The Debt Connection – December 2017 – Mid-Market Lending

In the latest debt advisory newsletter from Clearwater International, we look at mid-market lending following the recent Bank of England Brexit stress test on UK banks.

On 28th November, the Bank of England released its latest Financial Stability report, with a headline stating the UK financial system could withstand a disorderly Brexit. In effect, the Bank believes the financial system can survive the UK exiting the EU: without a trade deal to replace the current one, the introduction of tariff and regulatory barriers, and the potential forced relocation of people and businesses from the UK to the EU.

This doesn’t, however, mean all is okay as the Bank is saying the economic shock to the system would only be “no worse” than the economic tests it has recently put banks through. These include a 33% fall in house prices, doubling of the unemployment rate, 25% drop in the value of Sterling and a rapid rise in interest rates from 0.5% to 4%. This is not a positive situation, as this level of impact on the financial system, whilst manageable, would significantly reduce the ability of banks to perform their function of providing credit to businesses and individuals.

A consequence of this could be the UK mid-market opening more to alternative lenders, as was seen post the financial crisis. This may shift the lending market further towards that of the US, where the majority of business finance comes from non-bank lenders.

The attitudes of mid-market businesses have changed over recent years, with the knowledge banks are not able to support their financing needs in the same way as pre the financial crisis. They are increasingly aware of the wider range of lenders and funding structures available in the market, due to the advisory community and the alternative lenders themselves. This is a marked change in attitude from prior to the financial crisis.

We expect to see further adoption of banks having tie-ins and working relationships with debt funds. These tie-ins are when the working capital and sometimes 1st lien of senior debt finance is provided by the bank and the debt fund provides senior or 2nd lien finance. 1st lien and 2nd lien structures have certainly become more prevalent in the mid-market recently and offer banks the opportunity to participate in the debt capital structure, but with a smaller and lower risk loan tranche.

Structuring the loan in tranches and participating in the lower risk 1st lien and working capital elements, could well be a deliberate strategy by some banks to improve their capital positions. It also can play well to debt funds, who are under pressure from competition in some cases to deliver investment returns, as they can price 2nd lien loans higher than traditional unitranche loans. Importantly, this strategy allows he bank to undertake day-to-day banking services required by the business and to generate income via such.

Ultimately, whether there is an orderly or disorderly Brexit, it is likely there will be further diversification in funding options for mid-market businesses in the UK going forward. This will primarily be due to increased capital requirements for banks in the UK and Europe, and so will make the mid-market more diversified in the range of structures and lenders offering finance. This choice and competition should prove beneficial to mid-market businesses.

New joiners to the UK team

Corporate finance firm Clearwater International’s debt advisory team takes on two new experienced recruits in their London and Manchester offices.

The Manchester team welcomes Associate Director, David Grassby. David joins with over 8 years of experience, having previously worked at Deloitte in Debt Advisory. The team also welcomes Associate Director, Hertej Rattan. With 10 years’ experience, Hertej joins from Lloyds Banking Group, where he originated and delivered transactions in leveraged finance.

Mark Taylor, Partner and Head of Debt Advisory, Clearwater International commented: “The market has opened and a diverse range of funding options are now available to businesses. Debt advisory can add huge value in structuring finance to meet company strategic goals and has become a core service line for Clearwater. We’re advising on more debt transactions now than ever before. The continued investment in our team is representative of the growing opportunity in the market and there’s no doubt that David and Hertej will bring valuable experience and opportunities with them.”