Corporate Loan Market Trends in an annus horribilis

• United Kingdom

• Banking and finance
• Corporate
• Corporate finance

09-12-2020

Whilst Her Majesty, Queen Elizabeth, coined this phrase in 1992, there is no doubt that 2020 has been another ‘annus horribilis’. As we approach the end of this challenging year and reflect back as well as look forward, it is worthwhile pausing for breath to assess what has been a truly unprecedented picture for the global economy and the knock on effect on the corporate loan market.

In the early part of the year, before the reality of a global pandemic hit us, I remember contemplating three pillars of how funders think about corporate lending. These pillars, namely, the cost of capital, portfolio management and diversification were largely as a result of the landscape that emerged post the global financial crisis, where the bar for regulation, supervision and risk management of lending was permanently raised.

With the stark impact of the pandemic on the financial markets, I thought it would be an appropriate time to re-categorise these pillars and summarise what I believe are the important factors for corporate borrowers to now consider.

Access to Liquidity

Essentially, this combines the three previous pillars in one. It is fair to say that banks on the whole are well capitalised, and credit availability is generally sufficient to meet demand. Whilst current lender appetite can be greatly influenced by sector, banks are also still lending based on the relative performance of a particular business on a case by case basis. Naturally an institution’s risk appetite and existing portfolio will also determine credit decisions.  Relationships also matter, and whilst this means length of association, track record and proactive information sharing are important, it also means banks are focused on providing ‘relationship capital’. Access to ancillary business streams are often crucial to support the decision to lend, given that traditional term loan lending, in isolation, is less profitable for banks these days.

Against the backdrop of heightened regulation for banks, with a consequential increase to cost of capital, many larger corporates are now thinking seriously about diversifying their capital structures. Some CFOs and Treasurers are using their bank(s) for revolving credit facilities for working capital and short term needs, but looking elsewhere for longer term capital. It is noticeable that during the pandemic tenor appetite from banks for large corporate loans has typically reduced from 5 years to 3 years.

For larger corporates this search for longer term capital may involve a debate between private placements (essentially longer term loans provided by insurance and pension funds) or accessing the public debt capital markets (DCM). Both have pros and cons. The main hurdle to accessing the public markets being rating requirements and the disclosure that comes with this, but the reward is access to cheaper, long term, and predominantly covenant free capital.

Another form of private capital that has emerged in Europe over the past decade are debt funds (aka non-bank lenders or alternative capital providers). There are now hundreds of funds in existence targeting loans to corporates in different shapes and sizes and providing capital for a range of purposes. Much, but not all, of the capital is deployed in M&A situations, in particular to support private equity, but as the asset class matures, there is more and more capital being earmarked to replace some of the more traditional lending, historically provided by the mainstream banks. Many commentators observe the trend in US markets, where the majority of longer term capital is provided away from banks and question if that trend will take hold in Europe.

In essence, for corporates navigating the loan markets, there are now multiple providers and solutions and having a trusted advisor on board to help source the optimum capital structure is more crucial than ever before.

Balancing your Debt

At the outset of the pandemic and at the height of uncertainty, alongside seeking covenant relief, many corporates drew down their revolving credit facilities in full to ensure they had ready access to cash.  Others made use of good working relationships with lenders to re-purpose unused facilities such as acquisition and capex lines. Whilst much of this trend has now reversed and businesses have built up cash reserves and perhaps even pared back the size of their revolving credit facilities, this is not the case across the board, in particular for those who have seen cashflows hardest hit by lockdowns and other pandemic-related issues. With over £60bn of government backed interruption loans now in the system needing to be dealt with, and many corporates having little further access to capital beyond this, the next 12 months could be a bumpy period. The combined effect of higher debt and lower earnings may stoke an increase in refinancing discussions, as well as defaults and insolvency processes in some cases.

Whilst it is likely that some elements of ongoing government support will be made available, corporates will need to develop different strategies to survive and prosper during this period. With the threat of higher taxation levels also likely to be a feature for businesses, and with changes to capital gains tax and entrepreneurs’ relief for private shareholders, some owners may decide to de-risk themselves by selling all or part of their business.

For many corporates, managing dialogue with their lender will be crucial. Avoiding bank bashing and remembering that a Bank Manager is a human being are two obvious tips, but there is always a balance to be struck between being open with your lender and not over-sharing. Some businesses may have to prepare themselves for being transferred into a stressed/distressed lending unit but experience tells me that this is not always the doomsday scenario that is first feared. Whilst this is a decision a bank does not take lightly, and the borrower should take serious note, these units are very experienced and can have greater discretion to provide support outside of ‘one size fits all’ credit policies.

Investing for Growth

Looking beyond the pandemic, there may be cause for optimism ahead. Since the summer, M&A has returned and there is generally a positive tone around the availability of acquisition finance and the confidence in the market to get deals done. Commercial terms have largely reverted to those seen pre-pandemic. For banks, M&A can be a profitable business, particularly if lenders are able to generate extra fees from underwriting or can provide ancillary products from the debt and equity capital markets to their clients.

There is a significant amount of private equity and debt fund ‘dry powder’ ready for investment. Whilst 2020 was, on paper and pre-pandemic, due to be a key year for corporate refinancing, there is now more talk of 2020/21 being a great vintage for M&A.  As corporates realign, diversify or supplement their business models, and others dispose of non-core subsidiaries to generate cash, many boardrooms will be busy adapting to a post pandemic world.

It’s fair to note that whilst some stronger corporates may be looking for opportunistic acquisitions and will see this as a time to pursue aggressive growth strategies, at the other end of the spectrum, others will be much more internally focused and require time to consolidate and get business back to a sense of normality.

An area that is often overlooked and could provide challenges for some corporates is the need for funding for growth. As working capital inventories have shrunk during the pandemic, there will be a need to reinvest to enable a resumption in activity and take advantage of pent up demand that may ensue in certain sectors. For some, this will be at a time when interruption loan commitments will need to be dealt with and other government support ceases, creating further strain. I can see an uptick in demand for trade and asset based lending during this period, as some funders seek to get closer to the underlying working capital cycle as part of their lending criteria.  

Whilst no one has a crystal ball in terms of how next year will play out, let’s all hope we can look ahead to a world with a vaccine programme and, maybe even some sort of Brexit trade deal in place, where businesses are able to plan with more certainty and a clear path begins to emerge to navigate the future. Maybe in 12 months’ time we can even reflect on an annus mirabilis.