Trends in the UK Mezzanine Debt Market

Trends in the UK Mezzanine Debt Market

The tides are slowly changing in UK lending markets. Whilst the headline lending trend according to the Bank of England was positive for the three month period ended May 2014, the lending trend for the small and medium sized enterprises (SME’s) was negative. In fact, according to the Bank of England’s July Report, the annual growth rate in the stock of lending to SME’s has been negative since mid-2012. As banks adjust to the new normal with respect to capital adequacy, many medium sized companies have struggled to find financing. New schemes such as Funding for Lending and Business Bank have made it easier for some SME’s, but overall the market is unforgiving for most. A bright spot in the market is the emerging role that mezzanine debt lenders are playing with respect to providing direct lending. Historically, use of mezzanine debt in the UK was buy out related and most commonly utilized in a private equity sponsored buy out. As the leverage financing market in the UK has evolved, unitranche lenders and other non-bank lenders have emerged to bring efficiency and value to the buyout space. Yet, to most market observers, these types of lenders are transactional in nature. Whilst unitranche financing may gain share at the expense of mezzanine financing volume with buyouts, there is a large market segment of previously bankable SME’s seeking capital for growth and acquisition. This is the market that a growing number of middle market mezzanine lenders have set their sights on. Mezzanine debt lenders, due to their relationship orientation, are proficient at partnering with companies that need capital over the long term. Their underwriting approach is multi-faceted making them superior at the softer side of understanding credit. They take the time to understand story credits and to assess the quality of the management team, beyond simple analysis of numbers. This trend mirrors that of the US market with the emergence of the unitranche and BDC market. As these lenders gain in buy-out volume in the US, mezzanine debt lenders have repositioned to enter the direct lending channel as well as to offer unitranche capability. This provides additional capital bandwidth for deserving SME’s who no longer have access to the bank lending window. With economic headwinds blowing across the Eurozone, recently formed mezzanine funds are well positioned to address the future financing needs of solid SME’s.