According to a recent poll by KPMG LLP, the U.S. audit, tax and advisory firm, middle-market executives anticipate a shift from opportunistic deals to corporate M&A, which will be driving activity in the 2014 credit markets.
“Over the last few years, buyers and sellers have had different valuation expectations. Coupled with lingering uncertainty around the economy, this divergence created a slower deal market,” said Joe Rodgers, co-head for Capital Advisory for KPMG Corporate Finance LLC. “With economic indicators improving over the latter part of 2013 and the credit market remaining very supportive, all signs pointed to an uptick in M&A activity for 2014 at the turn of the year. However, recent unsettling events including fluctuating stock prices, disappointing economic news in the U.S. and China, and increased interest rates to battle inflation in several emerging markets have the potential to keep some buyers on the sideline a bit longer than expected – a situation that may quickly shift again given the fragility of the market.”
Thirty-six percent of respondents indicated that corporate M&A will serve as the primary driver of credit markets activity in the first half of 2014, whereas KPMG’s May 2013 survey found that just 18 percent expected there would be corporate M&A in the second half of 2013. Twenty-six percent of executives indicated refinancing would also result in credit market activity, dropping from 50 percent over the last six months. Expectations for private equity (PE) funded buyouts increased to 23 percent from 17 percent, and restructuring prospects remained at 15 percent.
“Despite a sluggish M&A market, businesses as well as private equity groups have taken advantage of a heated credit market to close on refinancings, repricings and dividend recapitalizations,” added Rodgers. “Most of these deals close with better terms and push out maturities. Businesses will still capitalize on the robust and active credit market in 2014, but opportunistic deals are likely to slow down since so many businesses have already taken advantage of this open window, and as the survey indicates, more companies are optimistic about increased M&A activity.”
Lending Environment Expectations
According to the survey population, in order to raise capital in 2014, respondents intend to seek out bank loans to refinance on more favorable terms (26 percent), raise growth equity (13 percent), and incur debt in connection with an acquisition (10 percent). Twenty-two percent indicated that their businesses will not be attempting to obtain capital this year.
“The role of banks, especially in the middle-market arena, is subject to change as government regulations evolve. If banks increase their cash reserves and liquidity positions in order to comply with new rules, their underwriting guidelines will tighten up, impacting mid-market businesses looking for credit facilities,” said Rodgers.
Regulatory conditions, including the new Dodd-Frank and Basel III rules, continue to affect the direction of the credit markets, particularly the role of banks. Fifty-one percent of respondents indicated that increases in bank regulations will have an impact on existing bank relationships, 28 percent were unsure about the impact, and 21 percent indicated that there would be no impact.
“In anticipation of banks pulling back on lending activity due to regulatory changes, other types of investors will be focusing more heavily on mid-market opportunities,” said Brian Hughes, KPMG’s National Private Markets Group leader. “Mid-market companies should understand that there are still plenty of financing options available in the form of alternative investment funds, institutional investments, CLOS, BDCs, and credit funds, among others.”
Interest Rates and Risks
With the Federal Reserve’s decision to taper its quantitative easing program – curtailing its bond-purchasing initiative – and concerns over inflation in the U.S. markets, potentially increasing interest rates, 58 percent of respondents expect yields to increase in 2014, compared with just 30 percent who thought there would be an increase through the end of 2013.
Rising interest rates and a stronger U.S. economy leading to higher inflation will have the greatest affect on the leveraged loan market in 2014, said 35 percent, followed by continued proliferation of new capital sources providing more options and flexibility to issuers (20 percent) and increasing loan issuance in connection with M&A, given higher public equity levels (18 percent).
The biggest risk to the credit environment in 2014 will be geopolitical instability, said 22 percent of respondents, reflecting no change compared to the second half of 2013. Inflation will be the second biggest risk, said 23 percent of respondents, compared to 17 percent last year.
About KPMG’s Credit Markets Survey
KPMG LLP held the Semi-Annual Credit Markets Webcast in December 2013 and polled more than 200 mid-market financial executives, investors and professional advisors from companies with revenue under $1.499 billion in an effort to gauge market sentiment for the first half of 2014. A replay of the webcast can be found by visiting KPMG Institutes.
About KPMG LLP
KPMG LLP, the audit, tax and advisory firm (www.kpmg.com/us), is the U.S. member firm of KPMG International Cooperative (“KPMG International”). KPMG International’s member firms have 155,000 professionals, including more than 8,600 partners, in 155 countries.