The Debt Connection – February 2014

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In this month’s Debt Advisory newsletter from Clearwater Corporate Finance, we make some predictions on what the funding markets have in store for mid-market businesses in 2014.

Clearwater enjoyed a prosperous 2013, advising on 28 deals with a total value of £750m, an increase of 50% in deal value on 2012. Despite the increase we have seen, particularly in the second half, general levels of M&A activity in the market are still relatively low compared to the boom years pre-Credit Crunch. As businesses start to use up facility headroom and cash reserves, we expect to see an increase in M&A led fundraisings during 2014.

Tough business conditions and continued talk over the last few years of the green shoots of recovery have left a number of companies wary of investing capital for future growth. Recent business surveys indicate confidence is returning, although it may also be a case of patience wearing thin with shareholders and management teams. We expect to see capital investment increase during 2014 with recruitment levels also rising.

The Mid-Market

The mid-market is likely to remain split in 2014, in terms of credit availability and pricing for borrowers. At the higher end of the corporate and IBO space we have seen funding options remain relatively strong, with appetite from banks, the direct lending arms of insurance companies, Private Placements market and High Yield Bonds market. This year we expect to see pricing continue to reduce for this competitive segment, as more overseas banks return to the UK market and the fight intensifies for the best quality assets to improve banks’ average loan book risk. The upper mid-market has also seen some investment grade funders enter in search of higher returns, but still with reasonable risk levels.

For the lower end of the mid-market, banks maintain that risk weighted regulatory capital requirements have kept it relatively expensive to lend to businesses and so correspondingly the availability of credit has been more limited with pricing not reducing by the same extent as the larger end of the market. Re-focus of the Funding for Lending Scheme to incentivise business lending, now excluding mortgages, makes it harder for banks to maintain this stance. As the economy continues to pick up and the pressure of competition higher up the market continues, we expect banks to seek greater returns in the lower mid-market, leading to more opportunities for businesses to grow through capital expenditure.

Asset Based Lending

Asset based lenders continue to be active particularly in the lower mid-market arena, whilst also participating in some big ticket syndicated deals. This has been driven by both the independent ABL providers and the ABL divisions of commercial banks. Awareness of their capabilities and reputations will continue to grow in 2014 as the UK has often followed US financial trends. We predict an increasing number of larger transactions being structured on an asset based rather than cash flow lending structure, providing financing for those businesses with asset rich balance sheets that need to invest to grow. Private Equity are increasingly utilising this funding stream and we expect PE transactions featuring structured ABL solutions to be frequent. In summary, this is becoming a more acceptable funding facility for all sizes of business.

Debt Funds

Debt funds raised significant amounts of funding over recent years and we expect to see large amounts deployed in 2014, along with fund raisings continuing to take place. Requirements to deploy funds raised in certain timescales will result in a widening of the targeting criteria used to assess opportunities. We have seen debt funds replace traditional banks in banking clubs, along with providing bilateral facilities and second lien financing. In addition, we have seen the provision of unitranche structures through joint ventures between banks and debt funds – such as Ares with GE and Bluebay with Barclays – which we believe to be significant developments in the funding market place. This can often fill a gap in a capital structure and provide longer-term funding than traditional banks may be comfortable with together with more flexible capital repayments. The problems debt funds will have to overcome are borrower reluctance to move away from traditional banks and lack of brand awareness. Given a lot of debt funds are new entrants to the market with no track record of lending through a recession, there are also unknowns in what happens with any future refinancings or distressed situations.

For the past few years there has been talk of “next year” being the year when the markets get better, we are confident (and hopeful) 2014 is that year – when people stop talking about doing deals and start making them happen.

If you would like to discuss any of the subjects covered in more detail, then please get in touch with us using the links below.

Chris Smith – Partner
Mark Taylor – Partner
David Burton – Manager
Tom Barnwell – Assistant Director