Study: European mid-market model changing quickly

The European mid-market will change from a bank-driven one to one where private debt funds play a leading role, with the change occurring faster than it did in the US, according to Fenton Burgin, head of debt advisory at Deloitte.

Commenting in the third issue of the Deloitte Alternative Lender Deal Tracker report, Burgin said in a statement: “The transformation from a bank-driven model to one dominated by funds in the US accelerated in the late ’90s but took over 15 years to reach current levels. The pace of change in Europe will be far more rapid, driven by a combination of ultra-low interest rates combined with high levels of newly raised institutional capital keen for mid-market investment opportunities.”

Research from Deloitte showed deal volumes from alternative lenders in Europe doubled year-on-year in the last quarter, leading to the conclusion that there is a shift in the European mid-market towards the US funding model. The majority of the transactions occurred in the UK but deal volume is growing at a greater rate in the rest of Europe.

The report, which looked at 33 alternative lenders and mid-market deals of up to €350 million of debt across Europe since October 2012, showed alternative non-bank lenders recorded 34 deals in the UK and Europe in Q1 2014, compared to 18 in Q1 2013. This was an 89 percent increase, up by 50 percent in the UK and 120 percent in the rest of Europe. In Q4 2013, there was a 69 percent and 240 percent year-on-year increase in deal volume in the UK and Europe respectively. The UK remains the largest market for alternative lenders with 47 percent of transactions, followed by 25 percent in France and 11 percent in Germany.

“We expect year-on-year increases to continue, reflecting a move towards a US model in the European mid-market,” Burgin said, adding “In the US, banks finance less than a fifth of mid-market business capital,” whereas in Europe, banks have traditionally provided the majority of debt capital.

The report found that unitranche financing has emerged as the dominant product, with 45 percent and 37 percent of UK and European deals respectively classified as having this structure. Borrower appetite for the bullet structures that non-bank lenders offer was also highlighted and raises the question of whether senior priced bullet only term loan B (TLB) structures may start to emerge in the smaller mid-market.

“To date, only a limited number of funds have been able to provide a TLB structure at close to bank pricing, but with funds applying leverage at fund level and thereby lowering their hurdle rates, we expect this number to increase over time,” the report states.

At present there is an uneven distribution of players in the alternative market, with the three top lenders participating in 38 percent of the transactions, Deloitte said.

Deloitte predicted: the number of alternative lenders will increase; more debt funds will be able to attract leverage at fund level; the hold size of loans by funds will  increase; there will be more senior bullet loan products in the mid-market; more funds  will target the smaller end of the mid-market; increased deal origination in the European market; stronger collaboration between banks and alternative lenders; a number of larger funds will be able to provide an underwritten option; and a continued inflow of US liquidity.

Burgin said: “Supercharged debt markets fuelled by institutional, non-bank liquidity, combined with low European M&A volumes mean non-bank lenders are very incentivised to deploy capital. On the back of our analysis, we envisage alternative lenders will play an increasingly important part in the mid-market, providing what many borrowers will see as a compelling proposition.”