Debt markets: Opportunities remain despite challenges

27 April 2023

Despite financial uncertainty disrupting the M&A market last year, our Debt Advisory team experienced one of its busiest periods, completing six transactions in seven weeks in Q1-2023. We showed that with the right approach, borrowers can still attract innovative debt structuring solutions to meet their ambitious funding objectives.

Key drivers behind lender behaviour

Economic uncertainty - With global supply chain challenges, increasing energy costs and widespread labour shortages, inflation hit 10.4% in February 2023.

Increased cost of debt - Central banks have continued to raise interest rates to curb inflation.

Challenging fund raising environment for private debt lenders – A combination of LPs conservatism in the face of economic challenges, and falling public stock market indices have created an overexposure to private markets (i.e. the ‘Denominator Effect’) for asset managers and has resulted in direct lending fund raises being drawn out or deferred.

Each of these drivers has reshaped lender behaviours, resulting in:

  • A polarisation of lender appetite towards credits that have reduced exposure to the economic cycle
  • A greater degree of scrutiny from lenders to deliver credit approvals
  • A softening of appetite for leverage, largely due to increasing debt service requirements constraining debt capacity

Reasons to be positive

We have seen a strong recovery in energy prices as the UK wholesale gas price has now fallen to £1/therm, down from a peak of around £6/therm in August 2022.

This has provided lenders and the market with more confidence that inflation should be approaching its peak. The markets expect bank rates to peak at c.5% this autumn and start to reduce thereafter. Also, the recent turmoil in the banking sector has put more pressure on central banks to reconsider the scale of any future increases.

Despite the fundraising challenges, there remains substantial private debt fund dry powder. Therefore, as lenders become increasingly confident regarding the economic outlook and borrowers demonstrate how they have managed the economic headwinds, we expect to see a more ‘borrower friendly’ environment to materialise.

Raising debt: How to optimise your funding

While the debt markets are undoubtedly challenging, there remains an opportunity to deliver borrower funding objectives if the right approach is taken. Successful debt raises share key characteristics - some learnings taken from recent processes include:

Preparation is key – As a prospective borrower, you should invest time in preparing your business plan before approaching the market to ensure it stands up to intense lender scrutiny. You should also create a lender briefing pack that really sells the credit story. As lender appetite becomes more polarised, it has never been more important to maximise traction with multiple lenders to de-risk your process and create competitive tension.

Know your lenders – Lender behaviour is typically predicated on past experience, policy and, for direct lenders, fund status - i.e. dry powder, the timing in their investment cycle and portfolio exposure. Having knowledge of these variables will enable you to approach the right lenders at the right time.

Continue to ask the question – If lenders buy into your credit story, they will be open to innovative solutions and should offer you some flexibility – so don’t be afraid to articulate your funding objectives and push lenders to deliver them.

Get the right advice – Having expert advice on your side can be worth its weight in gold when dealing with something as important and delicate as fundraising. An impartial adviser can identify where your business’ strengths and weaknesses lie, and help you identify the funders that will be the best fit for your business.

If you are looking to raise debt for your business, get in touch with our expert Debt Advisory team. We have specialists from across a full range of industries to ensure that you get bespoke support to achieve your goals.