High-yield Bonds & Loans: Slow but steady progress
While some European countries are making progress with respect to non-bank funding for mid-market businesses, others still have some way to go. Yet there is a growing appetite for the standardisation and transparency required to develop this market, write Alexandra Krief and Taron Wade
Many economic commentators consider the mid-market corporate segment the engine for growth in a Europe still struggling with economic stagnation. Yet funding concerns persist, with banks remaining constrained as they continue to clean their balance sheets.
Bridging this ‘funding gap’ is imperative, although progress in connecting the increasing investor demand for exposure to mid-market firms with the funding needs of mid-market borrowers has been slow.
Germany, France and the UK lead the way with respect to European mid-market private placements and direct lending, although work remains to be done. Indeed, with European capital-expenditure funding requirements for mid-sized businesses set to increase to between €2.4trn and €2.8trn in the next five years, Europe’s mid-market companies simply must establish alternative funding channels.
According to ECB data, 2013 was the second consecutive year in which net bank loan issuance to corporates in the euro-zone has been negative – a deficit that especially affects mid-market companies that continue to suffer disproportionately from banking constraints.
However – and as long as impediments can be dealt with – the hope is that this void can be filled by the direct lending and private placement markets, as well as through the use of retail bond exchanges. Interestingly, one key impediment for the development of mid-market funding alternatives is what appears to be a lack of funding demand from European companies – despite the clear requirement, according to analysts. Certainly, many remain cautious of over-leveraging themselves – mostly limiting themselves to refinancing – mainly due to the bleak outlook of the European economic environment, as well as a lack of awareness of alternative funding methods.
Developing private placement
Market participants, and even national authorities, have put initiatives in place to overcome this – with the aim of encouraging direct relationships between investors and mid-market borrowers. The goal is to help develop Europe’s private placement market.
Arguably the strongest private placement market in Europe is Germany’s Schuldschein. Yet it is not necessarily the most viable option for mid-sized business funding. The Schuldschein’s appetite is primarily limited to investment-grade issuers and there is little incentive for investors to move down the credit-risk curve towards smaller entities.
Meanwhile, in France, the private placement market (euro private placement or euro PP) is also a well-developed market. While it is still mostly a route for larger companies, euro PP investors are beginning to recognise the opportunity presented by smaller issuers. This has resulted in an expanding market share for mid-market borrowers. In 2012, larger issuers represented 96% of the total volume, but in 2013 this figure decreased to 84% – highlighting the slow, but steady, expansion of mid-market interest in the euro PP market.
Certainly, the French euro PP market is revealing a greater appetite for the opportunities available from a wider range of companies with lower credit ratings than both the US private placement (US PP) market, the world’s most developed, and Germany’s Schuldschein. The euro PP market totalled €3.9bn in 2013, up from €3.2bn in 2012. Of course, this was dominated by French borrowers and French institutional investors, but the euro PP is gaining interest from foreign borrowers: Italian utility company IrenSpA recently issued a €125m bond into the euro PP market, while the Belgian real estate company Codic Group issued a €14m bond.
The UK private placement market is also expanding. Estimates suggest that, in the past three years, between £3bn (€3.74bn) and £6bn (€7.48bn) has been raised. Also, major institutional investors such as Legal & General and M&G have opted to fund mid-market companies through direct lending, demonstrating the growing confidence in the UK’s alternative funding route.
There are also some pan-European initiatives. In March, the European Commission announced plans to conduct studies, as well as employ work teams, to assess foreign procedures – particularly the US framework – with the aim of enabling effective policy replication within the EU.
Creating partnerships between specialist lending funds and banks – in an effort to facilitate mid-market funding – has been another successful method implemented in France and the UK. French asset manager Amundi, for example, has partnered with lender UniCredit to offer financial support to German mid-market
Lastly, bond-exchange platforms are another alternative. These allow mid-cap borrowers the opportunity to tap bond investors without committing to the full registration process of a public bond issue, but they are far from providing a comprehensive funding solution. Issuer brand recognition is important to the retail investors accessing these markets, so exchange-based investors are unlikely to develop large appetites for companies with low-level brand recognition. In addition, these securities tend to be illiquid, which can deter some investors.
Given that all the above represent steady, but slow, progress, what can help accelerate the growth of alternative funding options for mid-market borrowers? Without doubt, standardisation of legal documents will attract new investment because of the potential for reduced transaction costs. In this respect, the euro PP charter has already begun to set an example by identifying, and documenting, the best practices for making the process more transparent.
In fact, the transparency of a company’s creditworthiness is increasingly essential to developing the private placement market in Europe. This is particularly important for investors with limited credit analysis teams. Of course, this is where the ratings agencies can step in. For instance, Standard & Poor’s offers its Mid-Market Evaluation (MME) service – the first European benchmark designed to provide independent and private opinion of the relative creditworthiness of a potential company, alongside an explanation of the factors that influenced the assessment.
Certainly, the appetite is there. New categories of investors that increasingly want to diversify their investments into this new asset class – not least because slow economic growth in Europe will almost certainly result in continued low interest rates, making more and more investors hungry for yield further down the credit curve. And, if handled efficiently, the direct lending and private placement markets have the potential to be the most important conduit in this respect – significantly contributing to the funding needs of mid-market corporates.
Alexandra Krief and Taron Wade are directors at Standard & Poor’s Ratings Services