Slower growth increases lender competition
Middle market borrowers explore nonbank loans
INSIGHT ARTICLE |
Middle market borrowers are pushing to complete financing deals before the president takes office in January amid expectations that post-election growth in capital expenditures will continue at a modest but slower pace.
Proposals by both the Democratic and Republican candidates to increase federal spending is causing uncertainty among both lenders and borrowers, said Joseph Brusuelas, chief economist at RSM US LLC. “The risk going forward is that policy changes surrounding the election may cause a more pronounced reduction in capital expenditures.”
The RSM US Middle Market Leadership Council survey of 700 middle market executives with $50 million to $2 billion in revenue, found many respondents reporting tighter access to credit.
As traditional loans come up for renewal, some borrowers have found their banks refusing to make new loans or offering far more onerous terms.
“The traditional market is less active than it was before,” said Brusuelas. “The terms are becoming more difficult, and a lot of people are basically being told, ‘no,’ as compared to 10 years ago.”
Nonbank lenders–hedge funds, specialty lenders, business development corporations and peer-to-peer lenders–are increasingly filling the gap. Once considered mainly as an alternative to banks. In the post-2008 regulatory environment, nonbank lenders have become an increasingly important source of loans for middle market borrowers.
While hedge funds began moving into the middle market finance business more than 12 years ago, banking regulations adopted in the wake of the 2008 financial crisis restrict banks’ ability to lend. Because they do not accept bank deposits, nonbank lenders don’t fall under banking regulations.
Investors, for their part, are turning to nonbank lenders in their search for yield. With equities trading at all-time highs and interest on bank deposits near zero, nonbank lenders offer a measure of rate protection as they typically charge a Libor-based floating rate, rather than a fixed yield as with high-yield bonds.
Many borrowers are still unaware of alternative funding sources, and think they are stuck having to deal with traditional banking sources.
For borrowers, the new reality carries both potential benefits and risks.
Nonbank lenders may offer more flexibility in terms, so borrowers have the possibility of customization and the opportunity to shop for the best deal. In some ways, the situation is an improvement over the not-so-distant past, when a business in a small or midsize city had the choice of only a couple of banks. A business turned down by one bank went to see the other one.
On the minus side, a company can end up paying a heavy price for capital. Premiums can range from 100-700 basis points over Libor, depending on the company’s risk profile and the type of lender.
Oversight provisions are another minefield. Without careful evaluation of loan terms, a company may find that the lender becomes more involved in the business than expected.
To avoid problems, companies should look at three or four potential suitors instead of just one. “There is a plethora of lenders out there,” Brusuelas said.
Distinguishing the best deal isn’t easy, as information on lenders isn’t readily available. By shopping around, however, companies may find that they can negotiate terms and the degree of oversight.
The choices in corporate governance, for example, can include “no board rep, one person on the board, no say in management, you can attend management meetings,” said Brusuelas.
Borrowers also should evaluate a lender’s long-term commitment, as well as any term that would let the lender call in the loan balance before the term is up.
Lenders, for their part, will be evaluating a potential borrower’s growth prospects, market position, cash flow quality and collateral value.
“Ultimately, aggressive middle market borrowers could find that a risk-avoiding environment works to their advantage in finding financing, particularly from nonbank lenders,” Brusuelas said.
“More lenders are competing for a shrinking pool of borrowers,“ Brusuelas said. “It increases the liquidity to support growth and expansion.”