Interest rates in Europe appear to have peaked, but buyout deal financing and portfolio company working capital remains expensive. With traditional lenders still cautious, midmarket alternative credit providers are finding ways to step up, work together and provide private equity-backed companies with capital in a still tricky environment.

In this roundtable discussion, Real Deals talks to lenders and advisers about how the former have kept deploying capital and supporting private equity firms in the face of stiffening market headwinds

At the table:

• Graham Barber, PNC Business Credit
• Don Brown, Stephenson Harwood
• Nicholas Buxton, Investec
• Steven Chait, IGF
• Michael Holmes, ABN Commercial Finance
• Jake Hyman, Blazehill Capital
• Ross Morrow, DunPort Capital Management
• Cem Yaslak, BZ

 Moderated by Nicholas Neveling on behalf of Real Deals

Real Deals (RD): How have the lenders around the table responded to the rising rate cycle? Have higher rates led to any changes in deployment appetite or approach to underwriting?

Cem Yaslak: Our appetite at BZ has certainly grown in the last couple of years. We have expanded our product range to include cashflow products, to complement our full-suite ABL offering. And we recently partnered up with UBS to meet increasing demand for these hybrid structures. BZ has a strong track record of working with sponsor-backed corporates. However, the recent softening in the M&A market has led to lower sponsor-led activity. This has been, to some extent, replaced by refinancing activity as existing facilities mature, and corporates find it more difficult to access liquidity via the mainstream bank market. This creates an exciting opportunity for alternative lenders like BZ to support these corporates going forward.

Michael Holmes: We have also seen an uptick in refinancings come to the table. We are an ABL lender and there is a growing interest from corporates to turn to their balance sheet in order to raise debt, whereas previously they might have used other financing solutions. We also see an opportunity to grow our business at the larger end of the market. Previously we had a lot of focus on the midmarket, but now we are working more regularly with bigger credits, which has been positive and has enabled us to sustain steady deployment. In terms of underwriting, our approach to assessing credit risk hasn’t changed. Obviously, you've got to buy into the forecasts you are looking at, and sense-check those forecasts. This is something that we would always look at, but in the current environment we take a bit more time to assess and make sure that forecasts stack up.

Ross Morrow: From an underwriting perspective, our priorities are unchanged. We still focus on the same things and want to see the same good-quality business fundamentals evident in the credits we finance. One area that we are focusing on more in an inflationary environment is the ability of a company to pass on prices. Businesses that have not been able to push through price increases have been challenged. If you aren't able to pass on price increase in an inflationary environment, margins will be squeezed and free cashflow will suffer as a result. With respect to demand, it has been marginally up year on year, and we considered approximately the same amount of opportunities in 2023 as we did in 2022, but I would say that the quality of what we saw in 2023 was definitely different. The quality was fine through the first half of 2023, but in the second half of the year a lot of what we saw just didn’t meet our underwriting criteria or risk appetite. As a result, we took a step back from the market in Q4 2023 and ultimately underwrote about 60% of our 2022 volumes in 2023. That hasn’t been a problem for us really, as our model is not a volume game, it’s about picking good credits and working with good borrowers.

One area that we are focusing on more in an inflationary environment is the ability of a company to pass on prices. Businesses that have not been able to push through price increases have been challenged. Ross Morrow, DunPort Capital Management

Nicholas Buxton: Lower M&A volume has meant lower demand, but as other speakers have highlighted, we have also seen rising refinancing volume. With a refinancing, however, you always have to ask yourself and get comfortable with what is driving the refinance. Does the refinancing solve a problem for a sponsor (for example, revised exit horizon, additional funding for growth, recapitalisation, etc) or for the incumbent lender (for example, the borrower is over-levered or facing structural headwinds)? Clearly the former is more palatable from an incoming lender perspective, with problem-solving for our sponsor clients something we pride ourselves on at Investec. In terms of appetite, we remain eager to do deals and maintain deployment. To that end, it helps to have an active and acquisitive portfolio when M&A activity cools. Private equity firms still have the ambition to grow their portfolio companies and we have been kept very busy financing buy-and-build
strategies across our portfolio. Yes, the M&A market has been a bit subdued, but our clients are still acquisitive, and we like to back those strategies. Our bold mandate on the term lending side means that we are well equipped to support these strategies and that represents a major differentiator for us.

