Alteris periodically reports on M&A valuation metrics in the middle market. We are sometimes asked to expand on what’s behind the numbers.
Especially given all the uncertainty during the pandemic.
The last two posts were about Deal Structuring and Due Diligence trends. This post is about trends in business lending.
There is no doubt: lenders are cautious regarding new lending and in underwriting new acquisitions. Instead, lenders are now focusing on the quality and liquidity of their existing loans. It’s a defensive mindset.
In particular, lenders are now very reticent about making loans to companies that are pandemic impacted.
For acquisitions, they prefer deals that have a higher level of equity / lower debt structure. They also prefer large, well-capitalized situations. The uncertainties surrounding the pandemic is causing this approach.
When doing business with new partners lenders seek to limit their risk through more conservative (less) leverage and more restrictive lending terms. This all means that transaction leverage is decreased. There are pricing increases of approximately 100-200 basis points. Also higher LIBOR floors.
A positive in this environment is that the cost of funds for lenders/banks is quite low. This raises the possibility of more opportunities to invest at reasonable spreads alongside reputable sponsors.
At the beginning of the pandemic, in March, the Federal Reserve moved aggressively to support flow of credit to businesses. This included reducing federal funds rates to zero. But also aggressive purchases of government and corporate bonds. They provided grants and/or loans to businesses.
The Federal Reserve will undoubtedly continue this support.
For example after the popular Paycheck Protection Program (PPP) that was focused on small business thee rolled out a midsize-business support program. The Main Street Lending Program started lender registration in June. Though it is not clear how widely the Main Street Lending Program will be used. Anecdotal reports indicate only limited borrower interest.
The pandemic has increased uncertain around the whole area of lending. Among other things, due diligence by lenders into the credit risk of potential borrowers has and will continue to increase due diligence periods. Put simply, the length of time required to get a loan approved has been lengthened. We expect that the approval times will continue to be long and may increase further.
While government entities have attempted to provide liquidity and provide a floor for credit risk, the effects of the pandemic have definitely harmed credit markets. It will be interesting to see how long lasting this negative effect will be.
