The Debt Connection – September 2015

Date

Is now the time to take advantage of cheap loan prices?

As the financial crisis hit in 2007/8, many overseas banks that had been operating in the European market retrenched to their homeland and domestic banks restricted their lending to the best credit rated businesses. This left an unsatisfied demand for debt financing from many good quality mid-market businesses, and so attracted the entrance of a number of new lenders to the market. Enter the debt funds and direct lenders.

Whilst alternative lenders and debt funds have been operating in the market for a number of years, there has been a material rise since the financial crisis, with over 200 now operational. Between 2010 and 2014, an opportunity was exploited by existing and new funders to fill the gap in the lending market.

The extent of reduction in lending by banks and increase in lending by alternative lenders can be seen in how European leveraged transactions are being financed. Between 2011 and 2014, the proportion of transactions including alternative lenders had risen from 17% to over 50%. During this time, we have seen pricing of unitranche loans from the debt funds reduce from around 8% or so, to now be closer to 7% and even below in certain situations. Debt funds and direct lenders are also understood to have $25bn of committed funding that is ready to lend to businesses in Europe and we are seeing higher levels of activity.

Over the past two years, we have seen a return in appetite to lend to mid-market businesses being displayed by traditional UK banks and also the return of foreign banks to the UK market. After a number of years of rebuilding balance sheets and restructuring, there is now a need to start generating increased fees and income through new lending. Correspondingly, we have seen corporate loan pricing reduce from over 2.5% to below 2.0% in many cases. What we have also seen during this time, is the debt funds have continued to raise ever larger funds, to deploy predominantly in the mid-market. This has meant there is a high level of liquidity in the market aimed at mid-market businesses, resulting in some welcome competitive tension.

Despite some of the macroeconomic turbulence surrounding Greece and China recently, this has not impacted mid-market liquidity, with loan pricing continuing to come down, terms and conditions becoming more borrower friendly and also an increasing amount of flexibility in the loan structures available. Private equity deals funded by banks saw interest margins peak at nearly 5% during the crisis, whereas now they are pricing at closer to 3%.

Over recent months there has been announcements from the Federal Reserve and the Monetary Policy Committee (the US and UK interest rate setting committees) that borrowing base rates will be raised from their current historic lows in the short to medium term. Any rise in base rates would likely lead to increased loan costs, so fixing or hedging against a future rise could protect borrowing costs.

The favourable pricing available to borrowers currently, when considered against the possible increase in rates means now could be the time for borrowers to take advantage of the attractive terms available, thereby securing medium term funding that supports their business’ strategic objectives.