Distressed debt investors are watching rising leverage levels with an eye toward potentially lucrative deals in the next year, according to a recent report by TMF Group. The slow government withdrawal of fiscal and monetary support could create more distressed opportunities as managers appear to bet that “some of the negative impact from the pandemic hasn’t yet filtered through to corporate balance sheets,” according to the analysis. Let’s have a look at winners and losers.

Bright spots for distressed M&A deals are the obvious suspects: consumer, tourism, hotel and travel firms. What is perhaps less clear, though, is fund managers’ preferred play to access these companies’ capital structures. Just over a third of respondents plan to target senior debt, but about a quarter plan to invest across the capital structure. It’s a reflection that the mid-pandemic rush of refinancings at lenient terms have changed the typical risk/return profile of some firm’s debt instruments.   

Interestingly, debt funds expect to rely on proprietary deal sourcing networks instead of banks by a 7 to 3 ratio. Banks’ general preoccupation with record deal flow could create more direct lending opportunities for credit funds in the middle market, as Mergers & Acquisitions previously reported. Banks’ focus on larger deals “especially among tier 2 banks, is likely to open up the direct lending middle-market, and lower middle-market, as businesses seek out alternative financing,” the report reads.  

The U.S. leads in the poll of most attractive markets, followed by the U.K. and Germany. The $848 billion private credit market could create selective opportunities in the months ahead.

-Brandon Zero