Europe’s Mid-Market Explores New Funding Sources
by Taron Wade, Associate Director, Corporate Ratings, and Alexandra Dimitrijevic, Managing Director, Standard & Poor’s Ratings Services
The funding landscape for European mid-market businesses is changing rapidly. As banks deleverage across Europe, the treasury and finance departments of mid-market companies – defined as companies with revenues between €100m and €1.5bn and outstanding debt between €50m and €500m – must look outside traditional banking relationships to secure funding for growth. And as yields in credit markets have recently been at record lows, investors’ appetite for this emerging asset class has never been greater. Yet despite a small amount of progress, a cohesive pan-European funding market remains elusive.
A fully-fledged European funding market for mid-market companies will require significant cultural and operational changes on the part of potential issuers and investors. Mid-market firms often find the interest rates demanded by institutional investors to be too expensive, yet lower rates will require a level of financial disclosure higher than that to which they are accustomed. This is particularly important for smaller investors without the means to build internal research and risk management capabilities. At the same time, differing regulatory and accounting environments across Europe also make establishing a cohesive funding market an uphill struggle.
A crucial sector for regional economies
New capital adequacy regimes – coupled with more general bank deleveraging throughout Europe – mean that European banks are limiting their lending to major clients, usually domestic companies with which they have strong relationships. The same deleveraging process also has the effect of restricting capital- and cost-intensive wholesale and international businesses. According to our research, this strategy is partly a result of pressure from national governments to prioritise domestic lending and increase purchases of domestic government debt to replace thinning foreign investment.
For these reasons, it is vital that Europe’s mid-market businesses secure alternative funding sources – for their own benefit, and that of the region’s economies. A critical engine for economic growth and employment in Europe, mid-market firms generate around one-third of private sector revenue and employ a third of the workforce across France, Germany, Italy, and the UK, according to research from GE Capital.
Alternative funding avenues are emerging
At present, the alternatives to bank borrowing for Europe’s mid-market vary wildly in maturity. Major markets include the developing loan fund market, the US private placement market, the German private placement market (the Schuldschein market), the nascent private placement markets in the UK and France, and – to some extent – regional bond platforms on exchanges.
However, the loan fund market has seen limited growth in Europe since the global financial crisis. Before 2008, this sector was led by collateralised loan obligation (CLO) funds, mezzanine funds - which specifically lend subordinated debt to companies - and some non-leveraged loan funds. But new entrants to this market were derailed by the crisis, particularly as new types of loan investors struggled to find capital while buyout activity stagnated and new deal flow slowed.
However, investors’ interest in lending to smaller companies in Europe has experienced a small resurgence over the past year. Indeed, Five Arrows Credit Solutions – a Rothschild investment fund set up in 2010 specifically to lend to Europe’s mid-market – announced its first close with commitments totalling €235m recently.