Europe’s alternative lending markets have developed in leaps and bounds, with as much as €38bn (£27.5bn/US$40.9bn) raised last year through private placements and direct lending. What is more, new developments – including the emergence of unlisted deals and senior secured debt – are increasing deal flow and ushering in a wider range of companies, many of which are from the mid-market sector.
As bank disintermediation continues throughout Europe, private investors will become increasingly important sources of funding for mid-market firms. However, economic stagnation in much of the region has dampened investor confidence. In an important attempt to counter this trend and encourage further private investment in Europe’s mid-market businesses, the European Commission (EC) – through its ‘Juncker Plan’ of economic investment – has set aside €5bn to promote growth in the sector.
With initiatives like this in place, opportunities will increase for investors looking for higher returns or diversification from mid-sized companies. Yet greater transparency and comparability of the creditworthiness of midsize companies will be needed in order for these opportunities to be seized.
In recent years, much of the increased issuance from European firms in alternative lending markets has come through private placement markets, such as US private placement (USPP) and the German Schuldschein. While the USPP has long been a key source of funding for European businesses, the Schuldschein market is increasingly embracing non-German issuers – as highlighted by the €359m issuance from French healthcare service provider Korian late last year, following its €1.1bn acquisition of peer Medica in November 2013.
Although the USPP and Schuldschein markets clearly dominate in volume – with about €13bn and €11bn raised in 2014 respectively – other European private placement markets have made significant headway in the past three years, with a combined €4bn of issuance in 2014, as outlined below in Figure 1.
Europe’s Mid-market Cheers New Developments
Indeed, Europe’s mid-market is embracing developments which are helping to open up new avenues of funding. One significant development has been the emergence of unlisted deals on the French euro PP market, which has been particularly successful in ushering in new international borrowers. This is because unlisted deals allow a wider variety of companies – including smaller ones – to source private placement funding from French investors.
As such, unlisted deals have proven popular with a range of mid-market businesses across Europe. For example, French mid-market metal and glass container manufacturer, Fareva, issued a record €275m unlisted PP bond in late 2014.
Further contributing to increased deal flow on the euro PP was the emergence of senior secured debt deals. Among these was French infrastructure group NGE’s issue of €70m of debt through the euro PP in July 2014, which enjoys equal footing to bank loans in the event of default. The appearance of this debt structure – which speculative-grade companies typically use in the public markets – also implies that the euro PP market is starting to welcome a wider range of credit risk.
Smaller companies are also beginning to explore other markets such as bond exchange platforms, typically for funding of less than €200m. For instance, the new professional segment of the ExtraMOT market on the Milan exchange – ExtraMOT PRO – saw incredible growth last year, with more issuers in 2014 than all other European exchange platforms combined and led mainly by small and mid-sized companies.
The European direct lending market – where dedicated credit funds lend directly to businesses mainly owned by financial sponsors, such as private equity investment firms – is also extending its reach. For example, S&P estimates that these corporates raised more than €10bn in capital in 2014 across more than 200 direct lending deals – at least double the volume and value seen at the end of 2013.
Industry Initiatives Offer Support
Although these developments demonstrate that alternative markets are opening up to a wider range of mid-market firms, investors’ bleak macroeconomic expectations are limiting their willingness to invest in the sector. However, a much-needed shot in the arm will come from the EC’s ‘Juncker Plan’, which proposes to inject €315bn into Europe’s economies over the next three years.
While the bulk of this funding will go towards supporting infrastructure debt investments, €5bn will be ‘ring fenced’ for small and medium-sized enterprises (SMEs) and mid-market companies in Europe in the form of equity-type investments and loan guarantee facilities. The ultimate goal is to convert this €5bn into €75bn of total investment for the sector before 2017, by raising additional private capital.
How the initial funding will be distributed will be decided by an administrative council jointly controlled by the European Investment Bank (EIB) and the EC. Since the funds are supposed to support growth and the creation of new jobs, we expect a higher percentage to be allocated to countries that have suffered most in the financial crisis. It remains unclear, however, which SMEs and mid-market companies specifically will benefit from this cheaper source of capital.
From an economic perspective, the EU money would probably best be put to work by supporting the plans of companies that are the most innovative and will create the most jobs as they grow, yet are currently cut off from external financing. Looking ahead, an improving economic outlook – and further development of the alternative lending markets – will mean that mid-market firms are well positioned to tap greater amounts of private investment over the coming years, but issues of limited transparency still remain an issue.
Indeed, the lack of transparency can deter investors – especially smaller investors without the capacity to conduct their own credit risk analyses. For this reason, S&P launched its Mid-Market Evaluation (MME) offering in 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. In the absence of credible credit assessments, that is, without opinions about default probability, investors have difficulties making appropriate decisions for their capital allocation and pricing. Such information and transparency are key to effective capital allocation.
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