State of Play
It is now almost two years since the catastrophic events of the Autumn of 2008, and while the market seems to have stabilised and there have been one or two more encouraging signs of late, activity in the mid-level leveraged loan market continues to be stuck at comparatively depressed levels.
The return of the UK economy to albeit insipid growth does give some cause for cautious optimism, but the Governor of the Bank of England has also gone on record to say that the UK economy's recovery will be "choppy" and that the economy will grow at a slower pace than previously thought.
Indeed, Mervyn King has gone on record to say that it will be "several years" before the economy adjusts "back to anything we can call remotely normal". The level of national GDP is now back below the level it was at in 2006.
Bank Lending
Bankers have been put under conflicting pressures. On the one hand, they are anxious not to make any further reckless loans, are monitoring borrowers closely and are requiring strict compliance with the terms of their existing facilities. With the recent recession and the fragile condition of many companies, it has made more sense to reign in lending rather than increase it.
On the other hand, the banks, and in particular those that were bailed out by the government at the height of the crisis are being accused by politicians and commentators of not providing sufficient support to businesses. The government in particular is keen to use its shareholdings to encourage banks to make further lending.
In the face of the downturn in the economy, it is not surprising that lenders have reduced their exposure to companies unable to comply with their covenants, whether financial, reporting or otherwise.
But coupled with the more vigilant approach of the lenders, the continuing low base rates have encouraged companies with excess funds to pay down their borrowings. As a result, the businesses that are the most attractive to banks are not generally in the market to take on more debt – making it accordingly more difficult for banks to increase their lending.
Furthermore, it is now clear that the more relaxed era of cheap debt and relatively light supervision of loan documentation is over and was itself an aberration. A return to the fees and margins that support a more realistic pricing of risk is an understandable response by lenders to their increased levels of bad debt, but does put off potential borrowers that expect the low rates offered a few years ago.
As a result of these conflicting pressures, it is not surprising that the net level of lending to mid-level corporates has reduced.
Window of Opportunity
The government pressure only has any teeth while it maintains its stakes. Given the return to profitability of all the UK's major lenders over the last six months, the government may well be looking to sell its bank shareholdings back to the market in the not too distant future.
Would credit be available at even the diminished level it currently is without political encouragement behind the scenes? Banks will tell you that they have money to lend - and are being incentivised to lend it - for strong, high quality, well thought-out and committed projects and acquisition opportunities. While these incentives remain, borrowers (and vendors) should look to take advantage.
However, acquisition opportunities that are being unearthed by potential borrowers are often struggling to progress - in many cases where they are over-valued and therefore difficult to finance.
Vendors that are reluctant to drop their valuations much below those available near the 2007 peak of the market despite the fact that those levels are no longer appropriate may need to wait some time for that value to return. They should also be aware that there are potential downside risks in the coming months which may have a further negative effect on values.
Issues on the horizon?
Even though the UK has returned to growth, that growth is far from being secure or particularly vigorous. It is difficult to see where a dramatic upswing is to come from. The cuts to public spending planned for this autumn and the increase in the rate of VAT scheduled for the New Year, while necessary for the purpose of rebalancing the public finances, may well cause a further recessionary "dip".
This is not the place to go into detail of some of the macro-economic issues that may still play out in the UK and world economies. There is sensationalist press comment of "Hindenburg" crosses, increased sovereign debt spreads, unsustainable pensions and inter-generational financial tension. However, it does seem that a change for the worse is more likely than a significant change for the better.
Wrapping up
With bank finance available, and being politically encouraged, for the right deal and with the uncertainty and austerity ahead, it may be that now with a relatively stable few months behind us is the best chance that vendors will have to arrange an exit for a while.
There may yet be a second "choppy" phase of this financial crisis, and there is no guarantee that the economy is going to return to the previously "normality" at any time soon.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
