Move over Omicron: INFLATION is the new buzzword. The threat of inflation looming over central banks has made an already difficult situation that much harder to deal with. Looking back on the past year we can see that much action was centred around driving economic recovery, but now private lenders, banks and governments will need to adapt.
Private lenders came into 2021 with diverse views on the year ahead. A poll conducted at the Kayo Women’s Credit Summit showed that 50% of respondents anticipated 2021 being a record lending year, whereas 38.5% believed the market would be patchy and 11.5% thought there would be a market downturn. Indeed, the majority were correct: 2021 was another strong year for private debt, with Europe, in particular, benefitting from buoyant housing markets and a downward revision in default forecasts from major rating agencies. Lenders sought to keep businesses with strong pre-COVID performance afloat notwithstanding struggling bottom lines, resulting in higher leverage multiples.
Competition has intensified, largely driven by new direct lenders entering the market and existing players raising record level of capital over the past 18 months. Another mark perhaps of just how competitive the direct lending market has become is that spreads have continued to drop in 2021. Lenders have also become more open to lending with less protection in a bid to stop spreads from compressing further – loans with 2 or more covenants have fallen 20 percentage points since 2020 and delayed-draw term loans have also become more common.
However, lenders may be hesitant to continue being this flexible in the near future. Inflation is now biting hard, and with consumer demand recovering across the board, we will only start to see downward pressure as supply chains begin to recover – unless of course central banks take swifter action in raising rates.
Lenders of all varieties have become reliant on the action of central banks, but none more so than the banks because of their lower cost of capital. Inflationary pressures in Europe and North America have led to central banks releasing forward guidance suggesting rates rises may take place in quicker succession and be greater than tradition dictates. However, some still believe central banks will err on the side of caution, arguing that raising rates pre-emptively could be particularly damaging if the supply-side of the economy begins to recover. The outlook for bank lending is therefore and correspondingly uncertain.
In the interim and as of January 2022, banks have indicated a slight tightening of credit standards happening across Europe, although they have maintained a positive economic outlook despite supply-chain bottlenecks. More notably, perhaps, was the significant increase in demand for bank loans in the 4th quarter of 2021, driven by both short-term working capital needs and the desire for longer-term financing.
Banks expect to continue expanding their loan books throughout 2022, while also managing down lending to companies who have struggled the most during the pandemic. We believe that banks will continue to be an important tool among the services Altimapa can offer its clients.
Governments all over Europe have introduced various policies with the aim of supporting smaller businesses. In the UK, for example, the Coronavirus Business Interruption Loan Scheme (CBILS) was introduced with the aim of supporting small and medium-sized businesses and it helped them access financing facilities with the government guaranteeing 80% of the loan and paying interest for the first 12 months. We have written previously about the UK government’s ambition to achieve an investment-led recovery, as evidenced by the super-deduction; such a strategy of propping up the supply-side of the economy may pay real dividends in the wake of inflationary pressures.
In the European Union, the Coronavirus Banking Package was introduced to boost banks’ flexibility in lending to businesses by increasing their ability to lend and absorb losses. Further liquidity measures were also implemented, such as the provision of €10 billion in dedicated liquidity lines to banks to ensure sufficient working capital support for SMEs. Credit holidays were also provided for companies under certain instruments within the European Investment Fund, such as the EU Programme for the Competitiveness of Small and Medium-Sized Enterprises.
Several of Altimapa's lending partners expect that government support schemes will be pulled back and reduced in size and scope over the coming months, as it has already started to happen. Neverthless, Altimapa thinks that it is most likely that governments will continue to play a considerable role in the economy in years to come, as the various support schemes come to an end, and as some of their recipients struggle to repay the debt or switch into commercially priced equivalents. This scenario is likely to be truest among the smaller businesses and those in low margin sectors.
To summarise, we are now beginning to see a shift in the behaviour of lenders and central banks as they respond to the challenges brought on by inflation. Governments have committed to extend their financing schemes within the short-term future, although whether these schemes will be enough to shield SMEs and mid-market companies from another economic downturn is yet to be seen.
Shifting from a low to a higher rate environment could increase the funding costs. Still, with Altimapa’s network of funds and advisory expertise, prospective clients should continue to expect competitive outcomes.