Debt Advisory Insights from Clearwater International
Autumn 2014
clearthought
Debt Funds in the Funding Market
An overview of recent trends in the market and expectations for the future
17%
Introduction
2011*
The appetite for alternative credit is soaring with debt
funds raising record amounts. In this Clearthought, we
examine the impact on corporates.
The speed of change and return of
confidence in debt markets is notable.
Debt markets were largely closed for
raising finance in 2009, it was a struggle
even for some of the best credits.
Since then we have seen a return in the
banks’ appetite to grant loans - partly
driven by the need to lend after a number
of years of shrinking balance sheets, and
partly as a result of the improvement in risk
appetite - as they seek higher returns on
their lending.
There have been fundamental changes
across Europe, as alternative finance
providers and debt funds have seen their
market share increase, often at the expense
of traditional lenders. This structural shift has
led to a more diverse lending environment
than was seen prior to the credit crunch.
According to Market Monitor data, non-bank
lenders were involved in 17% of deals in
Europe with ¤1.3bn or less of debt in 2011.
However, by 2013 non-bank lenders were
involved in 46% of these deals.
31%
83%
2012*
46%
69%
2013*
54%
n Deals including non-bank lenders
n Bank only deals
* 12 months to end of September. Multi-banked transactions
with ¤1.3bn or less of debt
Trends in detail
After a number of years with limited choice
in the mid-market, there is now a diverse
range of lenders and lending products
available to businesses.
Some of the new products in the market,
such as the much-discussed unitranche, are
not only supporting buy-out transactions and
leveraged deals but also offer an alternative
form of finance for businesses that require
more flexibility in their funding structure. For
instance, this could be in the form of lower or
no amortisation of the loan, providing the
business with additional cash resources to
spend on acquisitions or capital expenditure.
We have seen loan pricing reduce materially
in the last 18 months, as competition in the
European mid-market between banks and
debt funds has increased. The driver for
this has been the relatively low number of
deals and transactions taking place,
meaning lower demand from businesses,
and the entry of new non-bank lenders
which have raised large funds from
investors that need to be put to use.
With the exception of when debt funds
participate in club and syndicated deals with
banks, pricing from debt funds is generally
more expensive than banks. This is a
function of returns expected by investors.
As a quid pro quo, commitment periods can
be longer, covenants lighter and
amortisation less or non-existent.
Lower amortisation from banks is also
becoming more popular in the Leveraged
Buy-Out (LBO) market, with larger
proportions of non-amortising B tranche
term loans forming part of the structure.
Within some larger mid-market leveraged
finance deals, there have even been some
term-loan-B-only arrangements.
Seasonal and/or very cash generative
businesses have benefitted from
amortising Revolving Credit Facilities
(RCFs) being offered by senior lenders.
This structure is a committed working
capital facility where the limit reduces each
year. This reduces the refinance risk for the
lender and also cuts the interest cost for
the borrower during positive periods of
their working capital cycle. Term loans and
unitranche facilities do not tend to offer
this flexibility. Higher proportion B tranche
term loan structures and amortising RCFs
have been used by senior lenders in order
to compete and differentiate themselves
from the debt funds offering unitranche
style products.
The terms in the lower mid-market are not
quite so favourable as those in the midmarket, but we continue to see an
improvement in liquidity, interest from
banks and alternative funders, and an
increase in the leverage multiples offered
to businesses. This can only be good for
increased deal activity and growth.
clearthought | Autumn 2014
Debt Advisory Insights from Clearwater International
Interview: Ed Jolly, Pricoa Capital Group
Tell us about
Pricoa
Pricoa Capital Group
is the direct lending
arm of Prudential
Financial Inc* (NYSE:
PRU), and has been
one of the leading global providers of private
debt to companies for the past 75 years.
We have been in the UK for over 25 of
those years. Pricoa is also active in Europe,
with offices in Paris and Frankfurt.
Long-term lending has been a consistent
part of our investment mandate and our
business has grown steadily, even during
the recent global economic crisis.
If anything, the crisis has helped our
growth - when banks were turning away
companies in the depths of the crisis,
businesses turned to us as an alternative
capital source. In 2013, we provided more
than ¤1.5bn in capital out of our London
office alone. We have long-standing
relationships with many corporates and
have been in the private debt space for a
long time.
alternatives and this is where we find our
proposition resonates strongly. As a term
lender, we are under less pressure to get
our money back so quickly. Therefore, we
provide a longer-term funding option than
bank debt. Much of our activity this year
has been funding companies’ growth and
investment plans.
