FUNDING FOR UK MID-MARKET COMPANIES: CHANGE IS AFOOT

UK mid-market companies are facing a reduction in bank lending, and are subsequently looking to alternative funding markets. Taron Wade and Alexandra Krief, analysts at Standard & Poor’s, explore the different initiatives being introduced to encourage lending to midsize companies in the UK

The way many businesses operate has changed since the financial crisis of 2008, especially when it comes to their relationships with banks. This is certainly the case for UK mid-market firms. Partly because tighter capital adequacy requirements have slowed bank lending, these businesses – defined by Standard and Poor’s as having revenues of between £85 million and £1.3 billion – are currently looking at a funding shortfall of about £450 billion between now and 2017 (or £90 billion annually).

That said, there are some positive signs that this will be bridged. For instance, the UK private placement market goes from strength to strength. Meanwhile, initiatives to boost lending to midsize companies have been introduced by the UK government, among others.

Boosting lending to midsize companies

One such initiative launched by the UK Government is the “Funding for Lending Scheme”. Under the scheme, the Bank of England extends funds below market rate to banks, encouraging lending to Small and Medium Enterprises (SMEs). However, results so far have been mixed: while the scheme has helped to cut mortgage rates to record lows for homeowners, spurring activity in the UK housing market, it has done less for small and midsize companies in the UK.

Another scheme from the UK Government – the Business Finance Partnership (BFP) – attempts to incentivize lending from alternative funding sources, matching funding from the government with that from fund managers. As of November 2013, 18 midsize companies received a total of £827 million under the scheme, and at least six new funds were created by Alcentra UK Ltd, Ares Management LLC, Hayfin Capital Management LL, Intermediate Capital Group PLC (ICG), M&G Group PLC, and Pricoa Capital Group. ICG, one of the scheme members, reports making nine investments in the past twelve months in UK mid-market companies in support of their long-term growth aspirations.

In addition to the BFP scheme, a number of commercial initiatives have also been set up – from intermediaries such as Tresauris and Eurocredit Exchange Ltd – that aim to bring together mid-market borrowers and new non-bank investors. What’s more, the Confederation of British Industry has published a handbook for mid-market firms looking for alternative sources of finance, with information on vehicles such as asset-based lending and self-issued retail bonds as well as private placements.

Growth of the UK private placement market

Certainly, the growth of the UK private placement market suggests that it will be a vital source of funding for these businesses in future. According to market participants, private placement deal flow in the UK spiked in 2013, totalling between 30 and 50 loans (up from only a handful in 2011 and 2012). With the average size of these transactions about £85 million, the total amount raised in the UK since 2011 is estimated to be between £3 billion and £6 billion.

However, the UK market is still in its infancy, especially in comparison to the US and Germany where the private placement market is well developed. For the UK private placement market to mature, a number of obstacles must be overcome. Regulation is one of these, given the EU’s Solvency II Directive does little to encourage insurers – some of the biggest potential investors in this asset class – to provide funding. There are also other problems, including the need for indices to monitor market performance, lack of investment track record (including default history), the high cost of investment in credit analysis for investors, the need for standard documentation, and a lack of liquidity and transparency.

Indeed, transparency is one of the bigger challenges for alternative finance providers who may not have the capacity or expertise required to analyse the creditworthiness of midsize companies. Although banks are used to examining company finances, fund managers can find the lack of transparency prohibitive. For this reason, Standard & Poor’s launched its Mid-Market Evaluation (MME) service in June 2013, Europe’s first credit benchmark aimed specifically at increasing the transparency and comparability of midsize companies. An MME offers an independent and private opinion of midsize companies’ relative creditworthiness and the drivers behind this assessment.

Certainly, the UK alternative investment market has the potential to plug the funding gap for mid-market companies; however, there is still a way to go in improving the market’s transparency and accessibility before more diversity and competition is introduced in the lending market.