Through 2009-12, sponsors would have to work hard to pull together clubs of banks to finance midmarket acquisitions, refinancing opportunities were scarce and the bond market (whilst open) was the preserve of larger deals. Whilst some funds had begun to get some traction in the market, the prospect of obtaining debt finance from little known funds at high interest rates seemed unappealing to sponsors. They valued the longer term relationships with banks and were unsure how the alternative lenders might behave in difficult times.
Yet, in 2014, we are seemingly operating in a different land. Leveraged financings will now typically involve dual track processes considering all-senior and unitranche structures. Increasingly, the alternative lenders are providing the most compelling offers and some sponsors are questioning their former dependence on the banks.
So, why are sponsors turning to these alternative lenders and their unitranche product?
First, the answer is deliverability. If, for example, a sponsor is seeking to raise £100m of debt, the ability to borrow this from just one or two alternative lenders is compelling when contrasted with the alternative approach of bringing four or five banks through their credit processes. The simplified processes, compressed timelines and larger hold levels when dealing with alternative lenders could make the difference in a competitive auction process.
Second, the alternative lenders can accept greater leverage which allows sponsors to commit smaller equity cheques. The recent refinancings of Trust Inns and Caffe Nero are good examples of this, as are the stretched unitranche products now being marketed.
Third, the flexibilities on offer are very appealing to sponsors. Alternative lenders can be more accepting of well-reasoned requests – for example around financial covenants, bolt-on acquisitions and capex, portability on a change of control, reduced amortisation and cash sweeps, unusual capital structures or funding shareholder distributions. These benefits can be difficult to price but the advantages can be compelling.
Finally, sponsors are not being put off by the higher margins required by these alternative lenders. In particular, on a refinancing, the ability to replace expensive shareholder debt with a unitranche facility can help deliver more concentrated value in the pure equity.
What does the future hold for mid-market leveraged finance opportunities?
The presence of alternative lenders and unitranche structures is here to stay. Many sponsors have now borrowed from these new lenders and they are becoming known to, and trusted by, sponsors. BlueBay is a particularly good example of a direct lending fund that has quickly gained a presence in the market.
It is interesting to see how the banks respond to this challenge. The year started with many seeking partnerships with the funds. Barclays and BlueBay were the first out of the blocks and the market is awash with other partnerships being forged. These partnerships involve banks clarifying their role as providers of RCFs, hedging and the lucrative ancillary banking. Some banks are also seeking firstranking slices of the term debt. The challenge for lenders is to agree the intercreditor terms at the outset to avoid extensive negotiations when implementing deals.
Equally, challenges remain for the alternative lenders to win mandates in a competitive landscape. Which lenders can distinguish themselves and offer sponsors the more compelling or creative structures?
The European leveraged finance market is in the midst of a dynamic and structural shift, which is offering private equity sponsors an unparalleled choice of product.