What is your view on the new
funds that have entered the
market?
There is a considerable structural shift yet
to happen in a region such as Europe, and it
is the beginnings of this shift that have
been driving our business in recent years.
However, one of the challenges is that there
are barriers to entry in setting up the funds in
the first place. You have to have people on the
ground who can structure the transactions,
and it is a very hands-on asset class.
Big US insurers have been doing this for a
while, but it is a big investment to launch a
platform. That has been a barrier for
European institutions which are serious
about entering this market. However, a
new asset class has undoubtedly emerged
over the past few years.
How does the Pricoa model work?
What we do breaks down into two main
areas. Firstly, private placement financing
for medium to large companies with longterm fixed rate funding. Secondly,
mezzanine and senior lending to lower midmarket companies (¤5m EBITDA upwards).
The fact that our model is built around longterm relationships gives us a big advantage.
Half of what we do is offering repeat
business. We find a company, deliver
finance, and then continue to provide capital
in the future for that business.
We provide capital in both sponsored and
non-sponsored transactions. Private equity
(PE) and corporates are becoming more
aware of non-bank options. Nonsponsored transactions still lack funding
What is your view on the current
market?
Over the last six months, the market
definitely feels far more positive whether
from public or private companies. There are
more conversations about M&A and
investment opportunities, which is starting
to drive deal flow. We have also seen
activity pick up in the PE market.
Ultimately, company default rates are very
low right now. Many corporates have
weathered the storm and paid down their
debt. The main factor that could derail the
corporate debt market in the short term is
some kind of big global economic shock.
* Prudential Financial Inc is not affiliated in any manner
with Prudential plc, a company incorporated in the
United Kingdom.
clearthought | Autumn 2014
Debt Advisory Insights from Clearwater International
Hot Topics
New funders
European Leveraged Loan Issuance Volume (¤bn)
A number of new debt funds have entered
the European market, adopting a range of
different strategies including private
debt, mezzanine, special situations and
distressed debt. This inflow of liquidity has
helped to drive a number of leveraged
refinances, leading to the high issuance
seen opposite.
80
Debt funds can generally be split into two
distinct categories. Firstly, the direct
lending arms of pension funds and
insurance companies; and secondly, those
that have raised a specific lending fund
from an investor pool. The debt funds often
have structures similar to those seen in the
PE market, with investment periods of
three to five years and a life of around 10
years. The limited partners in these funds
are usually insurance companies, pension
funds, private wealthy investors, banks and
sovereign wealth funds.
20
Key differences in the debt funds compared
with banks are:
4
n
Higher leverage multiples (as
demonstrated in the graph opposite)
n
Non-amortising / bullet structures
n
Structural flexibility around covenants,
headroom, cash sweeps and dividends
(lower graph shows loosening of
covenant controls)
n
n
60
58
50
43
42
40
29
30
15
10
2008
2009
2010
2011
2012
2013
European Leveraged Loan Pro Forma Debt/EBITDA Ratios
5.9
6
5.4
5.2
5.3
5.1
5
4.5
4.1
4.2
2009
2010
4.7
4.4
4.5
2011
2012
3
2
1
2004
2005
2006
2007 2008
2013 Q1 2014
Options across the capital structure
with senior, second lien, unitranche,
mezzanine and quasi-equity
instruments, including warrants
Average Number of Covenants per European Leveraged Transaction
Shorter credit decision processes
5
Limitations of debt funds include:
n
67
70
Inability to offer clearing or ancillary
facilities
n
Higher pricing to account for the
increased flexibility offered
n
Lack of track record managing
distressed situations
4.3 4.2
4.3 4.2
4.2 4.1
4.2
3.9
4
3.5
3.7
3.6 3.7 3.7
3.6
3.0
3
2
1
Increase in Leverage
Leverage has increased over the past 18
months, moving gradually towards precredit crunch levels. Leverage levels in the
European LBO market have risen steadily
1999
2001
2003
2005
2007
2009
2011
2013
clearthought | Autumn 2014
Market Outlook
n
Debt funds’ share of the market will
continue to increase, but the banks
will fight to retain market share
n
Appetite for a wider range of
deals will grow to get funds out
the door
n
Term loan B tranches will increase in
popularity as banks look to
compete with credit funds
n
Lower mid-market space to
become more competitive,
offering options for borrowers
n
Europe will see further liquidity
inflows from the US
n
Greater collaboration between
banks and debt funds
Debt Advisory Insights from Clearwater International
since a low in 2009 of 4.1x, up to 4.7x in
2013 and now a high for the first quarter
of 2014 at 5.3x. The pricing of senior loans
in the European mid-market also appears
to be following that seen for larger loans,
with margins now reducing to sub 5%.
