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Banks are not the only fruit: firms seek new funding tools

Fears that UK industry could not escape recession because it was in the cold, hard grip of miserly banks have proved unfounded. The tens of billions of credit continuously provided by banks have seen most companies through, with some casualties. Innovative financing techniques like private placements, direct lending, retail bonds and crowdfunding have helped at the margins. But as Jon Hay reports, it is when companies begin to grow that these instruments may come into their own.

For the UK’s small and medium sized companies, things are — don’t jinx it — beginning to look up. After one of the longest slumps in living memory — though by no means the worst, on some important measures — Britain’s economy is growing.

Company liquidation rates are heading back towards record low territory and unemployment is falling. However, there is little cause for celebration yet. Growth of 0.7% across the economy means some companies and industries may be expanding decently, but others are still flatlining or contracting. Hope is returning, but has not yet been fulfilled.

“Investment intentions have really rebounded in the past few quarters,” says Lee Hopley, chief economist at EEF, the manufacturers’ trade body. “They’ve been very depressed since 2008 but are now at their highest level for six years. We expect actual purchases of new capital equipment to start to rise.”

As the mood lightens, the UK’s obsession with whether banks are starving the economy of credit is beginning to ease and become more nuanced.

“The interface between banks and customers was damaged in the crisis and hasn’t really recovered yet,” says Hopley. “Companies may not be willing to have discussions with their finance providers, perhaps because they think costs will be prohibitive, or collateral requirements too much.”

There is some evidence for this in the quarterly SME Finance Monitor survey of 5,000 SMEs — though it also says 76% of SMEs were happy not to seek finance in the past 12 months.

Stephen Pegge, group external relations director, Lloyds Bank, says SMEs’ deposits are still growing as they hoard cash, while they are only using about 50% or 55% of the overdrafts available to them. “We have to hope businesses do start to invest, because unless they invest in developing new markets, in R&D, they are not going to have the most competitive positions,” Pegge says. 

Bucking the trend

Lloyds Bank has managed to grow its SME loan book 5% to about £25bn in the year to June, in a market that shrank 3% overall — an uptick from Lloyds Bank’ 3% or 4% growth rate throughout the contraction. 

The government’s Funding for Lending scheme has helped somewhat, most agree, if only as an interest subsidy for some new borrowers.

“The real hard battle in going out and finding customers has been to fight the discouragement factor — the sense that ‘finance isn’t available, so I won’t borrow’,” Pegge says. “The great thing about SMEs is that they are very diverse. Where we’ve made headway has been where we have industry specialists targeting particular sectors.” 

Others who work with SMEs say it is not so much that banks won’t lend, but that they are stuck in an unhelpful mindset. “There is a bureaucratic/regulatory/capital cost/fear of losing money logjam in banks,” says Bill Blain, head of the special situations group at Mint Partners, a division of BGC Brokers. “Do you really want one financial sector to be doing 100% of the lending to the growth drivers of the economy? We want to create a more interesting variety by encouraging the growth of a private placement market.”

Sweet spot

While companies at or near investment grade — and unrated equivalents — have long enjoyed many financing options (see box on US private placements), many players are now striving to broaden choice for the next tier down.

“Companies that are deemed too small to come to the private placement market are incredibly well served by the banks at the moment,” says David Cleary, co-head of US private placements at Lloyds Bank. “Banks are short of assets, they want new clients and loan pricing is very competitive. The hardest question for a CFO is when to go from all bank funding to put another piece in the capital structure — do you bring in another bank or diversify?”

The UK’s steadily growing retail bond market, where deals of £25m to £60m are common, suits companies of this scale, especially if they have transparent business models that can readily be explained to retail investors (see roundtable, page 48).

But a few UK institutional investors and specialist credit funds are trying to build a domestic PP market for midmarket companies.

“Most corporate finance in the US happens through alternative networks, PPs or direct lending,” says Blain. “But too many investors are wedded to the idea of only buying bonds that they think are liquid. The costs of ratings and legal fees are also way too high — we think you can get it down from six figures to five by using common sense and standard documents.”

New talk on the street

At the bottom of the SME food chain, PPs may sound very remote. But even here, innovation and diversity are changing the landscape.

Alex Jackman, senior policy adviser at the Forum of Private Business — most of whose members have fewer than 10 employees — highlights the strain on small business of late payment by customers.

“There’s £36bn tied up that doesn’t need to be,” he says. An EU directive, now UK law, imposes a statutory interest charge on invoices more than 60 days late.

