Rothschild: Regional debt markets – adapting to challenging times
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 By David Dodds and Guy Bagshaw
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THE UK banking market is undergoing a structural shift with political and regulatory pressure combined with media and public scrutiny impacting heavily on banks’ activities and appetite for risk. For regional borrowers this can manifest itself in a number of ways but perhaps most prevalent is the scarcity of credit; whether refinancing existing debt facilities, funding corporate acquisitions or financing private equity backed buy-outs of companies. However, reduced levels of traditional mainstream funding combined with sustained periods of low yields across government bonds have paved the way for new investors and funds to offer borrowers alternative options. Many regional borrowers are exploiting these forms of finance and we expect the trend of dual or multi-track financing processes to continue. Leveraged finance Mezzanine houses have opportunistically re-entered the market, raising multi-billion funds and specifically targeting mid-market transactions. Mezzanine finance is commonly used as a final additional slice of debt, though at a cost of 12% does increase the cost of capital. Unitranche debt, a product more commonly seen in the American debt market, is quickly becoming a one-stop-shop for buy-outs. Unitranche is a blended product of senior debt and mezzanine finance offering ‘stretched’ leverage multiples without the need for complex intercreditor agreements. It is typically provided by a leveraged finance fund that can often sole bank a transaction. Pricing is a blended all-in cost of around 7% to 9% and whilst more expensive than a senior debt deal, bespoke packages and flexibility with regard to amortisation and cash interest payments can make it attractive to borrowers, and we expect to see growth in its use. Asset-based lending (ABL) The increasing prevalence of ABL is in part due to a number of new entrants into this market, including those backed by US money, and because of regulatory capital treatment means lenders can offer it as a lower-cost form of financing. Private Placements and Retail Bonds The market has remained open throughout the downturn and a number of investors have increased their focus on the regional market place. By dealing directly with one or two investors, borrowers are able to access long term, bilateral facilities from £20m upwards at coupons of around 4%. The recently created retail bond market is ‘coming of age’ as UK retail investors, who are perhaps wary of depositing all their savings with banks at current low rates, chase a greater return on their capital. It is open to medium-to-large borrowers that typically have ‘investment grade’ characteristics (although a credit rating is not required). The market is widening, particularly for companies with strong brand recognition. Recent issue sizes have ranged from £25m to £125m and generally have no financial covenants. Optimal refinancing processes often start sooner to allow the development of funding alternatives. This is largely due to reduced banking liquidity and funders demanding higher levels of scrutiny and downside protection. Borrowers considering a refinancing should factor in additional time for detailed preparation significantly ahead of any impending debt maturities. Sound preparation has always been a key success factor in any financing process, however in our experience taking additional time to present the business in the best light, explore the financing options available and foster competitive tension both within a funding class and using other funding classes is fundamental to securing optimal terms in the current market. In summary As we enter the final quarter of 2012 and we consider where activity might lie in 2013, one does so with ‘cautious optimism’. Whilst there have been some excellent deals in 2012, one should remember that it was just 12 months ago when the national banking market all but froze in response to the Eurozone crisis. Major economic shocks such as the Eurozone aside however, a degree of creativity of approach and objectivity of thought from both funders and borrowers, will continue to deliver high quality debt finance deals in our regional markets. More articles in
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