With competition continuing to flood the mid-market lending space, banks and funds are forging new linkups to secure their place in the market and get one step ahead of their peers. The total number of funds chasing the mid-market space in Europe ranges from a conservative 40 figure to as high as 80, depending on which investment criteria is applied. But one thing is clear – the number of lenders far outweighs the number of good deals so banks and funds need to get creative to stave off their close rivals.

RBS is the latest mid-market lender to jump on the bandwagon. The bank is working with AIG, Hermes and M&G to provide up to GBP 100m of senior debt with a view to upping its mid-market footprint with a ready-made club, as reported by Debtwire. This arrangement is mutually beneficial, offering RBS an advantage to take the larger deals while AIG, Hermes and M&G get quick insight into each credit.

While tie-ups between banks and funds have been commonplace for the last couple of years, the joint venture is a first for senior debt-only deals. GE Capital and Ares Management led the way for bank-fund tie-ups in 2012 with its unitranche agreement called the European Senior Secured Loan Programme. At the start of 2014, Barclays teamed up with Bluebay to provide unitranche financing, while other non-exclusive relationships include Lloyds and Aimco, as well as RBS and Rothschild’s Five Arrows in a pull-off-the-shelf style unitranche partnership.

With unitranche tie-ups, the debt is usually retranched into a first loss junior piece accounting for around 70% of the total deal and a second loss senior piece (30%). Banks have lower cost of capital so they take the senior piece, which is considered to offer good yield on a senior leverage basis, while funds increase their yield by retranching the debt and only taking the higher-paying piece. Banks also benefit from the ancillary business. It’s a win-win situation.

“The bank fronts the deal, maintains client relationships and it is low maintenance for the borrower and private equity house,” said one banker.

“Funds need diversification. It enables you to win a mandate and not have massive exposure to one deal,” added a fund manager.

Tie-ups are also usually non-exclusive so participants can still do deals independently and the bank is not limited to undrawns and can tailor the structuring.

“It simply differentiates what they have in their kit bag,” according to a second banker. “Not every deal will suit the relationship, but it is speedier and allows you to build on reputation of execution.”

Those funds which lack the origination capabilities of their larger counterparts also benefit from the banks’ front end workforce. For Canadian pension fund Aimco for example, its relationship with Lloyds has resulted in some 10-12 deals together since they teamed up two years ago.

RBS’s new tie-up will likely increase the bank’s footprint in the middle market, although the model still needs to be put to the test. Market participants also question whether having too many names in the mix could raise conflict of interest problems.

“I am not sure what would happen if there is disagreement between the three parties on which deals they want in on. We think the fewer parties involved the better,” a fund manager said.

Success may hinge on the agreement they have with individual credit committee approval, and how fast this can be passed, a second fund manager said.

“Tie-ups sound great in theory but in practice they can be very difficult to execute. Every institution has to take its own view on a credit to avoid being negligent, so if credit committees have differing objectives it can be difficult to reach consensus,” a third fund manager said.

“From a private equity point of view, it often makes more sense to go with one provider,” the fund manager added.

RBS’s partnership with Rothschild’s Five Arrows to provide unitranche financing has already proved a successful relationship, while Barclays and Bluebay’s tie-up failed to gain as much traction, and was ultimately damned by Barclays’ retreat from market. The banks is seeking a sale of its cGBP700m leveraged mid-market portfolio, as reported by Debtwire.

In order to fend off competition, a growing number of funds are opting to work together on a casual basis, allowing them to pitch for larger deals while limiting the exposure to the single name - EQT, Crescent and Babson have teamed up, and so have Babson and Sankaty. As more funds spring up, this practice is likely to increase as everyone scrambles to get a share of the pie. As the market becomes more saturated, the smaller and less well-established funds are lined up to be the first casualties.

“There is a limit to the scope of tie-ups between funds and banks in the mid-market, and once the market is consolidated the smaller funds are going to struggle,” said the second fund manager. “They will try to put too much money out the door on the wrong deals, with bad terms.”

by Emma Roche & Mariana Valle

Debtwire's European Mid-Market Forum takes place on 26 May 2016 at Rosewood London. 

Emma Roche Reporter Debtwire

Reporter for Debtwire’s mid market desk since August 2014. Emma has worked as a print and broadcast

journalist for 10 years focussing on the financial and political sector. Previous employees include Euromoney,

BBC News, Sky News and UTV. Emma holds an LLB qualification from King’s College London and an MSc in

International and European Politics from the University of Edinburgh.