Graham Barber: The last 12 months have been a period of unsettled activity for lenders, which is not surprising given that interest rates have gone up by 500 basis points since December 2021 and inflation has been high. Against this backdrop, we have spent our time understanding the ability of borrowers to service and repay debt. You simply have to do that because we are in a different market now. Debt costs are up and therefore liquidity has come out of the market because of that. There is, however, capital available to deploy. From a new business perspective, there was less activity through the course of 2023 but good-quality assets still came to market. With fewer assets seeking finance and lenders aiming to deploy the same level of debt, it becomes more
competitive and you have to pick and choose what credits you want to pursue. You've just got to be choosy. You also have to make sure that you have a product offering that is relevant and can help clients across a number of scenarios. For PNC, that has meant evolving from being an ABL lender offering additional ‘stretch financing’ into a more sophisticated senior secured lender both in the US and here in the UK. That evolution has enabled us to do deals in the ABL arena, the technology finance arena with software-as-a-service recurring-revenue lending and the super-senior/’first out’ arena of revolvers and term-loan-As in front of private credit funds. Our ability to do more, and add more value, is probably greater than its ever been and we have to continue aligning ourselves with the needs and wants of sponsors, and being a relevant player for them.

Steven Chait: The slowdown in the M&A market has meant that activity has ebbed and flowed. One month it will be really busy and then the market will go quiet. We have a strong appetite for new business but it is a choppy market. That said, we have seen opportunities to help companies that have CBILs and (recovery loan scheme) RLS loans to repay. Another interesting area has been carve-outs. When businesses are carrying leverage, we've been able to carve-out some of that leverage against some of the assets in the business and repay some money to a sponsor by taking security over the receivables, for example. In the current high-rate environment, another unique selling point for us has been speed to market. If we say we're going to do something, we do it, and we can do it very quickly. We've just done our largest deal of all time within a month. Sponsors and portfolio companies really value that certainty of execution in an uncertain market.

Jake Hyman: Rising interest rates and widespread uncertainty have created opportunity for Blazehill, being a fund that operates in the midmarket private credit space. The ABL heritage of the platform coupled with our flexible mandate and ability to stretch meaningfully beyond the value of the assets and into the cashflows has meant we’ve been uniquely positioned to support a range of sponsor and non-sponsor backed business during a time where we’re seeing the more traditional cashflow market be a little bit more selective. As mentioned by Graham earlier, when it comes to underwriting, one of the key areas of focus in the current higher interest rate environment is sensitising a borrower’s ability to service debt. Yes, Blazehill has the ability to push beyond conventional lending parameters and provide enhanced flexibility and quantum, but we still need to ensure the facility doesn't put too much pressure on a company's longer-term liquidity position – it's about picking the right opportunities. As an example, we’re seeing a number of transactions that are growth-like in nature, where during the quieter M&A market sponsors have turned their focus to existing portfolio companies, identified accretive investment opportunities and are now looking to raise transformative capital to accelerate growth and provide a bridge to an exit for what are fundamentally strong businesses.

Another interesting area has been carve-outs. When businesses are carrying leverage, we've been able to carve-out some of that leverage against some of the assets in the business and repay some money to a sponsor by taking security over the receivables, for example. Steven Chait, IGF

Don Brown: Everything that has been said chimes with what we have seen across the deals we have advised on. Credit committees are definitely tougher. Due diligence has been enhanced and transactions that don't fit the box have been struggling to get approval. There is undoubtedly a much more selective approach to risk. On the borrower side, sponsors are cautious when it comes to putting extra money into portfolio companies and this is one of the main reasons we've seen deals fail. There is not an unwillingness from lenders to put debt in, but deals can end up stuck because the borrower can't raise the equity injection on which the debt is contingent. These scenarios, however, can open up opportunities for alternative lenders to step in and plug funding gaps between debt and equity; and also help sponsors who are under pressure to take money off the table and make distributions to investors.

RD: An uptick in refinancing is something that has been mentioned by everyone. During the next two to three years, there is a big maturity wall approaching. How does that play out, given that cost of capital is much higher than it was when this vintage of loans was first issued?

