While some US middle-market companies are still finding lending markets tough, others are being welcomed with improving lending conditions as the US economy emerges from the Covid-19 pandemic. The key challenge for all, however, is finding the right solution among a multitude of potential options.
Many companies worldwide, particularly those in downtrodden sectors like travel and hospitality, had a tough time in 2020 as lockdown measures slowed economic activity.
US middle market companies were no exception. Indeed, in 2020, many of the estimated 200,000 US middle market businesses were forced to shelve investment and growth plans as banks and other lenders shut their doors to these companies. Larger public companies, on the other hand, generally found the going easier as debt markets remained open, buoyed by stimulus measures from the Federal Reserve, the US central bank.
“It was more difficult for companies to access financing and pricing spiked for a period of time in 2020 as the COVID pandemic hit,” says Jason Sutherland, Head of Debt Capital Markets at Brown Gibbons Lang & Co, a US advisory firm serving middle market companies.
Getting attention was tough in this uncertain environment
adds David Doherty, Chief Strategy Officer at Oak Paper Products, a US middle market firm in the packaging sector. “Within the last year banks have gotten very selective.”
Some companies were forced to cut back investments or turn to the Paycheck Protection Program, the US government-backed loan scheme designed to help companies keep employees on their payroll. Not all middle market companies were shut off from lenders, however. Those largely unaffected by the pandemic were still able to tap finance to shore up their balance sheets or pursue growth plans.
So, as the US economy starts to pick up speed in 2021 helped by an aggressive Covid-19 vaccination program and President Joe Biden’s $1.9tn stimulus package, will more lenders start to open their doors to middle market companies, enabling them to ramp up capital expenditure and even reignite M&A activity?
It is a mixed picture, says Brown Gibbons Lang’s Sutherland. “For companies in favorable industries with stable financial performance, debt market receptivity is as good if not better than it was pre-COVID,” he says. “If you look at all the disruption that happened over the last year, what better test of the resiliency of a business then if it performed well over that timeframe. Lenders are very aggressively pursuing those types of companies.”
Others, where sales suffered amidst the pandemic, need to look harder for attractive financing. “The further you get from a stable end market and financial profile, the enthusiasm for any individual credit becomes increasingly sporadic,” he adds.
But that does not mean that lenders have shut their doors to all middle market companies. Far from it.
Companies just need to know where to look
Middle market companies have in effect two choices when it comes to debt financing: banks and non-bank lenders (this includes private credit funds, public or private business development companies (BDC), insurance companies and hedge funds). The former will offer the cheapest debt (generally between 2.5 and 4.5 percentage points above LIBOR, according to Sutherland at Brown Gibbons Lang) but also with the strictest terms and the lowest leverage appetite. Non-bank lenders, on the other hand, will normally be willing to lend more and with less restrictions. The trade-off is a higher cost, typically from 4.5 to up to 7.5 percentage points above LIBOR for standard first lien or unitranche debt, according to Sutherland.
The traditional view is that bank debt is better because it’s cheaper, Sutherland says. Increasingly, however, companies are looking beyond bank lenders. With “a tremendous amount of liquidity available in the private markets right now”, non-bank debt can sometimes be a better solution for companies, he says.
“In a recent deal, despite the higher cost, a client chose the non-bank route because it was much more flexible in the required paydown of that debt, and had significantly more cushion from a covenant perspective,” Sutherland explains. “It gave them a lot more comfort that they were not going to run into trouble down the road.”
Doherty at Oak Paper Products agrees, saying that non bank lenders may be less onerous in how they set covenants, giving companies more room for maneuver. “There is a lot of flexibility with these lenders that take the time to understand the company. Some of the larger banks tend to be a bit more rigid,” he says.
When it comes to traditional bank lending, many banks – particularly the larger ones – have toughened up their lending criteria amidst the pandemic. But, where middle market companies find doors are closed at the major banks, some neighborhood banks may still be willing to lend, Doherty says.
Regardless of the approach – whether companies are looking at bank or non bank lending – the challenge is finding the right deal.
This can be very time consuming
says Doherty. “You’ve got to spend a lot of time on the phone or find a way to access to the wider market.”
Sutherland says companies, particularly those which have been disrupted amidst the pandemic, may have an opportunity to look for a “partner who can provide operational guidance or expertise, or other ways to help beyond just capital” within the non-bank lending market.
“Finding the right partner is more important now than ever because there is a lot of activity in the market, and many lenders have become more specific about the opportunities they choose to pursue,” he says.
As the US economy recovers and lending conditions improve, those companies that can find the right lenders to spur capital expenditure or M&A activity will be able to score a valuable advantage over their competitors.