The last few years in the mid-market acquisition finance market have been tough for all parties. Opportunities have been fewer and the market more cautious and therefore slower to move when they do arise.
Whilst the market is unlikely to (and arguably should avoid) returning to the pre 'credit crunch' activity and risk appetite levels, as we head towards 2014 the finance market is becoming more optimistic and competitive.
We are seeing the following key trends:
Alternative Finance Providers
Whilst the stressed market has been a challenge for the traditional bank lenders, it has provided opportunity for alternative finance providers.
Those alternative providers will often look at funding deals with a higher leverage which a traditional bank may not be in a position to consider. We have seen alternative finance from:
- 'unitranche' lenders - a single arrangement under which a borrower is provided with term or revolving facilities with a blended interest rate on a non-amortising basis. There are a number of benefits for borrowers, not only in the documentation which is often quicker to agree (as there is only one lender) and easier to manage throughout the term (as everything is in one place), but also in the commercial terms.
The financial covenant testing tends to be less onerous and the general terms can be better tailored to the long term goals of the business as there tend to be fewer internal policy requirements
- PE houses - who have shown more willingness to provide debt to the businesses they're already working with. This can be new debt (to provide working capital or headroom for growth) or in some cases to refinance the debt of outgoing bank lenders
- insurance providers and pensions funds - which have also increasingly made their presence felt in the loan market as they look for ways to invest their funds. To date this has been in the syndicated loan market and is unlikely to have a significant impact on the mid-market
- peer to peer lending - which has become increasingly important with predictions that it will ultimately be worth £12billion a year
There may be downsides however:
- unitranche providers and insurance / pensions funds don't provide the relationship that borrowers might be looking for and, more importantly, if (or more likely when) their customers hit troubled times they may not have the capacity or resource to nurture them back to life
- they cannot service the day to day banking
- overall pricing might be higher
Competition should help revive the market but it needs to be balanced to avoid a debt bubble.
Increased regulation to mitigate risks of an unsustainable bubble will remain a theme in the years to come. In particular:
- Capital adequacy requirements and the Vickers reforms mean the banks do need to be more careful about who they lend to and the terms on which they lend. There is also a drive within banks to lose their 'bad debt' and to focus on particular sectors which are seen to be more robust post credit crunch
- 'Know Your Customer' (KYC) - Banks are required to understand their customers' structure to a much higher level than previously. There is not a market wide agreed approach on how best to tackle KYC. Bank's KYC teams have had to grow as a result, despite the need for banks to reduce costs.
News last month that the government has decided to make the new register of company beneficial ownership information publicly accessible should be good news for banks and lawyers alike. Whilst it is unclear at this stage when this will be implemented, what the triggers for updating that information will be, or how a failure to comply will be policed, the new register will provide an extra layer of information which will assist with the KYC process, for English companies at least
Loan Pricing and covenants
Inter bank competition, as well as the new alternative finance providers has resulted in a reduction in pricing and a drive from strong borrowers to push down fees. This competition is likely to continue into next year. One of the implications of this is that strong borrowers are often running more than one bank until late in the process.
As well as reduced margins, the mandatory costs schedule has been dropped from the LMA loan documents. Banks' approach on mandatory costs varies - some include generic wording around costs of compliance, others have dropped mandatory costs provisions altogether on the basis that the cost is minimal and in practice was rarely passed on to the borrower.
LIBOR has continued to make headlines throughout the year. Arrangements are being made for the changes ahead. Screen rate definitions are being amended to take account of the fact the BBA will no longer provide the rate, and a fall back mechanism, whereby banks can calculate an interpolated rate, are often used as another protection in case a screen rate (from whichever information provider is tasked with publishing the rate in place of the BBA) is not available.
The syndicated loan market has seen a surge in "covenant lite" transactions. That has not yet hit the mid-market but we anticipate that it will start being pushed in 2014.
The Debt Wall
In previous years there has been concern about the market hitting a 'debt wall' - when the loans which were put in place pre-credit crunch mature, and the banks no longer have the appetite or resources to refinance all of their existing customers' debt, at least not on the same terms.
Despite the concern, 2013 has seen a staggered approach to refinancing. Many of the more savvy borrowers have taken advantage of the reduced rates, and competition in the market, and refinanced early. Equally, most banks have put in place specific teams and processes to manage those customers who may be less reliable, or operate in sectors for which the bank now has less appetite.
2014 is likely to see the same steady flow of refinances - whilst in some cases banks will be able to use this as an opportunity to re-price. It will not be long before the loans being re-financed will be those which were put in place in 2009, at which point the banks were at their most risk averse, and as a result borrowers may, in fact, see pricing fall.