Morrow: The so-called ‘maturity cliff edge’ is a topic that comes up time and again, and I remember having this exact same conversation back in 2011-12. It's all about supply and demand, and if you step back for a moment and look at the private credit landscape specifically, the vast majority of private credit funds are focused on the mid and upper midmarket. There are large pools of capital to service companies at this end of the market, and lenders in this space can get creative and use holdco financings, preferred equity, PIK toggle and similar instruments to manage refinancings. In addition, the liquid high yield and levered loan markets will deliver capital solutions to a proportion of affected borrowers, and for the rest I’m sure ‘amend, extend and pretend’ will be prevalent for a while. When you look at businesses with Ebitda below the £7-8m threshold, however, the supply of capital is much tighter. That presents an interesting dynamic. If lower midmarket sponsors want to refinance in order to extend investment periods and wait for multiples to normalise, they may require larger financing packages to cover the longer hold periods. It is going to be interesting to see how lower midmarket lenders respond to that. Most private credit lenders in the lower midmarket can't hold more than £30m, and most top out at about £20m. When refinancing, companies
will either have to grow into a new, larger lender who has the capacity, or try and introduce a new lender into the club of existing lenders. While not common in the lower midmarket, there is precedent for club transactions among participants and an increasing willingness to facilitate some. I do think demand will outstrip supply in the lower midmarket, so there will be some tension.

Hyman: There is a cohort of legacy acquisition finance facilities that have approached or will be approaching maturity. We find ourselves in a very different credit environment today compared to when these loans were initially issued, so there will be instances where it may be suboptimal for sponsors to simply amend and extend existing facilities, as there may be a more economically efficient source of third-party capital available. Sponsors should use the opportunity to reappraise their options and consider alternatives to bank syndicate term loans when it’s time to refinance. For example, a conventional ABL revolver that can flex in line with a company’s working capital profile may be more fit for purpose for certain businesses, particularly if partnered with a more creative slice of credit fund debt to ensure day one and ongoing availability is maximised.

Chait: We've seen refinancings where debt funds are at the limit of their ticket sizes and have approached us to consider a carve-out of the receivables, which we've done. In these deals there is additional liquidity coming into the business as a result of a more flexible working capital facility secured against the receivables. We can get comfortable with these structures because of the secured nature of invoice financing.

Brown: The maturity wall is creating more space for creative structures, where other lenders can come in to help secure refinancing and lower financing costs. We have seen transactions, for example, where borrowers can refinance with an existing lender, but only at a much higher cost, and will look to bring in other lenders to lower the all-in cost of capital. Sometimes, a second lien structure can help firms avoid the need to sell the business at a discounted valuation multiple. So, there can be opportunities for ABLs here.

We find ourselves in a very different credit environment today compared to when these loans were initially issued, so there will be instances where it may be suboptimal for sponsors to simply amend and extend existing facilities, as there may be a more economically efficient source of third-party capital available.  Jake Hyman, Blazehill Capital

RD: How comfortable are different types of lenders when it comes to working with each other?

Buxton: That is a good question. At Investec, we have the ability to lead-underwrite or participate in larger deals and have developed a list of partners that we can share deals with and who are comfortable with having ABL and term loans in the same structure. We have completed a number of deals alongside a varied cohort of lenders, from traditional ABL lenders and private debt funds to high-street lenders, with lenders participating in the ABL, term loans or both tranches. Trusting your partners and understanding what their requirements are is essential for these partnerships to work and deliver. The key is getting that first deal over the line. Once the first deal is done and you have first-hand insight into a partner’s credit committee process and legal requirements, the process becomes smoother. That makes the intercreditor documentation much easier and it makes sharing deals much easier. With the recent re-emergence of club deals, we believe it is vital to have this capability in the current market.

Chait: Intercreditor agreements are much more advanced now and precedent has been set, which makes working with other lenders and the debt funds much more palatable. We've got so much more experience in the industry when it comes to building clubs of different lender groups, and most borrowers and advisers will know what we can and can't deliver. Good relationships have been built between lenders and with the sponsors. It has taken a long time but I think we're definitely in a good place.

