Alternative lenders should consider transactions in new territories. As the 2008 financial crisis unfolded, stories of failing banks and businesses dominated the headlines. However, there were companies in distress that survived, in spite of their precarious situations, as a consequence of lowered interest rates. Just as these lower rates helped banks stay afloat, they also helped to keep some less-than-healthy companies alive. Call it the Federal Reserve’s secondhand bailouts; this artificial business environment enabled those companies to stay in business until today.
The outlook for 2015 is no different, with many businesses still surviving because of low interest rates, resulting in a static market for financial restructuring. According to a recent Deloitte LLP report, three-quarters of United Kingdom banking institutions, asset-based lenders and alternative lenders expect no improvement in their restructuring activities for the rest of this year. It’s a sentiment echoed throughout the rest of Europe and the U.S. But this scenario may change, creating opportunities especially for alternative lenders.
Although some banks are aggressively competing for private equity-sponsored transactions, their appetite for risk doesn’t seem to include turnaround and restructuring opportunities. Indeed, many traditional lenders seem hesitant to extend credit until they’re confident a company has proven its turnaround, waiting up to three years.
However, there’s another kind of lender that may be better suited for today’s restructuring landscape: the covenant-lite lender. While this lender does confer with management and ask for financial projections, the deal structure allows the company to run its operations freely, while still providing the lender with appropriate collateral coverage. This flexible approach makes the covenant-lite lender an attractive restructuring partner. (To read more about covenant-lite loans, read Lenders Loosen Up.)
With more companies doing business beyond their own borders, the most successful covenant-lite lenders are those that operate globally and are equipped to finance both domestic and international operations.
Banks have been apprehensive about the turnaround market because the risks are real. Sufficient time and money are rarely readily available, reliable data to identify risks is lacking, the market’s demand for the company’s products and services could shift at any moment, and there is the concern over whether the management team will remain intact.
For the covenant-lite lender, some of the risk can be mitigated by efficiently monitoring the collateral. Other tools and considerations include partnering with the right turnaround professionals, vetting the turnaround plan, and utilizing risk enhancement tools such as credit default swaps and insurance against fraud.
Another tool is credit insurance. While credit insurance is younger than other risk mitigation tools, it is increasingly popular because it is very cost effective, and it provides protection around the world and coverage against political and commercial risk. Today’s worldwide lending market is mixed. Mexico is quiet but active, and while the Asian market hasn’t been as quiet, it has taken cyclical pauses.
One answer lies in Europe, where financing activity is rapidly returning to pre-crisis levels, particularly in the U.K. According to another recent survey by Deloitte, a record 57 percent of chief financial officers in the U.K. believe this is a “good time to take risk onto their balance sheet,” and that business optimism is at its highest level in three and a half years.
Much of this surge in activity is the result of rising multiples. Many strategic buyers are so eager to acquire that they’re willing to offer whatever capital it takes to close the deal.
For U.S. companies, great opportunities can be found even closer, in Canada’s growing M&A market. What’s driving these prospects? A key factor is that the country’s resource-rich economy has made many of its companies attractive targets.
Companies in Canada and Europe represent some attractive opportunities for alternative lenders in the U.S., but can also provide obstacles.
As rates remain low and companies find growth more difficult, they will reach out to buyers. In today’s global marketplace, companies looking for financing are as likely to look across oceans as they are to look across town. What they’ll find, however, is that many buyers and their traditional lenders, which provide leverage for these acquisitions, will encounter legal challenges when financing in foreign jurisdictions. These traditional financial institutions often hesitate to lend against international assets, because of the legal complications.
Forward-thinking lenders on the other hand, have thrived in the international financing market. These lenders have a thorough understanding of the regulations that are unique to each country, enabling them to assess deals regardless of jurisdiction. It’s not surprising that these lenders are better suited to handle cross-border transactions. In today’s market, it’s likely that one financing company will have to partner with another.
Here are some tips for a solid partnership:
Study your counterparts. What’s their risk tolerance? Are they non-institutional lenders? Are they subordinated notes holders? The more you initially know about your partner, the fewer surprises you will have down the road, which will make those inevitable bumps a little less jolting.
Joint lenders, joint contracts. A solid intercreditor/subordination agreement helps keep the deal on track, whether you’re partnering with a huge bank or a small lender. This way, you’ll know what to do if, for example, someone interferes with someone else’s collateral.
Listen and learn. Talk to your partner’s credit officers, get an idea of their vision and read their case studies.
What does the future hold for alternative lenders? Much depends on interest rates. If rates are going to rise, so should the number of workouts and other restructurings. Should rates rise sooner than expected, this will stimulate even more activity, because pressure for cash flow will increase. Many firms that stayed afloat in the past because of low rates may not find themselves as lucky in 2016. Higher rates also mean higher returns for investors, further supporting the turnaround market. The alternative lenders, particularly the ones prepared to do business across borders, will be poised to take full advantage.
For more on lenders looking abroad, see Mezzanine Lenders Look to Asia Pacific.
Sami Altaher is the executive director at FGI Finance, a New York-based commercial lending business.