Debt Update // Pricing, Privatization & Alternative Financing — Virtual Roundtable

In this week’s virtual roundtable, as the country slowly begins to reopen, a dozen Axial members came together to discuss the new normal in the private debt market. Now that government funding has been deployed, travel is slowly coming back into play, and financials are beginning to normalize, what does that mean for lower middle market lenders? This week’s discussion covers everything from pricing, leverage & interest rates to when & how the debt market will make a full return.

Thank you to below Axial members who participated in the discussion:

Jay Braden, Co-Founder, Bastion Consumer Funding

Aaron Brand, EVP of Business Development, LQD Business Finance

Gerry DeBiasi, Partner, Kidd & Co.

Rob Gettinger, President, Strategic Finance, Inc.

Lawrence Litchfield, Director of Business Development, Columbia Pacific Advisors

Daniel Nanson, Managing Partner, Cliveden Advisory

Bill Overbay, Co-Founder & Managing Partner, Stone Road Capital

Tom Romero, Managing Partner, Capital Research Partners & Co.

Karen Small, Partner, Sterling Commercial Credit

Matt Smith, Vice President, St. Cloud Capital

Tim Williams, Founder & Principal, Fortis Capital Management

Access the recording here:

Show Notes 

Introductions 00:00 – 15:30

Securing debt post-COVID: 15:30

• Multiple firms have closed one or more deals since the pandemic began
• It comes down to the people — if you observe the business’ performance during COVID and see that they’re reacting well then you feel more comfortable closing
• St. Cloud Capital is already back to 70-80% of where they were before the pandemic
• New acquisition financings are on pause until getting on a plane
• Desktop audits for smaller transactions are possible
• Sterling Commercial Credit uses an audit team who has offices across the entire U.S. so they can still do diligence in person 
• Deals that are driving distance are much easier to get done right now

Government funding and its impact on the private market: 22:52

• PPP money has helped smaller companies stay afloat, but it’s only short-term
• A lot of receivables are status quo right now
• Payments are still coming in on a regular basis, which is a bit of a surprise
• 25-30% of Sterling Commercial’s portfolio was able to get PPP
• Anyone with an existing SBA loan had payments forgiven for six months, so those companies may not be looking for working capital right now
• There will probably be fewer opportunities through Q3, but when PPP runs out and payments aren’t being forgiven anymore,  the following two quarters will be extremely busy

What are lenders looking for from businesses? 27:00

• While in underwriting, clients should put together a post-COVID plan for the next four months so they can provide more realistic projections
• Asset-based lenders are cautious because they’re not sure what to expect — if defaults start to come in they’re going to have to raise ratings and it creates a domino effect
• 90-day deferrals on interest will have to be paid in the near future, which is a major consideration when looking at businesses
• Most companies coming to the table are now going to have a “story” and there is likely going to be some sort of issue that will need some attention
• A lot of banks were just pricing the availability of capital before all of this happened — risk wasn’t being priced in. That is starting to correct itself now.
• Private capital had already priced in risk, so the higher price is now more reasonable
• Deal flow has gone down a little bit, but not as much as was expected

Deals that are NOT getting done: 34:20

• Opportunities that have an international piece (especially Asia-related)
• Hospitality transactions (for obvious reasons)
• Airline deals – there was originally an expectation that airlines would come back sooner than they have, but what people thought would be a short pause has turned into much longer holding pattern
• PPP funding ended up blowing up a few deals that were in process

Government contractors: 38:15

• Government contractors have a better sightline than most, so is this now going to be a more attractive sector for people?
• What is the hit going to be for government budgets in 2021? While they may have security now, this is not guaranteed to continue.
• It could depend on what layer of the government you’re talking about — municipalities will likely be hit first, followed by state, and then federal 
• Customers oftentimes have 2-3 year terms on their contracts which is a saving grace for some of these businesses and the lenders that serve them

Consumer & e-commerce deals: 43:20

• Online retailers are really poised for growth right now and are coming out on top 
• Some consumer brands are seeing an uptick as their products are consistently being taken off the shelf
• It’s a small segment of the lending community that is comfortable taking on a business with a highly-concentrated Amazon segment; a lot of lenders will not even look at a business with high Amazon concentration
• This could be a space where there are a lot more opportunities now
• Amazon started their own lending program to address that issue 

Interest rates & risk: 48:25

• Interest rates have been low for so long and an immense amount of credit money and distressed money was raised in that time period
• People have been preparing for a recession
• There is a lot of non-institutional liquidity that is available to work through this downturn
• Intermediaries have been receiving a lot of inbound calls from distressed groups wanting to know what’s going on and what deals are in market 
• A lot of new clients are coming to the table and expecting low rates despite everything that’s going on
• The rates are not going to be what they used to be because you need to pay for risk
• Due diligence costs are going to have to go up, which will enforce higher rates
• There is going to need to be a lot of education for small businesses around what is happening in the debt markets to get them more comfortable
• There will likely be a lot of exceptions and creativity from lenders in the coming months
• Something else that needs to be incorporated for prime lenders: the addition of floors

Where are leverage multiples? 56:00

• Pricing is up about 200 basis points for a cash-flow loan
• A lot of that has to do with BDCs and their liquidity strength 
• It’s very situation specific when it comes to structure and pricing
• Leverage is down about a full turn
• While it was close to 4x leverage prior to the pandemic, it is closer to 3.25x now

Transaction timelines: 58:15

• Processes are taking a lot longer — diligence in particular — which is dragging out deals 
• A lot of a deal timeline is now spent trying to understand where individual businesses stand when it comes to the new normal
• Most LOIs on Axial have moved from a 60-day close to a 90-day close out of the gate
• Diligence taking longer because of travel constraints, but there are options
• Pensions are looking to invest directly into private debt and they’re open to closing without having done diligence on site
• Anyone can hire a local outsourced service to do on-site diligence 
• Even if a buyer and/or lender is comfortable closing a deal without in-person meetings, the business owner also needs to feel that way
• On the equity side, almost no one is open to closing without meeting management teams, so it doesn’t matter if the lender will fund the deal without on-site diligence
• When you have asset-based lending, it’s really tough to get people on site to appraise inventory right now (both due to plant restrictions as well as getting boots on site)
• As different states start opening, people are going to be more open to travel, but all parties need to be aligned and have the same comfort level
• Data sets from Apple Maps show that people using their maps for directions (for driving, walking, etc.) went completely off the rails in mid-March, and has since picked up 
• Data from the TSA shows air travel go down 90% during that same time and it has now started to pick back up
• This shows some promise that travel is returning and this summer may provide an opportunity for people to get back on the road

Other sector perspectives: 1:14:30

• Will people be open to looking at restaurant and hospitality opportunities any time in the near future since they will be so slow to come back? Costs are higher because of packaging and food distribution apps, and revenue is low because most restaurants are still takeout only — most barely can pay their bills.
• There have been virtually no active restaurant deals seen in the market nor have there been active health club transactions (which are in the same category of businesses that have been hit extremely hard)
• IT services and data center companies are booming
• Fiber optic deployment businesses are doing extremely well and have been working through the pandemic because they’re considered essential
• Non-essential healthcare providers are faced with a big unknown around when people will go back, even if the practice opens its doors
• OpenTable released a data set showing the total demolition of online restaurant reservations during COVID