Improved Credit Markets Yield Opportunities for Middle-Market Businesses
By G. Thomas Doyal & Chris Berkimer
Corporate Finance
Universal Advisor , 2004 Issue No. 2


Two years ago, we wrote about the negative impact of the economy and tightened credit standards on middle-market businesses. Banks had sharply reduced their willingness to lend and, subsequently, it had become difficult for middle-market companies to find financing for growing businesses or acquisitions. Many companies turned to alternative capital sources to support their borrowing needs, increasing their cost of capital and making some transactions more difficult to complete. Although the heady days of the mid-to-late ’90s are still a distant memory in comparison to today’s credit market, many companies are experiencing renewed optimism by their senior lenders or alternative credit provider.

New Trends in Bank Credit Markets

Over the last 12 months, there’s been a marked change in the lending behavior of regional and national commercial lenders. Banks, which had been steadily withdrawing from the market over the last five years, have become increasingly more aggressive at levels unseen since the late ’90s. Their willingness to lend is exhibited by a historical analysis of total debt to EBITDA (earnings before interest, taxes, depreciation and amortization) ratios (refer to the chart on page 14).

By the beginning of 2004, banks were lending at a 3 multiple of EBITDA, a ratio that has continued to climb throughout the year. Recently announced transactions in the second quarter of 2004 have reported a continuation of this trend.

Why Is This Happening?

Most bankers agree their more aggressive stance is a result of a number of factors, including encouraging economic trends, positive corporate earnings, growing backlogs, and improved loan portfolio quality. Banks have cleaned house, eliminating underperforming or problem credits from their portfolios and freeing up lenders to concentrate on new opportunities.

Recent statistics issued by the Federal Reserve Bank of New York reflect a marked improvement in the percentage of non performing commercial loans, falling 30 percent since their peak in the second quarter of 2002. Net charge-offs by banks are also declining, indicating banks have taken their hits and are looking to the future.

What Does This Mean to You?

Senior bank managers are encouraging their lenders to become more aggressive in their marketing activities, resulting in an increase in the attention paid by bankers to new borrowing opportunities. This activity fuels competition among lenders, improving borrowers’ negotiating positions on rate and structure. PMCF has experienced a significant change in the number of banks willing to propose on new lending opportunities, in many cases yielding upwards of four or five proposals for each new transaction. In addition, the growth in loans made by non-bank financial institutions (such as GE Credit) has had a dramatic impact on credit availability. These institutions haven’t been subject to traditional bank regulation and oversight over the last few years, allowing for a more agile and aggressive approach in their attempt to secure new loans.

Asset-based or collateral-based lending structures continue to be the structure of choice with most middle-market lenders. Improving economic trends and subsequent increased demand for equipment and raw materials to support growth will yield better appraised values for borrowers, increasing the amount of available credit on traditional assets. Borrowers who obtained appraisals three or four years ago may want to update their current fixed asset and inventory appraisals to determine if increased credit may be available through their current lending arrangement.

As backlogs have improved, banks have recently shown a willingness to make loans beyond traditional collateral positions. Companies that can effectively demonstrate a clear increase in backlog or new growth opportunities are obtaining cash flow loans that exceed their current collateral base. Typically known as “stretch” or “B” loans, these structures provide a short-term cash flow bridge that amortizes over one to three years. This type of credit was recently supplied by subordinated or mezzanine lenders who had entered the market when traditional senior lenders retreated. Banks have started to evaluate the 16 percent to 22 percent returns required by subordinated lenders and are now attempting to take another bite out of the apple. Their willingness to lend into this second tier at lower rates has forced sub debt lenders to reduce their yield expectations. Borrowers can take advantage of these new stretch loans, maximizing credit availability from their senior lender before entering the mezzanine market, reducing overall cost of capital, and strengthening their relationship with their primary lender.

In Conclusion

The capital markets over the past year have experienced a dramatic shift in lending practices. Banks are hungry for new business and are looking to companies with solid backlogs and good earnings. It’s a good time to maximize your borrowing capacity and take advantage of commercial bank interest in supporting new opportunities with fresh capital.