20� HealthInvestor�•�March��2015

Alternative�lenders�are�fast�becoming�serious�rivals�for�bank�business�in�the�UK.�Ploy Radford�finds�out�more�

Watching with interest

Like a lover scorned for someone who “appreciates me more”, banks are finding themselves jilted as of late. A clique colloquially known as direct lenders or alternative credit funds have

been springing up and are muscling in on their patch.

“In the US at the moment, 90% of all funding is coming from alternative lenders in the mid-market; if you go back five years ago the majority of funding was coming from the banks,” says Floris

Hovingh, head of alternative lender coverage at Deloitte. “Now we’re seeing this same shift in the UK; in Europe the UK has been an early adopter of alternative finance.”

Deloitte’s quarterly ‘Alternative lender deal tracker’ has covered 301 transactions

debt finance

debt finance

by 35 alternative lenders since October 2012 and estimates that European direct lending funds have in excess of €$45 billion (£33.3 million) of committed capital dedicated to private debt. Furthermore, Deloitte expects these funds to raise in excess of €$15 billion (£11.1 billion) in the next 12 months.

These alternative lenders have been popping up in the health sector too. BlueBay, Hayfin and Ares have all got skin in the healthcare game. Most recently, Omni Capital has entered the market by providing LNT Group with a £30 million, four-year debt facility to fund care home developments.

Who exactly are these alternative credit funds though? By loose definition,

direct lender or alternative credit funds are simply non-bank institutions. They range in size from large asset managers looking to do something different to smaller boutique firms set up by a pioneering investment professional. They have a similar structure to private equity firms with 10-year funds where the usual suspects (institutional finance, investment banks, sovereign wealth funds) are the limited partners.

Their lending habits have certain characteristics that have won over some parties, the most relevant one being that “they want to provide a slug of lending” according to Jackie Bower, chief executive of JC Rathbone. This is so they can achieve their holy grail of a high return of up to

5-7% profit margin over their interest rate floor.

As such, most alternative lender activity has centred around supporting private equity in leveraged buyouts. “Private equity like to leverage up their companies to increase their equity returns, and where you leverage up there’s a higher risk and associated returns for debt funds which fits well with alternative lenders,” explains Hovingh. The debt typically takes a unitranche form that sits in a subordinated position to bank facilities.

“Development finance is becoming a mainstream product for some of the alternative funds, including specialist bridging or short term finance companies that price the risk accordingly,” adds Chris Babington, managing director of Hervines Capital, who advised LNT Group on the Omni debt facility. This is again an area where the borrower needs a serious amount of firepower for a potentially risky situation if no one buys the new units, which suits credits funds to a tee.

The terms attached to that sum of cash are more flexible as well: bullet structures are available instead of amortising debt and there is more headroom with covenants. This is great for a firm looking to change its structure or do buy and build. Credit funds are also happier to lend for a bit longer than UK high street banks are currently willing to do; they can do up to seven years.

Talking about its recent deal with LNT Group, Omni Capital chief executive Colin Sanders said: “The facility we’ve made available is a pretty flexible one... LNT don’t need to draw it all out at day one they can daw it as and when they find the sites. So it’s fairly efficient – they don’t need to borrow more than they need at any one time but they do have certainty over the facility they have.”

Another plus point of direct lenders is that they are speedier. They lack the bureaucracy of a bank and typically they have small teams of around 10 people making the lending decision process quicker. When you take into account that punitive Basel III conditions mean a club of banks would be necessary to provide the same amount of debt one or maybe two credit funds could supply, dealing with alternative lenders seems even more attractive.

What is more, there are some company sizes banks are less willing to cover for risk reasons and direct lenders can happily

HealthInvestor�•�March�2015� 21

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22� HealthInvestor�•�March�2015

debt finance

fill that gap. These companies often fall into the mid-market – they need sizeable amounts of debt but aren’t big enough in value to provide security against those debts. Hence the need for direct lenders to provide the oxygen for fast-growing companies, backing deals with firms in the £10 million to £40 million ebitda range.

