Speculation about the availability of debt in the post-crunch period is rife. Morag Dickson assesses what it all means for mid-market M&A

If there is an upside to the banking industry’s exposure to the sub-prime loan crisis, it’s that a sensible attitude to debt has now been restored.

John Gregson, director of Debt Advisory at professional services firm Deloitte, says that opportunism and risk-taking, such as on large leveraged buy-outs, will be on the back burner as quality and caution become the buzzwords for dealmakers.

None of this is necessarily a bad thing, although no one likes to see several of the UK’s large clearing banks reporting significant writedowns – namely HBOS, Royal Bank of Scotland and Barclays. In the US, where there is increasing talk of recession, the credit crunch has seen the departure of the heads of investment banks Merrill Lynch (Stan O’Neal) and Citigroup (Chuck Prince) after billions were lost.

For dealmakers, the resulting lack of confidence in the market means that debt-financed transactions in the £500 million to £1 billion range are simply not an option. “The banks are forced now more than ever before to assess how difficult it could be to sell transactions to participant banks should they decide to underwrite large deals, and so we can wave goodbye to the big tickets, for now at least,” comments Gregson.

Picking up the pieces

The situation has been eased by the Bank of England’s decision to lower interest rates. John Jenkins, chief executive officer of GE Commercial Finance, welcomes the move, but he is circumspect about the months ahead.

“In my opinion – and it’s only my opinion – the confidence factor weighs heavy in the UK economy, and if people aren’t as confident, they tighten their purse strings,” he says. “What we are seeing from our clients is the increasing impact of hikes in raw material and fuel costs. If they’re unable to pass much of that price on, margins will become thinner. That’s the reality.”

Kate Sharp, chief executive officer of the Asset Based Finance Association (ABFA), agrees. “You’ve always got a lag between the actual event and the eventual fallout, so we’re all waiting to see how that lag manifests itself. Inevitably there will be casualties. Will we see an increase in corporate insolvencies? Probably. Will it be massive? In my opinion, I don’t think so.”

In terms of debt structures, banks are reverting back to the more tried-and-tested packages. Gregson advises: “In June of last year we were able to do transactions for £140 million of debt, £120 million of which was structured as a term loan B – a big eight-year bullet loan – without the requirement of an amortising loan,” he explains. “By contrast, today, banks are going back to basics and issuing term loans A, B, and C.”

It pays to be prudent

Gregson argues that lower mid-market transactions are carrying on as usual. The difference being that banks are still happy to invest smaller amounts – between £15 million and £40 million – off their own balance sheets in transactions that meet the banks’ credit criteria.

According to Sharp, there is no evidence to suggest it should be otherwise on the ABL front either. “We’re not finding that the credit squeeze is restricting fund flow in respect of asset-based lending packages put together by ABFA members… I’ve spoken to providers that are offering large ABL packages and they’re saying that their doors are still open for business.”

By the same token, she doesn’t envisage a mad rush for deals: “People in the business community are adopting a wait-and-see policy and stalling transactions that might ordinarily have gone though in the first half of 2008… The second half of the year may prove more active as we all take risks in business when it makes sense to do so. What we don’t do is leap from the frying pan into the fire.”

GE’s Jenkins takes a similar stance: “2008 will be a good year for asset-based lending providers due to the security and transparency of ABL offerings. It represents an effective funding solution for many businesses, including those seeking to restructure, refinance, grow, and acquire.”

Survival of the fittest

A lot of money is still out there to finance good deals. Given the higher level of quality control, those lesser quality or marginal businesses that may well have found a ready demand in the banking market to finance their deals 12 months ago, are going to struggle.

Says Gregson: “Companies with assets to borrow against on a transaction are going to be well placed to access finance. For example, we are currently in the process of selling a healthcare business; part of that transaction comprises physical properties so if there is potentially a downturn out there, the property aspect will cushion the blow.

“Then there’s the question of sector. Those areas which are less cyclical and less dependent on GDP will benefit at this time. Since healthcare is not a discretionary spend, it constitutes a recession-proof business and exemplifies exactly the kind of businesses that banks look to lend to.”