PitchBook News - How slow can PE go?

High debt costs and lack of credit availability have been a significant headwind to completing buyout deals. Although private credit continues to increase its share of LBO debt, an effectively closed leveraged loan market has created a big hole to fill.

Buyout deal activity (in dollar terms) over the past six months fell to its slowest pace since 2020 and, prior to that, 2008. Deals less reliant on leverage, however, continue to get done as GPs are finding ways to put money to work.

The increase in debt costs also continues to put pressure on portfolio companies with high leverage. Strong revenue and profit growth helped many companies weather the need for more cash flow but falling profit margins may put that at risk.

After reaching a record high of 16.2% in 2022, nonfinancial corporate profit margins have fallen to 13.8% through Q1. Slowing profit growth has likely influenced early signs of credit distress for risky borrowers. The distress ratio by issuer count in the Morningstar LSTA Leveraged Loan Index has ticked up to 9.3% and the default rate for loans with financial covenants is at its highest level since 2008.

Exit route options for PE-backed companies are extremely limited. The current slowdown in exit activity is on par with those that occurred in 2008 and 2020 despite public market conditions that are relatively positive.

Based on the deviation of exit activity from its long-term trend, we estimated that the cumulative exit shortfall from the beginning of 2019 through Q1 2023 was $60.2 billion. Slower exit rates will have important implications for fund performance as distributions get delayed. We show that even if TVPI ratios recover, slower distributions can materially reduce IRRs.

For more information and data on the topics discussed, please download the free report: Pumping the Brakes

 

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