This increased appetite from senior lenders
and banks could cause issues for debt
funds which may struggle to achieve the
return required by their investors. In turn,
increased supply and reduced margins may
lead to looser terms being offered by the
debt funds as a differentiator to compete
on flexibility.
Cov-Loose & Cov-Lite
Cov-loose & cov-lite refer to the practice
of reducing or having no covenants
attached to a loan facility. The terms
available today have improved since the
credit crunch. The average number of
covenants in a mid-market leveraged deal
reduced to 3.0 in 2013. Clearwater
International has also seen an improvement
in the level of headroom in the covenants
that have been set.
Basket levels for acquisitions, demergers
and asset disposals have shown an
improvement in favour of the borrowers,
allowing larger baskets without seeking the
prior consent of lenders. We expect the
larger baskets to drive increased acquisition
activity, although larger deals for any
particular business will still see borrowers
seeking consent from lenders.
Although covenant-loose structures have
become more common in mid-market
businesses, following the trend of large
market deals, we do not expect to see
cov-lite deals proliferating in the midmarket. This will principally be driven by
lenders wanting to see greater control over
smaller market deals, due to the increased
risk of default with smaller businesses.
“The entry of debt funds to the European markets and the improved risk appetite
of banks has benefitted businesses, with improved flexibility and better terms
supporting deal activity and business investment.”
Summary
The growth of new lenders in the mid-market has
brought many new options to businesses and
dealmakers looking to raise finance.
There remains some scepticism about
debt funds, with a need for lenders to
build further trust and relationships with
advisors and businesses. Credibility is key.
There is a track record with the traditional
“known” funders, but they should not be
put on a pedestal given differing levels of
support during recent distressed times.
both operational management and
investors, with the current low levels of
interest rates assisting here. There will be
greater collaboration between traditional
lenders, debt funds, asset based lenders
and the direct lending arms of pension
funds & insurance companies, resulting in a
new mix in the funding market, longer term.
There are concerns that increased
competition amongst lenders is pushing the
lending market back towards the leverage
multiples and minimal covenants seen
ahead of the credit crunch, however these
terms are only available for the best
companies. We see increasing confidence in
Our opinion is that the entry of debt
funds to the European markets and the
improved risk appetite of traditional
funders has benefitted businesses,
with improved flexibility and better
terms supporting deal activity and
business investment.
clearthought | Autumn 2014
Debt Advisory Insights from Clearwater International
Interview: Jerry Wilson, UK Private Credit - Chenavari Investment Managers
Tell us about
Chenavari
We are an asset
manager investing
across a broad range
of credit products
throughout Europe
and Asia, with some
¤4bn of assets under management.
Chenavari has grown successfully on the
back of very solid results since it was
formed in 2008 and our funding comes
from a broad range of institutional
investors across the US, Europe and Asia.
How does the Chenavari
model work?
Chenavari's UK Private Credit business
offers an alternative to successful, well-run
SMEs (EBITDA ¤4m - ¤20m) in a market
where there is a significant disconnect
between the supply and demand for credit.
Our model consists of three principal
components which differentiate us from
the mainstream commercial banks.
Firstly, any debt capital the firm structures
does not have scheduled regular
amortisations, giving the management team
the flexibility to reinvest free cashflow back
into the business. Secondly, management
teams and stakeholders gain direct access
to our decision-makers as the UK Private
Credit partners are members of the
investment committee. Thirdly, there is goal
alignment. Chenavari partners are invested
in the funds, which drives a distinct
difference in behaviours and philosophy
when compared with 'salarymen' in the
mainstream banking community.
Making our funds available to companies in
this SME segment affords management
teams access to a model that until recently
had only been available to bigger midmarket companies, where many of the
larger US-owned debt funds operate.
What is your view on the new funds
that have entered the market?
The recent arrival of debt funds to Europe
is a positive move for the market. In the
US, some 70% of debt is sourced from
funds independent of mainstream
commercial banks whereas in Europe the
reverse is the case. I expect companies in
Europe to increasingly reduce their reliance
on the commercial banks for credit,
although I don’t expect it to approach the
70:30 US ratio anytime soon.
