A BUOYANT mid-market is important to Europe’s economic growth. But as Europe’s mid-market firms look to develop, so do their refinancing needs.
A recent panel, hosted at Standard & Poor’s Annual European Leveraged Finance & High-Yield Conference in London, was unanimous in its opinion that although midsize companies currently consider bank loans to be their most popular choice of funding, their funding sources are likely to diversify in the future.
Alexandra Krief, head of mid-market evaluations and credit estimates, EMEA, at Standard & Poor’s, estimates that mid-market companies – which the rating agency defines as those with revenues below €1.5bn (£1bn) per year – will need to raise between €2.4trn and €2.8trn of debt over the next three years to fund their development and refinance existing loans.
“With the banks focused on restructuring their balance sheets to meet regulatory requirements, alternative financiers such as institutional investors and direct lenders have an opportunity to step in and assist in funding these companies. And with investor appetite for higher yields growing stronger, we can be confident that the demand for mid-market assets exists,” Krief said on the panel which brought together key industry figures from S&P, HSBC, Aviva Investors France, and Alcentra.
The question now, however, is whether mid-market companies will continue to tap alternative lending markets as banks recover from the global financial crisis and begin lending to the sector once more.
Alternative lenders broaden their horizons
Alternative lending has grown rapidly over recent years. Standard & Poor’s research shows that European companies issued roughly €31bn of private debt in 2014 alone. The development of the European private placement (PP) market – which still predominantly comprises French euro PP issuance – is notable. Indeed, it is now establishing itself alongside the much larger US private placement (US PP) and German Schuldschein markets as a viable option for corporate funding.
“Last year, we saw approximately €6.4bn invested via the European private placement market, up from €3.5bn in 2012,” noted Krief.
In Standard & Poor’s opinion, this growth is largely due to the fact that investors in the European PP market are embracing a wider range of company credits than those in the US PP and Schuldschein markets, which lend almost exclusively to investment-grade type companies (i.e. those with an indicative rating of ‘BBB-‘ or higher).
Antoine Maspétiol, head of private debt and corporate credit at Aviva Investors France, informed conference delegates that the UK insurer tends to target midsize companies with an implicit rating or equivalent up to ‘BB-‘. As an investment adviser, he explained that by widening Aviva’s scope to encompass this type of credit “we can diversify risk without deteriorating the credit quality of the portfolio.”
The European direct lending market (in which dedicated credit funds lend directly to predominantly sponsor-owned businesses) has also shown considerable growth. In 2014, it reached more than €10bn spread across more than 200 transactions, up from about €5bn at the end of 2013. However, this market targets a different range of credits to the European PP market.
Pascal Meysson, managing director at Alcentra, a global asset management firm that focuses on speculative-grade corporate credit, noted that, unlike Aviva, most of Alcentra’s credits reflect a lower, single ‘B’ rating. He explained that this is because Alcentra typically lends on a bilateral basis, driven in the main by leveraged buyouts (LBOs). “In fact, 80% of what we do involves LBOs, and in about 70% of cases we are the sole lender to the company,” he said.
Banks stand their ground
Even though alternative lenders in Europe are broadening their scope, some midsize companies are reluctant to tap them for investment. This is partly because of the uncertain economic outlook in most European countries, which is limiting corporate investment, but also because European banks are returning to levels of liquidity last seen before the financial crisis.
Joanna Tibbitt, co-head of corporate capital origination at HSBC, explained how banks are able to compete: “For now, smaller (mid-cap) companies are quite happy to stick with their bank debt. And banks are willing to lend with a lot more flexibility – five-year tenors are now relatively standard, where previously three-year tenors were more common. Bank loans also tend to be much cheaper than alternative sources of funding, particularly for midsize companies in the single ‘B’ space, because of the ancillary wallet banks can access to make returns work,” he said.
This is especially bad news for direct lenders since, according to Meysson, “it’s impossible for the direct lending market to compete with such loans, which do not have the same ancillary products or incentives to lend on such low levels.”
Growing the market
Despite the banks’ return to prominence, Meysson, Tibbitt, and Maspétiol all agreed that the prospects for growth in Europe’s alternative lending markets look promising. This is partly because midsize companies are becoming more comfortable with the level of information disclosure required by investors.
“Without doubt, transparency is key for us, especially when we analyse a company’s credit risk,” confirmed Maspétiol. “Mid-market companies need to appreciate the standard of transparency that investors expect. When millions are placed on the table, investors expect full disclosure. Banks that act as arrangers can be very helpful in this sense.”
“Additionally, increased standardisation gained through improved transparency will help achieve better pricing,” he argued. “For this, we need a comparable benchmark. Therefore, any information available on the market that we can use to complement our own analysis is useful.”
This is an area where S&P’s Mid-Market Evaluation (MME) framework – which provides an expert opinion on a mid-market company’s creditworthiness relative to its peers – is designed to help.
“Standardisation and transparency can help issuers and lenders assess credit risks and bridge the information gap,” said Krief. “Benchmark tools that meet these requirements should help mid-market companies diversify their pool of investors and secure the funding they need to ensure their future success.”
Maspétiol believes such a development would be healthy for the overall economy. “The market is ripe for the picking, and the investors are ready. The task now is convincing corporates to make the effort to prepare all the information expected by new investors,” he concluded.