Credit funds are by no means profligate with their lending, though. These ‘risky’ businesses are arguably ones that banks would want if they looked at them from a different angle; credit funds get a bird’s eye view due to their small teams and lack of restrictions. “Some banks have said to businesses that perhaps do not fit certain size requirements or covenant metrics on a look-back basis, that they will not support them, whereas an alternative lender will work with a firm on a forward-looking basis or will specialise and understand the specific risks, which is key,” says Babington.

Matt Lowe, finance director at LNT Group, concurs. “We have what we consider to be a unique business in that we develop land, build care homes and operate care homes and people try to put us in a box. If you’re dealing with the banks they tend to have a policy they will follow and our way of operating doesn’t necessarily follow that policy, whereas alternative lenders look at each case on its own merits and offer more flexibility for businesses like ours.”

Of course borrowing from alternative lenders isn’t for everyone; it is expensive. “The main feature of credit funds is that they tend to have an interest rate floor, which can be set at 1%. Traditional bank lending is less likely to have this, so the borrower can benefit from floating rates at less than 1%,” says JC Rathbone’s Bower.

This is why the size of the asset is important, as is the stage of its development. Leveraging up small companies isn’t a good idea as they probably can’t handle that much debt. Non-private equity backed corporates also tend to be wary as they lack the sophisticated financial controls to take on so much debt.

Babington adds that sometimes the credit funds will not hold some of the debt on their balance sheet and “they’ll take the total debt and tranche it into both mezzanine and senior and offset some of the risk with other lenders, so

you’re not always sure who is controlling the debt at the end of the day”. However, he points out that this is no different to what the banking world does “It is only if it goes wrong perhaps that who holds the debt is important.”

So these direct lenders have their pros and cons. The question on the lips of healthcare players, however, is ‘are we going to see more of them in the market?’

Well, the first thing to say is that they are largely sector agnostic. They follow where the debt is required and thus where private equity goes. However, private equity is a prolific player in the healthcare industry and there are certain sector dynamics in the sector that would attract them.

“If you look at a service-led sub-sector, such as fostering or healthcare staffing, which the private sector is good at, there will be more PE transactions because it’s more profitable, which will drive up asset valuation multiples and therefore PE will want to source debt from lending funds where they can get more leverage,” points out Viral Patel, senior banker at Investec’s corporate & acquisition finance division. “In contrast, sub-sectors like care homes, where returns have deflated because of fee pressure and there is increasing reputational risk from high profile care home failures, bank appetite is less so, which will drive people towards direct lending funds.” Investec has backed dental chains, domiciliary care and lab software businesses among others through direct lending.

Additionally some funds may be persuaded to go into healthcare because they want to diversify their portfolio. “We feel that having a broad range

of products in different sectors makes our business more robust,” says Omni Capital’s Sanders. Indeed, the LNT Group deal marks Omni Capital’s first move into healthcare for its property finance arm, while its retail arm has in the last year started providing point-of-sale credit to cosmetic surgery and dental businesses.

And at the end of the day, healthcare has defensive characteristics, in that it is sorely needed, that make it attractive to lenders.

The expanding presence of these alternative funds does not spell the end for banks, though. “It’s a symbiotic relationship to a degree,” reflects Patel. He points out that besides providing the debt there are other aspects to lending such as providing transaction clearing services and revolving debt facilities that businesses need for daily functioning. “The funds have none of these skillsets or capabilities... so these two type of lenders have to come together to make it work.” So to a certain extent the banks get a good deal; they receive a nice revenue stream without a hefty commitment.

However, the banks are determined to regain and reinforce their territory and have thus fought back to a certain degree. ”They may not bend on their amortisation requirements, but they are trying to compete on the price of the debt in terms of margins and other fees.,” says Bower.

Whether alternative lenders will woo over the healthcare sector is not clear cut. Even so the presence of new debt providers could be a much needed catalyst to shake up valuations and activity further in a market that is cautiously regaining its pre-recession mojo. n

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