“But there are ways your customer will get round it,” says Jackman. “Marks & Spencer have extended their payment terms from 60 to 75 days, Sainsbury’s from 30 to 75.” Big companies are effectively using small ones as a free source of working capital. 

To ease it, Lloyds Bank has introduced supplier finance, where big companies can borrow from the bank on the strength of their own credit and pay suppliers on the nail, at a small discount reflecting the borrowing cost.

Jackman also welcomes the government’s new Business Bank, a one-stop shop for entrepreneurs to access help, and its Start Up Loans, as well as trends like crowdfunding. “I don’t think there is that much of a shortage of finance,” he says. “It’s just that businesses need to be more expansive in where they look for it.”   

     
 

Widening range of UK firms find path to US honeypot 

 
  US private placements have long been a favourite financing technique for a select group of UK investment grade borrowers.

Issuers do need to be of a certain size and credit strength, but the US insurance companies that buy PPs are willing to look at unrated, unlisted companies and do not need deals to be of liquid size. This can make the market more attractive than public bonds for successful midcap companies.

After 2012’s record issuance of $53bn, of which $10bn was from the UK, volume is down a bit this year, but only because companies are well-funded.

“The vast majority of US PP investors are very willing to lend to UK Plc, though some do have concerns about Europe as a whole, not just the southern nations,” says David Cleary, co-head of US private placements at Lloyds Bank in London. “The market is in great shape — books are hugely oversubscribed.”

UK midcap or unrated issuers this year have included Sage Group, Serco, BBC Commercial Holdings, the Portman Estate, Johnson Matthey, Genesis Housing Association and Associated British Ports.

US investors are so keen that they are competing to offer borrowers extra convenience features.

One is the ability to issue in sterling. A record 38% of UK issuance this year, Cleary reckons, has been in sterling.

That includes paper from UK institutions like M&G or the BAE Systems pension fund, which are interested in homegrown PPs, and from US investors willing to use their own credit strength to swap deals advantageously for a borrower.

Investors are also willing to agree delayed settlement dates — on one recent deal the borrower will not receive the money for nine months after closing. This means issuers can obtain certainty of funding well before they need the money, but not suffer negative carry. Investors usually give up to three months’ delay free, then charge 5bp a month. But issuers can more than recoup this through the favourable basis swap back to sterling.

While the US PP market is fully mature, its European wing remains juvenile. “In an ideal world, five or 10 years from now, it would be fantastic to have deep pools of liquidity in the US, UK and Europe,” says Cleary. “At the moment there is a deep pool in the US, some institutions in London and a handful in Europe. We haven’t got the depth of liquidity we need. Unfortunately, if I’m a classic UK unrated but triple-B corporate issuer, I will generally get the best reception from US firms.”  

 

     
 

M&G digs deeper into UK midmarket

 

M&G Investment Management caught the limelight in 2009 when it launched its first UK Companies Financing Fund, to help business find alternatives to bank funding amid the credit crisis.

The idea may well have contributed to the government’s decision to invest £1.2bn in a Business Finance Partnership scheme. Most of this, £863m so far, has been handed to six fund managers, among them M&G, Intermediate Capital Group, Ares and Alcentra.

Each will lend government and private money together to businesses with turnover between £25m and £500m. Another set of lenders are targeting smaller companies.

While M&G’s first fund lent £930m to 11 companies that were roughly in the FTSE 250 band, this time it is delving deeper into the middle market. 

“This is really the core area for banks because the midmarket returns are attractive versus larger corporates,” says James Pearce, director of fixed income, who manages the UK Companies Financing Fund 2. “It’s good to be targeting a space the banks like.”

This kind of company is mostly too small to issue bonds or US private placements, so until now has had no alternative to banks. The problem is not lack of bank funding but lack of diversity.

The banks, Pearce says, “all offer the same thing and all want ancillary business.”

M&G’s proposition is to be as user-friendly as a bank, using similar documentation and covenants, but offer longer debt out to 10 years, at around 300bp-600bp over Libor, without any demand for ancillary business — useful for a small company that does not have enough to feed two or three big banks.

“People really desire diversity of funding sources and the longer tenor, otherwise they can end up on a refinancing roundabout,” says Pearce. “A piece of longer paper is less time-consuming and gives a more stable structure.” That can make it easier for a company to focus on growing its business.

Launched with £200m of government money and £250m from M&G clients early in 2013, the fund has so far lent £10m to Begbies Traynor, the corporate insolvency specialist, and £45m to Workspace, which provides serviced offices for small businesses.   
     
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