A recent report on alternative lenders1 reveals a peculiar gap in the funding available to private businesses.
Traditional senior debt (with margins priced from 200-450bps) and unitranche funding (600-800bps) are both well-served by established players. However, there’s a marked absence of what’s known as stretched senior debt, with margins priced between 450-600bps and designed to offer increased borrower flexibility without maximising leverage to meet the yield targets required by unitranche funds.
This gap creates a significant opportunity for lenders and private debt investors who have a flexible mandate across the yield curve, like Investec.
Why does this funding gap exist?
On the supply side, there is a limited number of providers out there who are willing and able to provide funding at this pricing range (Investec being one of them).
That’s because it sits in a difficult space: returning less than the usual target hurdle rate for private debt funds, and just out of reach for traditional banks’ risk appetite as they seek to retrench.
But we believe supply dynamics is the wrong reason for a company to structure its borrowing a certain way.
There are many good reasons for borrowers to want to avoid heady leverage: primary buyouts with management teams new to leveraged borrowing, minority investments or even a regulated operating entities all come to mind. Perhaps an amortising strip or a more revolving acquisition facility would suit best, both of which suit the stretched senior pricing range well.
By taking a partnership approach with borrowers, we are able to work closely with them to support high-quality deals, building a base of senior debt from which we can selectively stretch up the capital stack. This allows us to match much more tailored needs – blending risk, flexibility and pricing – rather than solving on price alone.
By taking a partnership approach with borrowers, we are able to match much more tailored needs – blending risk, flexibility and pricing – rather than solving on price alone.
From a lender point of view, the result is senior risk exposure with superior pricing, or stronger risk adjusted returns across the cycle.
Who can it help?
We are seeing growing interest from cautious borrowers who don’t want to over-leverage.
For example, we were recently approached by an acquisitive financial services provider who was uncomfortable with the idea of taking on significant leverage given where we may be in the cycle. They also sought a flexible solution with a redraw feature on a committed acquisition facility allowing them to save on interest costs following periods of significant cash generation. This highly bespoke solution offered them fire power for acquisitions but also allowed them to capitalise on the variability of their likely drawing profile to save on interest costs versus a traditional unitranche solution.
Other borrowers might simply want to maintain financial discipline.
We recently funded a sponsor-backed business which was concerned that, with interest rates potentially on the rise, a 100-150bps price differential across a large debt stack would become meaningful and create a significant interest burden on the operating company. With stretched senior debt, the borrower was able to take comfort from a lower margin and “through the cycle” leverage, providing an extra financial cushion to navigate any choppy waters.
What next?
We continue to see a significant opportunity for lenders and investors in the stretched senior market.
There is a genuine business need for this form of financing. What’s more, for investors, this is a long-term opportunity, complementary to an existing private credit portfolio and with an improved risk/return trade-off.
There is a genuine business need for this form of financing. What’s more, for investors, this is a long-term opportunity, complementary to an existing private credit portfolio and with an improved risk/return trade-off.
Investec is one of a limited number of lenders with the expertise and origination infrastructure required to offer stretched senior financing, with an experienced team focused exclusively on lower and mid-market sized corporates across Europe.
1 Deloitte’s Alternative Lender Deal Tracker Report, Autumn 2021
About Investec Growth & Leveraged Finance
Investec Growth & Leveraged Finance provides financing to businesses (typically with EBITDA £2m-£75m) in the UK, Ireland and mainland Europe.
Finance provision is typically event driven and includes growth capital, acquisition finance & management buyouts, leveraged finance & syndicated debt, refinances & recapitalisations and structured corporate lending. Structures are typically senior secured debt and unitranches, integrated asset-based & cash flow solutions, subordinated debt and minority equity, working capital and capex/acquisition facilities with the ability to provide underwrites and/or bridge structures where a client need exists.
Financing is provided both from Investec’s balance sheet and our dedicated fund, Private Debt Fund, which was raised in early 2020.
This is for information purposes only and does not constitute an offer or commitment, a solicitation of an offer or commitment, or any advice or recommendation, to conclude any transaction (whether described in this document or otherwise). This document does not constitute an offering document and does not purport to contain all of the information that an interested party may desire.
Investec Bank plc whose registered office is at 30 Gresham Street, London EC2V 7Qp is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, registered no. 172330.
