All over the world banks are stumbling over the rocky ground of the credit crunch, but what is happening in the North West? Rupert Cornford reports on the regional debt appetite to see if there is still money to be had.
We've all heard about the credit crunch. In fact it's all we seem to be hearing about at the moment. While the sub-prime mortgage crisis in the US has shocked the global money markets and caused banks to disclose heavy losses, it has also acted as a catalyst for the deals market to slide.
According to the Centre for Management Buyout Research, the number of deals done in the North West in the second half of 2007 was down on the first six months and the average transaction value fell from £346.65m to £318.4m. In the last quarter, just 14 deals were completed.
So, with all the doom and gloom surrounding the debt markets, what is really going on at the banks? Deloitte's nationwide Debt Confidence Survey 2007 highlights the waning optimism of the banking industry. Just 18 per cent of those interviewed think that the good times will continue in the debt markets, compared to 71 per cent in 2006. But the North West has always prided itself on the strength of its mid-market dynamics and, in an effort to understand the regional implications of the credit crunch, Insider knocked on a few doors to see if the credit committees have really gone on holiday.
"Today we are open," says Stuart Gray, head of leveraged finance in the north at HSBC. "And if the markets stay as they are, then we will be open tomorrow."
While Gray admits that it is impossible to predict the future, he believes it is the movements of the markets over the next few months that will cause banks to reassess their hold levels.
"It's not what you know today; it's what will happen tomorrow. It's uncertainty that is making banks unwilling to underwrite," he says. "It is still possible to arrange underwritten debt facilities but banks are being more selective and across the market pricing has increased, leverage has reduced and structures have become more conservative."
Phil Tarimo, director of the debt advisory team at Deloitte, agrees: "You will still get banks saying they will underwrite £3200m, but the sort of the deals where they will be prepared to do that will be restricted. For any deal north of £325m I would expect the banks to ask themselves the question: "So do we want to be holding all of this, or do we want a banking partner?'"
According to Paul Shephard, director of specialist and acquisition finance in the North West at Yorkshire Bank, a distinct lack of liquidity in the syndications space has led to banks shying away from underwriting large, leveraged deals on a lead arranger basis due to uncertainty over their ability to sell down this debt. "The market is adjusting and moving forward, and it's likely we'll see more club deals," he says.
A club deal is where a group of banks team up to share the debt provision for a transaction. Rather than one bank underwriting the whole transaction and syndicating it out afterwards, a club deal will be agreed beforehand. But club deals can have their limitations. While a group of banks move forward on the same terms and pricing structure, experts say that it can take more effort to coordinate the transaction.
"It is a more complex process, because you are dealing with more parties. So unless you manage that process particularly carefully, then it can be more cumbersome," says Tarimo.
Tim Hamilton, partner at Addleshaw Goddard, agrees: "This means that the deal process is slowed down, and also that banking terms are not as attractive as they were in the first half of last year. Deals are still happening, but they are taking more effort to set up, and longer to process."
But the flip side of this is that a well-run club process achieves competitive tension between banks, so they do put their best foot forward.
In June 2007 private equity group LDC backed a deal to buy British Salt from its US parent company for £3100m. Debt funding for the deal was provided on a club basis by Lloyds TSB Corporate Finance and HSBC. While this took place pre-credit crunch, it is being cited as an example to follow as more banks join together to fund transactions.
As well as a shift towards club deals initiated by banks, changing credit controls reflect a tightening of the market, according to Gary Davison, debt advisory director at Ernst & Young in Manchester. "Local banks are taking the opportunity to realign the lax credit controls that we have seen through 2006 and in the first half of 2007," he says. "Banks have moved from covenant-light to a covenant-heavy approach in 2007 as a form of self protection so they can act quickly when the warning signs are flashing."
According to Tarimo, this will mean that deals will face tougher competition to make it through. "People are focusing on higher quality deals than they were previously because banks are having to micromanage their balance sheets so much," he says. "For every ten deals that go to credit committee - even if they are all good - they might say: "Right, which three shall we do?'"
Although this trend is not seen by everyone as a flight to quality in the market, it will definitely weed out some of the more marginal deals that may have been done during the good times.
"One potential knock-on result could be that banks' prudent management of capital will see the market price risk more accurately," says Mark Blower, director at Lloyds TSB Corporate Markets. "The deals that are done are more likely to be high quality, with sensible prices and good structures. I think we'll see a correction rather than a crash."
But banks are maintaining that their level of scrutiny remains the same.
"The factors involved in deciding whether to back a marginal deal are the same now as they were in previous years and will involve evaluation of the company's business plan, strategy and balance sheet," says Tony Dean, managing director of corporate and structured finance in the north at The Royal Bank of Scotland.
Gray adds: "We are not seeing an increase in proposals being rejected by credit. We are selective anyway and only pursue the stronger proposals. That's our job."
But beware if you are a retail business. With a struggling US economy affecting the UK, the consumer market is set to struggle. Retailers are grappling with price deflation at the same time that the cost of raw materials is shooting through the roof.
"Anything in the retail consumer market will be getting a good kicking by way of interrogation at credit committees these days," says Tarimo, although he admits that deals in this sector may still be possible. "Banks tend to monitor a huge amount of information. So if ever a sector shows signs of weakness, then they will be aware of that. It doesn't mean the deal won't get sanctioned, you will just have to be prepared for some tough questioning."
But there are other sectors that may perform more strongly. In 2007 Deloitte advised on the £3783m sale of Doncaster-based regeneration business Keepmoat, which was backed by an integrated finance deal from Bank of Scotland.
Tarimo says: "We still had a good number of banks willing to do the debt package on that deal because of the business characteristics, the fact that social housing was high on the agenda of the government, and where the business is positioned in terms of its partnership approach with customers."
Just because a business falls within a particular, difficult sector the door to funding may not necessarily be closed. The importance of credit history, strength of the management team and position in the market may still be enough to gain support from banks.
So deals will still get done in 2008? The banks are, of course maintaining that they will lend money. After all, it's their job - they have to do it to make a profit. But it is by no means business as usual.
The front men will be out there looking for deals as hard as they ever have done. But the reality is that any bank managing its balance sheet won't be able to carry on the way it has historically, so it will be restricted by what it can get through the credit committees.
"Generally, this is likely to be a challenging year in leveraged finance, although we are also seeing some encouraging signs," says Dave Rimmer, director of leveraged finance at Barclays. "The terms on which banks lent in 2007, both price and amount of leverage, increased and reduced respectively and this is unlikely to change in 2008."
Tarimo adds: "2008 is going to be a tough year without a shadow of a doubt. If you have price deflation and increasing costs, it doesn't take genius to work out that it creates a tough environment in which to make profits and invest in a business."