Bank deleveraging turning Europe’s mid-market to investors, suggest S&P’s Taron Wade and Alexandra Dimitijevic
Taron Wade, associate director, Corporate Ratings, and Alexandra Dimitrijevic, managing director, Standard & Poor’s Ratings Services see different sources of funding for Europe’s middle-sized companies.
The funding environment for mid-market companies in Europe is at a turning point. As banks embark on a deleveraging process that may take many years, mid-market companies are increasingly seeking to diversify their funding sources. At the same time, investors searching for yield increasingly want to diversify their investments into this new asset class. However, despite some progress on linking together mid-market companies with willing capital, a cohesive pan-European solution remains elusive.
Developing an efficient pan-European funding market for these mid-market companies will necessitate changes for both issuers and investors. For debt issuers, expanding outside of a long-term banking relationship can be a significant cultural shift. For investors, we believe that better access to timely financial information could go some way in aiding their activities in this new asset class – particularly for those too small to develop internal research and risk management capacities.
A critical engine for growth
The mid-market – which S&P defines as companies with revenues between €100m and €1.5bn and outstanding debt between €50m and €500m – generates about one-third of private sector revenue and employs a third of the workforce across France, Germany, Italy and the UK, according to research from GE Capital. However, the alternatives to bank funding for European mid-market companies form a cluttered and incohesive landscape.
These include the developing loan fund market, the US private placement market, the private placement market in Germany (the “Schuldschein” market), the very young private placement markets in the UK and France, and – to some extent – regional bond platforms on exchanges.
Institutional lending by funds has been slow to develop in Europe, partially because of a lack of new deal flow since the global financial crisis of 2007-2009. Pre-2008, non-bank lending in Europe was dominated by collateralized loan obligation (CLO) funds, mezzanine funds (which specifically lend subordinated debt to companies) and some non-leveraged loan fund managers, such as M&G Investments. Unfortunately, the financial crisis derailed new entrants to this market, particularly as stagnant buyout activity and the subsequent lack of new deal flow meant that it was difficult for new types of loan investors to raise investment capital. However, over the past year there has been a small resurgence in fund investors’ interest in lending to smaller companies in Europe. These lenders include private equity and asset managers, such as Axa Private Equity, Ares Capital, and Amundi.
Private placement markets offer stability and simplicity
The most developed of the European private placement markets is the German Schuldschein corporate market, which is essentially a bilateral, unlisted, unregistered loan market governed by German law. Both large multinationals as well as midsize domestic companies have historically tapped this as a well-established source of funding.
In the UK, the Association of Corporate Treasurers (ACT) is leading a working group exploring the development of a private placement market. The group released an interim report in December, saying there is clear demand for this type of market but that changes are required to facilitate a UK version of the Schuldschein. These include the need for clear regulatory treatment for insurance company investors, standard documentation, readily available information about market activity, a track record of performance and defaults built up by individual investors, and investors that are prepared to set up internal resources to participate in the market.
Bond platforms on exchanges are still in development
Germany has also taken the lead in developing funding avenues for companies in Europe via exchanges. More than 55 companies have debt of approximately €3bn that is actively traded across the three main stock exchanges in Germany: BondM, Mittelstandsmarkt, and Entry Standard.
Again, these exchanges are less developed elsewhere in Europe. In the UK, the London Stock Exchange has set up The Orderbook for Retail Bonds (ORB). This allows private investors to buy into individual corporate bonds in small denominations. It mostly started with large issuers such as Royal Bank of Scotland, Tesco Bank, and National Grid. Yet some mid-market companies are beginning to tap the market, such as International Personal Finance PLC. In France, NYSE-Euronext launched its bond market in 2012, which is open to retail investors. It has seen three transactions so far; from agricultural commodities company AggroGeneration SA, family-owned property developer Capelli, and camping resort firm Homair Vacances.
Although the European market has made some progress in linking together mid-market companies with willing capital, a cohesive pan-European solution remains some way off. Partly, we believe that issuers, for their part, can find expansion beyond a long-term banking relationship to be a significant cultural shift, which can coincide with a reluctance to disclose financials. Nevertheless, we believe it is crucial for the future of the European mid-market that these obstacles are overcome. Bank lending will not disappear entirely, but severe economic and regulatory pressures mean it is likely to be increasingly unavailable to mid-market companies over the foreseeable future.
Taron Wade is associate director, Corporate Ratings, and Alexandra Dimitrijevic (pictured) managing director at Standard & Poor’s Ratings Services.