Funding costs for high-quality borrowers remain low right now – a point noted recently by the Reserve Bank of Australia.
In contrast, we’re seeing a tightening of lending to lower quality credits or ‘less desirable’ assets such as certain residential developments in the real estate market. So, what should business borrowers – private equity or otherwise - keep front of mind right now when it comes to financing debt?
Inbound investment and new entrants to the market
The loan market is becoming increasingly crowded due to overseas interest.
We continue to receive approaches from overseas lenders (both banks and non-traditional lenders) who are keen to do business in Australia. The competitiveness of the loan market in Australia has previously seen many such lenders adopt a ‘wait and see’ approach. However, we are now experiencing greater demand, similar to the trend experienced with banks from China over the last 12-18 months. We expect to see continued growth in the number of overseas lenders doing business here as potential returns become more attractive - at least on a comparative basis - and the outlook for credit defaults remains low.
This stretches beyond China. Japanese clients are also becoming more acquisitive in Australia with one recent transaction having been the purchase of an Australian foreign currency broker for a Japanese client. This is also indicative of the appetite of overseas investors for Australian financial services businesses. In relation to technology and financial services, we are closely following the proposed regulatory framework released by ASIC which allows fintechs to experiment in the ‘sandbox’ without being required to carry an AFS licence.
Looking beyond Asia, in its most recent Budget, the Federal Government announced plans to relax the tax treatment of asset-backed financing arrangements - otherwise known as Islamic finance. If the changes are legislated this may facilitate additional lenders from countries such as Saudi Arabia and the UAE with a focus on infrastructure projects. Whichever continent an inbound investor may hail from, they’ll need to consider the structuring stage of the transaction. For example, in relation to real estate transactions we’re seeing increased appetite in developing understanding of managed investment trusts and how this relates to the taxation of rental income and capital gains.
Higher leverage for real estate transactions continues to appeal to achieve desired returns.
Financings in the real estate sector continue to attract both senior and mezzanine financings or perhaps stretch-senior financing, often from non-traditional lenders including super funds and private equity sponsors. So long as property prices remain stable, we expect to see continued appetite for these structures.
There is a continued drive to ensure there are no gaps in conditionality.
Borrowers are continuing to focus on the move from a commitment letter and term sheet to a long-form facility agreement to ensure no additional conditions arise or onerous terms that could jeopardise the transaction. While clients may frequently have alternative lending options offering cheaper debt, if there are any time constraints then they often opt to proceed with their relationship lenders. We are seeing this in a number of instances where new lenders can offer better pricing or a higher leverage but may have additional documentation terms, security requirements or attempt to impose greater oversight on the operation of the business.
Borrowers are keen on minimal reporting requirements with their lenders.
Clients are seeking a facility agreement that will impose the fewest possible constraints on the time of management during the term. Facility agreement terms are reasonably well established in the Australian market but wherever such flexibility can be made available by a lender, it provides an attractive option to borrowers. In particular, this means they often press for reporting requirements in line with the existing practice of the underlying business, rather than adapting the business to the requirements of the bank group.
It’s worth noting that private equity sponsors have a strong offering for portfolio companies in this regard given their sophistication and experience relating to the management and delivery of such reporting requirements and corporate governance experience generally.
Focusing on what they’re best at
Our clients want to simply focus on what they’re best at (namely investing in and managing assets) with a continuing trend towards creating value for portfolio companies through innovation. Lenders and service providers can assist in this regard by sharing their experience in relation to the relevant target asset, especially where that asset is more complex or may be of a class that is coming to the market for the first time such as the privatisation of certain government assets.