Yaslak: We have worked with several lenders in the past, including Leumi and Secure Trust, and remain open to partnering with others where together we can offer the most optimal solution for our clients. As these types of partnerships have become more commonplace, it has allowed intercreditor precedents to be set, providing a smoother path for future transactions. In addition, it has demonstrated to sponsors and corporates that mainstream-alternative ABL club structures can offer the best structure in certain situations. BZ can lend from £20m to £150m, and at the higher range of ticket sizes there is an opportunity to partner with other lenders.

Chait: Relationships and reputation are critical. We all want to do bigger deals, control the collateral and control the transaction ourselves, but there is a maturity and recognition in the industry that sometimes deals do have to be split between a first lien and second lien lender, or put together by a club. Partnering with other lenders is a real focus for us at IGF and something we definitely want to do more of.

Morrow: Lending partnerships between term debt and working capital/ABL lenders are certainly possible and have many advantages in the right circumstances, but they are no panacea for an over-levered balance sheet. Just because it is possible to combine term debt with ABL financing, doesn’t mean that it’s necessarily the right thing to do. The quantum of debt won’t change and a borrower will still have to match interest costs to cashflows.

Barber: Ross makes a good point. Revolving ABL facilities are there to help generate liquidity as well as lower the overall cost of debt for borrowers and sponsors. By nature, working capital ABL revolvers are self-liquidating. Where challenges arise, it is normally because of a one off or ongoing cash-burn event and even the ABL revolver has become core borrowing. Problems don’t come out of nowhere, and lending clubs/syndicates and sponsors have to have honest discussions upfront about what the purpose of a financing deal is. Is the ABL adding liquidity because the business needs more working capital headroom, repaying some existing debt with a lower cost of capital to save on interest costs? Does this saving on interest costs actually stop cash burn? Is the ABL solution allowing for a turnaround/improvement plan to be implemented and actioned? Is it part of a new debt structure to effect a sale?

ABLs accept not every deal works out but we all want to make sure that borrowers have a runway to success as opposed to just adding liquidity to prolong the inevitable. It is crucial to have the conversations and join the dots because when you do, different lenders can work very well together. A private debt fund will want to be close to full-drawn and see its money at work and the ABL can do the revolving facility piece that the private credit fund can’t. While bringing an ABL into a structure can often generate extra liquidity on its own, sometimes the answer to getting the extra liquidity is to do it in conjunction with a balance sheet restructuring, with debt being taken off the table to provide companies with a chance to survive. ABLs have always had a role in all sorts of financing events over the years, especially in times of economic challenge or change. There is no reason why that won’t continue in the higher debt cost environment of today, even when there is more lender choice than ever.

ABLs accept not every deal works out but we all want to make sure that borrowers have a runway to success as opposed to just adding liquidity to prolong the inevitable. It is crucial to have the conversations and join the dots because when you do, different lenders can work very well together. Graham Barber, PNC Business Credit

RD: Given the dynamics involved in pulling clubs together, how easy (or not) is it to negotiate and agree on intercreditor documentation?

Barber: The intercreditor is always the elephant in the room that you have to address. When you are working through an intercreditor, it is important to take a few steps back and interrogate what is driving the need for a new financing facility. M&A is relatively easy to understand because you are all going in together and everybody has bought into the story. But if you are refinancing an existing deal and existing lenders, then something has changed. ABL is all about financing change but the question is what has changed and what that means the intercreditor should look like. What are you solving for? What does the sponsor really want? People like single-lender solutions because they're easier to understand and you are in control of what goes on. In the current environment, however, everyone has to accept that you can’t do every deal as a single lender. There have to be some trade-offs on the intercreditor to unlock more opportunities for everyone. That's just how it works. It requires all the parts of the puzzle to come together. The good news is that there is appetite to do it.

Holmes: For the last 18 months, we've been trying to establish relationships with alternative lenders, and the intercreditor agreement is always tricky. It is very difficult to agree a vanilla intercreditor when each transaction is different. Our approach has been to get as far as we can with standard intercreditor terms and then negotiate further details when a specific need or transaction arises.
We've made it a long way down the line with a number of lenders, but these transactions have unfortunately not always happened. You still see situations where one lender can come in and do the whole deal. Borrowers prefer that. That said, we will get there. I'm convinced that it's a matter of time because there are obvious benefits for borrowers in working with us and other lenders.

