that the outcomes in some cases could prove flawed.

Chart 4

The differences between the two group's credit metrics helps explain their different rating splits. While the groups' debt-to-EBITDA metrics are similar there are notable differences in their interest cover and cash flow metrics. For example, interest coverage is generally stronger for existing BSL issuers (including Group 2), while FOCF to debt is significantly higher among the new BSL issuers (Group 1). We consider this to be the main reason why the share of 'B-' rated issuer is about 50% of Group 2, but accounts for only one-third of Group 1.

BSL Lenders Showed A Lower Risk Tolerance Than The Private Lenders

Banks reduced their exposures to risky credits after the 2007-2008 global financial crisis, while tougher leveraged lending guidelines for banks provided non-bank financial institutions an opportunity to expand their footprints in the private debt market. Guidelines also recommend leverage limits for BSL, while leverage levels in private deals have the capacity to be higher. In Group 2, in every case, issuers' leverage ratios were higher at the time they raised the private debt, compared to when they refinanced in the BSL or high yield bond markets.

Chart 5

Refinancing Private Debt With BSL Delivered Interest Savings

Based on information available in issuers' accounts, the refinancing of private debt by BSL resulted, on average, in lower interest rates relative to issuers' respective benchmark rates (interest margins). That conclusion is admittedly based on a limited dataset--we were able to retrieve the margins on previous debt instruments for one-third of the issuers entirely new to the BSL market (Group 1). Yet, among that sample, all obtained lower margins in the BSL market than they had achieved in prior years in the private debt market.

The extent of that gain amounted to an estimated median 138bps based on issuers' 2022 interest expenses, prevailing benchmark rates at that time, and after accounting for interest hedging (see chart 6). The variance around that median was large, ranging from almost 350bps positive in one case to 430bps negative in another. We regard both those results as outliers and note that the negative result included transitional M&A that was also funded with the refinancing, and hence is excluded from our calculation (see Company 9 in chart 6). Interpretation of the result should also take into account the generally elevated spreads in public markets during 2022 and 2023, which offer a favorable comparison for issuers that raised debt during those years and then refinanced.

Chart 6

Similar margin gains were observable in Group 2, where refinancing of private debt in the BSL market achieved a median margin saving of around 150bps (see chart 7).

Chart 7

That gain can be attributed to greater activity in the European BSL market in 2024, due primarily to opportunistic re-pricing. Increased volumes in the BSL market reflect favorable conditions and reduced debt costs that lead to increased refinancing. At the same time, banks have resumed underwriting deals, and significantly reduced pricing to remain competitive, adding to the downward pressure on rates.

The combined effect of those factors was notable beyond the syndicated loan market. For example, a UK insurance broker was able to complete a bond offering, with three tranches, that enabled the refinancing of about 50% of its direct lending debt and resulted in interest savings. We expect those benign conditions to persist, enabling larger borrowers to refinance private credit in public debt markets at improved rates.

Continued Refinancing Of Private Debt In Public Markets Will Depend On Spreads

We expect public debt markets will continue to be used to refinance private debt in the near term, underpinned by public market spreads that appear likely to remain at currently tight levels.

We nonetheless remain cautious of economic risks and geopolitical risks, including the possibility of a wider conflict in the Middle East, fallout from the ongoing war between Russia and Ukraine, and tensions between China and the Western World. Escalation of any of those issues could trigger a sudden halt to public debt markets' current pricing advantages and reverse the recent trend in private debt refinancing.

Related Research

• 2023 Annual European Corporate Default And Rating Transition Study, July 15, 2024
• Public-To-Private Borrowing Is A Two-Way Street, May 7, 2024

Writer: Paul Whitfield