Debt market: Spring update

Thursday June 6, 2024

Tom Cox reviews the current state of the UK debt market

Tempered optimism

Supported by more positive sentiment at the start of the year, conditions in the UK’s debt market are looking up, but rate pressure remains.

Despite more optimism than 12 months ago, the general consensus that interest rates will stay higher for longer, to stave off the risk of a secondary bounce in inflation, will likely see some of the debt service pressures that have marked recent months persist a while longer.

Here, we take a wide look at the state of the UK debt market landscape, and what could lie ahead.

Two sides of the story

The UK debt market has been somewhat polarised in the first half of 2024 when it comes to both corporate and private equity-backed lending.

In recent months we have observed more enquiries from businesses that have been travelling at a steady pace for the last two or three years that are now seeking to refinance because they are looking for a more efficient capital structure (price and shape) to grow. Unsurprisingly we are seeing credit committees review such opportunities with increased focus – wanting to really get under the skin of a borrowers USPs, their contractual dynamics and the strength of the management team. As a result, we have seen a drag on transaction timelines as owners spend longer considering their options, unable to make a decision, or dealing with increasingly detailed due diligence requirements. In the face of a relatively uncertain macro-outlook that is perhaps not surprising, but momentum has always been the key to transaction delivery.

Nevertheless, we have witnessed a highly active and competitive market place especially at the smaller end of the mid-market, where credit providers remain keen to deploy capital and there is substantial competition for high-quality businesses with a track record of growth and defensible downside characteristics. High quality assets have always attracted the best terms and competition for these high-quality firms is intense, allowing such deals to be completed at pace while more cyclical deals take longer to close.

On balance, deal volumes have been steady in H1 2024, but we are hearing anecdotally that there has been an uptick in opportunities landing on private equity sponsor desks in recent weeks ahead of the summer, which is a positive sign for activity levels in the second half of the year. Time will tell how much investors value such opportunities, but the general consensus is that the second half of the year will be more fruitful than the first.

Ultimately, lenders want to lend, and private equity investors need to both invest and divest to keep the funding cycle turning. As a result, we expect it to lead to a significant increase in transaction volumes throughout the rest of the year and into 2025, especially as private equity looks to unlock a challenging fund raising market by successfully returning capital to their limited partners.

Sectors unchanged but structures differ

Perhaps unsurprisingly, one thing that has not changed since last year is the types of businesses that lenders are eager to back.

Tech-enabled software and services businesses with robust annual recurring revenues offering a critical customer service continue to attract strong valuations and credit appetite. On the flip side, lenders remain more reticent when it comes to more cyclical industries like retail, hospitality and leisure which remain highly susceptible to consumer sentiment. The Euros and Olympics are just around the corner which may offer some respite through the summer, but we expect some consumer assets to face increasing cost and demand pressures toward the end of the year.

Nevertheless, we are seeing an evolution in the funding structures businesses are looking for, and that lenders are willing to offer, in light of debt service pressures caused by the higher interest rate environment.

Given such pressures, we are seeing an increasing interest from business leaders and management teams looking for more hybrid structures, such as combined asset-based and term debt solutions to maximise funding capacity. At the same time annual recurring revenue financing products continue to mature in Europe, resulting in an expansion of funding options for stakeholders in delivering growth in software and contracted tech-enabled sectors.

Calmer waters, for now

Recent times have taught us to expect the unexpected, and despite the impending general election we are not anticipating significant turbulence in the debt market between now and the end of the year. Indeed a change of government has not been a hot topic of conversations with businesses or investors in recent months – perhaps a reflection of businesses and lenders not expecting to see any major impact on the credit funding landscape – time will tell and a few surprises will likely emerge, but we are not currently seeing the typical rush to complete transactions ahead of major fiscal and electoral events.

Amid further upcoming announcements around inflation and interest rates, we also do not see the relative volatility of the mortgage market trickling down to the corporate lending market. The general sentiment is that 2024 started with a lot more optimism, and business owners still want to access finance to grow.

Preparation is paramount

For those owners and management teams looking to attract credit, the importance of being well prepared cannot be underestimated. Prospective lenders are likely to continue to put operations under heightened scrutiny, and it is therefore critical to have robust financial models and forecasts in place that give lenders the confidence they need to deliver the facilities businesses require.

Appointing an adviser early helps to understand exactly what best practice looks like and provides sufficient time to find solutions to any issues which inevitably emerge in any process. Giving modelling and forecasting due attention will also give businesses a strong foundation for future deal activity.

Whether it be growth capital at the smaller end of the scale or anticipated higher levels of transaction activity in the mid-market in the second half of the year, lender appetite will be there to help businesses along the next stage of their journey. Businesses that can prepare effectively will be in the best possible position to secure the backing they need, while securing the most attractive terms to support their growth ambitions.