Anyone must be brave to publish a business-focused outlook at this particular time; with the uncertainty over Brexit and the potential effects on UK and European businesses, consumer confidence and financial markets.
However, as a result of macro issues such as Brexit, the US-China trade war, and other Geo-political tensions, business managers and owners have lived with so much uncertainty over the last few years that “Uncertainty has become the new normal.”
Does this uncertainty extend into the UK’s financing markets, and what will happen to the availability of finance for businesses following Brexit?
To attempt to answer these questions it is necessary to understand how the UK debt markets have evolved since the 2008/9 financial crisis. The principal two factors have been:
- the restructuring of the traditional UK banks, resulting in increased regulation and oversight; and
- the explosion of a new type of financiers in what is known as the “alternative lender market.”
It is worth trying to understand how the banks have been regulated, and what impact this has had on their appetite to lend into the UK market. Primarily through this increased regulation, the banks now have to operate with higher costs, as a result of;
- increased regulatory capital costs (the amount of capital they have to set aside to protect depositors) meaning longer term and more leveraged loans have become too expensive for banks to provide; and
- having segregated their UK market and investment banking operations which, again, has forced them to increase their cost base as a result of duplicated management functions, and more stringent capital requirements.
Overall this means that the UK bank market is now stronger, if more cautious, than before; in general, there’s been a contraction in banks’ appetite and capacity to lend; and an increased focus away from certain lending areas. However, all is not doom and gloom;there is also now a vast pool of debt capital available to be lent, in situations where the banks no longer have appetite. Bring on the “Alternative Lenders.”
What are Alternative Lenders?
Alternative Lenders are known by a number of terms; Credit Funds, Direct Lending Funds, Unitranche Funds, etc. Well-known names such as Ares Management, CVC, Goldman Sachs have long established funds, and a huge number of lesser known fund managers, all with various “lending strategies” addressing different parts of the market and seeking differing types of risk and returns have set up and are actively lending in the UK.
Alternative lenders are essentially a “credit strategy” employed by fund managers in the same way as private equity, listed company and infrastructure funds where investments are pursued to gain a return for their investors. Compared with the banks they are less regulated but rely on their track record of lending to attract the next round of fund capital from their investors to support subsequent funds.
The market was established a few years before the financial crisis, in the mid-2000s and, in a globally low yielding environment, has become an attract place for asset managers to invest pension and insurance investments. In the UK mid-market there are now well over 70 alternative lenders providing a real choice to mid-market borrowers in the event that their requirements fall outside of the bank’s appetite.
What does that mean for me as a borrower?
Most alternative lending is used to provide capital for some form of transaction; whether that be a private equity buy-out, an acquisition or recapitalisation of shareholders. Where the financing requirement demands a more innovative solution than the traditional banks are able to provide, then it is worth considering the alternative lender market. It will, usually, have a higher “sticker price,” (for example by way of interest rate) however the real cost of capital comparison is generally with equity (the typical alternative if the bank won’t lend); and alternative debt can therefore be used to generate greater shareholder value in the medium term.
So what about post Brexit?
There has been, and will undoubtedly continue to be, caution around the economic and business outlook post the Brexit date. However, it is difficult to see debt liquidity being materially impacted as a result. Banks may well tighten their lending criteria and alternative lenders may review their risk / reward criteria, but the overall quantum of debt capital available from the market is unlikely to reduce to any great extent. There may well be a “financial market reaction” to the Brexit outcome but business, in the real world, and the financing of it, will go on.