The deal with debt

Imagine your company frequently evaluates acquisitions or capital projects, and you have to report at quarterly board meetings on the availability of debt finance.

Looking back at 1998, you would have noted conditions ranging from a glut of cheap money to a virtual credit crunch. Worse, a status report made on a Friday could have been invalid by Monday.

The turmoil in international financial matters has challenged the conventional wisdom of the last few years. Confident predictions were made of corporate borrowers flocking to the bond markets: Euro or Yankee issues for established borrowers, and the high-yield market for lower quality credits. Recent events, however, have demonstrated that, while valuable and growing in importance, these markets are essentially opportunistic. They may have a place in many firms’ borrowing armoury, but should not be relied upon as a consistent or stable fund source.

War stories abound as illustrations. A number of management buy-out transactions have been left high and dry following the collapse of the high-yield bond market. Corporates reliant on bond market financings, or even accessing commercial paper programmes, have had to defer plans, look for alternative financing or draw on credit facilities.

Part of this can be attributed to the natural cycle and rhythm of financial markets. But there is also an underlying structural change.

The relentless consolidation and reorganisation among financial institutions has changed the nature of banking. Banks are driven by return on capital.

Straight corporate lending in isolation is an inefficient use of capital.

Many banks have responded by withdrawing or scaling back lending. Others have begun debt repackaging programs. The focus has shifted towards originating transactions which can be arranged and distributed to other investors.

This transactional approach is not unhealthy and may ultimately lead to greater efficiency and transparency in financial markets. But, for corporates or other borrowers, more used to a relationship banking service, there are some major pitfalls.

Before the era of integrated investment banks, treasurers and finance directors could be clear about banking. Investment banks thrived on combining advisory work with a highly selective use of capital, while commercial banks were based on lending, treasury and clearing services. This distinction no longer holds. All banks now wish to cross-sell added value products.

In this environment, independent advice can be very hard to obtain due to perceived conflicts. This comes at a time when instability in the markets makes expert, objective advice critical. The major accounting firms have undoubted credibility in independence and general financial expertise.

Some, like KPMG, have responded to these market developments by building specialist debt advisory teams, including the recruitment of experienced investment bankers.

Debt advisory work is partly a natural extension of the firms’ existing business. Leading firms already advise on many aspects of corporate and institutional fund raising – for example, management buy-outs and PFI projects. Expertise on specific capital markets complements this. It is also a logical stand-alone business, given client range and depth.

The type of service provided ranges from strategic advice – advising on types of finance available and advantages and disadvantages of each – through to detailed help with negotiating documentation. At the strategic level, the approach focuses on client objectives and matching different types and providers of finance to achieve the best fit.

This can involve trade-offs. For example, a single financing market is unlikely to offer, simultaneously, the cheapest price, longest maturity and most flexible covenant package. Additional complications come from choosing currency, fixed or floating rates and relationship considerations, and comparisons can become complex and bewildering.

It is in this environment that inappropriate financings can be undertaken – either because the full range of products and techniques is not explored objectively or because borrowers are pushed towards the markets that suit the arranging bank(s). This represents a significant opportunity for the accounting firms.

The gap in the market is more than just theoretical. KPMG Corporate Finance advises a Russian company on asset-based export finance; a European municipality; and a UK education institution on finance issues.

For accountancy firms building up debt advisory resource and expertise, transactions such as these represent the tip of the iceberg. Treasurers and CFOs welcome expert, dispassionate advice in a difficult and uncertain world – and no-one is better able to provide it than accountants.

Simon Collins is director in the financing group of KPMG Corporate Finance and former global head of debt structuring at NatWest