Considering the market further, in Europe I see
two segments. Firstly, there are the core
mid-market companies with an Enterprise
Value (EV) of anything between ¤90m and
¤650m. These businesses have increasing
levels of choice when it comes to sourcing
their debt and there has been a wholesale
influx of debt capital in recent years from
American-owned institutions such as Alcentra,
Ares, Babson, BlueBay, Hayfin and HIG.
This influx of capital has been good for
companies, particularly with regard to
higher degrees of leverage with reduced
pricing available for transactions. However,
this has reduced visibility over stable returns
for investors. We therefore deliberately
don't target this segment, instead focusing
on the lower mid-market arena (EBITDA
¤4m - ¤20m) where SMEs have had
limited options when it comes to sourcing
credit, other than the commercial banks.
What is your view on the
current market?
The current market is healthy. There are
many great businesses run by talented
management teams seeking funding to
support their next phase of growth. Whilst
these companies have overcome the
recent economic turbulence, private
owners have perhaps been cautious about
exiting or taking on additional finance. The
relative scarcity of debt in the lower midmarket may have hampered company
valuations and FDs may also have been
struggling to garner decent levels of
traction from their relationship bank.
I believe that leverage levels, and the
approach to covenants and documentation,
will remain sensible in this lower midmarket segment. In the core mid-market
(EV ¤90m - ¤650m), the increasing supply
of debt will push leverage positions and
result in more relaxed documentation and
financial covenant terms, contributing to an
increase in the volatility of risk and returns
for investors.
With regard to the 'great wall’ of
refinancing, whilst the benign interest rate
environment has led to subdued levels of
portfolio churn amongst the mainstream
banking community, our analysis indicates
that in Europe Basel III means that banks
today have a shortfall of core Tier 1 capital
of around ¤1tn that will need to be met by
2019. There will undoubtedly be a myriad
of further portfolio and individual deal
refinancing opportunities ahead.
clearthought | Autumn 2014
Debt Advisory Insights from Clearwater International
Meet the team
Mark Taylor
Partner, UK
Royal Westmoreland
Gascan
¤24m refinance
¤38m debt restructure
Luxury golf and spa resort
in Barbados
Portuguese distributor and marketer
of propane gas
Clearwater International secured
funding from Grovepoint Credit to
refinance existing borrowings
Clearwater International led the
process and negotiated the
restructuring of the ¤38m debt
portfolio
+44 845 052 0346
[email protected]
Chris Smith
Partner, UK
+44 845 052 0308
[email protected]
Rui Miranda
Partner, Portugal
+351 918 766 799
[email protected]
Vanguard Healthcare
Joules
¤21m debt refinancing
Buy-side debt raise
Provider of mobile surgical facilities
Leading British lifestyle brand
Clearwater International advised the
company on refinancing, leading
negotiations and raising senior debt
facilities
Clearwater International advised
LDC on its minority equity
investment including raising debt
facilities to fund the ongoing growth
of the business
Optos
Cepsa S.A.
Kai Bech Andersen
Associate Partner,
Denmark
+45 25 27 00 52
kai.bech.andersen@
cwicf.com
Barry Chen
Partner, China
+86 6341 0699 x 881
[email protected]
Antonio Tomás
Director, Spain
Strategic advice on offbalance sheet refinancing
Recapitalisation/
Development Capital
+34 629 024 286
[email protected]
Leading provider of devices and
solutions to eyecare professionals
Supplier and manufacturer of
mid-stream chemicals
Tom Barnwell
Clearwater International provided
guidance to this UK plc on its
international vendor refinancing
exercise, introducing new US funders
to the process
Clearwater International represented
the buyer in the restructuring of the
company’s phenol operations
Associate Director, UK
+44 845 034 4767
[email protected]
Jesper Agerholm
Associate, Denmark
+45 29 92 91 06
jesper.agerholm@
cwicf.com
www.clearwaterinternational.com
David Burton
Associate, UK
AARHUS • BARCELONA • BEIJING • BIRMINGHAM • COPENHAGEN • LISBON
LONDON • MADRID • MANCHESTER • NOTTINGHAM • PORTO • SHANGHAI
+44 845 052 0357
[email protected]
Afonso Lima
Associate, Portugal
+351 910 766 229
[email protected]