Hyman: This is an area that we've come to know really well over the last few years at Blazehill. We’re continuing to build on what is already a pretty comprehensive playbook and believe we have developed a strong reputation in the market for deliverability and commerciality, which are both critical, particularly on sponsor-led transactions. Over 75% of our existing deals are either structured with an ABL in a senior position ahead of a junior Blazehill hybrid term loan, or are structured on a bifurcated basis where each lender carves up separate security for themselves. The facilities are always bespoke to the situation and specific transaction dynamics, and the intercreditor agreements look very different across each of the deals. In the past, it has been notoriously difficult to partner a senior ABL with junior term debt, particularly when the junior term debt is stretching into the cashflows, due to competing interests between the two lenders. The cashflow lender wants to preserve enterprise value for as long as possible, while the ABL lender will always need to reserve the right to reduce advance rates, build in reserves and manage their position
carefully. That can be difficult for more traditional cashflow lenders to accept.

The rise of midmarket private credit funds, however, specifically private credit funds with an ABL heritage, has meant we’re starting to see these facilities executed on a more regular basis. Having sat the other side of the table in previous roles, we at Blazehill appreciate the core ABL principles are centred around having a certain level of borrowing base control, but we also understand that ABL as a product has come a long way since the ‘lender of last resort’ days, and that mainstream ABLs will invariably look to preserve enterprise value and avoid a liquidation at all costs, working collaboratively with all parties. Awareness of the ABL’s key priorities and approach to lending has made partnership between senior ABLs and junior credit funds possible – and that is very good news for sponsors and borrowers going forward.

Buxton: Whether a multi-lender or bilateral deal, the vast majority of deals that we do are on an integrated ABL and cashflow basis, with term lending typically between 1-3x of leverage on top of the ABL. The sizeable term lending element gives other parties – sponsors and other lenders – confidence because there is a natural alignment of interests between the debt tranches. In bilateral deals, an intercreditor would simply not be required. Because we are in both tranches of the debt structure, enterprise value preservation is always a key consideration in our credit decision-making and it would be self-harming to unduly alter ABL funding metrics to the detriment of our term loan position.

Holmes: To add to that point, in the discussions around intercreditors we have had during the last 18 months, many concerns come from preconceived ideas of ABL. We've all spoken about how much the ABL industry has grown but I think many of the concerns around the intercreditor emanate from how ABLs might have been viewed 10 years ago. But that is not what ABL is today. ABL has matured and evolved, prioritising a relationship-driven approach to meet the needs of our clients. I have been in situations where we are one of many parties involved and there is no need to turn to the intercreditor because there is a partnership and a determination to find the best outcome for all parties involved.

RD: Don, as the lawyer at the table, what have you observed with respect to intercreditors? Is it becoming easier?

Brown: As lawyers, there is nothing we like more than an intercreditor… especially a complicated one that needs a lot of legal focus! There is a whole area of the market where there are ABL club deals, which are just like any other syndicated transaction. Everyone is sharing the same security, has exposure to the same assets and is more or less aligned on enforcement strategy. Partnering ABLs with cashflow lenders, however, can be difficult and there are sometimes challenges at the intercreditor stage. It can be hard to get everybody on the same page, especially where the parties haven't worked together before, and even more so if the cashflow lender is working with an ABL for the first time. Each intercreditor discussion is different, because every deal is different, so agreeing a standard creditor agreement is hard.

But despite these challenges, we are seeing more and more examples in the market of ABLs and cashflow lenders working together successfully. There is more willingness to be flexible than previously. ABLs are getting more comfortable with tiered events of default, for example, where the ABL will accept different standstill periods, unless there's been something fundamental like a fraud requiring the ABL to act quickly. The emergence of hybrid lenders, who have one eye on the borrowing base analysis and another on the cashflow, has really helped to move the market on. We are also seeing examples of split lien structures – where one ABL lender will take a second lien position behind a senior ABL. These deals can sometimes be quite easy to negotiate because of both parties' familiarity with asset-based lending.

There is still a way to go but the market is coming closer together. Private equity sponsors are now much more comfortable with ABL as a potential solution than they were 10 years ago. As a result, we are seeing more and more deals succeed with cashflow and ABL, or split lien ABL, in the capital structure.