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3Q 2020 Trends and Insights

Look no farther than the commercial lending market: COVID has most certainly changed the world. When 2020 began, qualified mid-market borrowers could expect competitive loan terms with interest rates in the mid-single digits from large commercial and regional banks.

After the pandemic hit the US in Q2, commercial banks froze and lenders everywhere tightened their standards. The Federal Reserve’s Senior Loan Officer Survey at the end of July confirmed this, with commercial banks reporting across the board tightening lending standards almost mirroring 2008 levels.

Cerebro recently hosted a webinar to share market intelligence on the Q3 lending landscape and help borrowers understand their lending options going forward. Even with the expected credit challenges, Cerebro saw some bright spots in Q3—particularly with non-bank lenders picking up the pace.

Commercial lenders play hard to get

Borrowers looking for conventional cash-flow loans in Q3 were met with continued challenges. They were expected to show strong cash flows in 2019 and 2020. Banks expected collateral if their business earned less than $10 million EBITDA. Personal guarantees were the norm, with fewer exceptions allowed.

With asset-backed loans, borrowers needed to show EBITDA of 1.25 times their debt service coverage. Due to COVID’s impact on corporate financial performance, ABL collateral requirements are now up 10% vs. prior levels.

Cerebro also found that it’s taking lenders longer to appraise assets as shutdowns interrupt normal business procedures and they become more deliberate in their decision-making, leading to lengthier due diligence process times.

Main Street Lending Program loses ground

Many borrowers turned to the much-hyped Main Street Lending Program (MSLP) in Q3. The Fed-backed program, designed to help businesses cope through COVID, didn’t take off.

“The promise of MSLP is not living up to reality,” says Lacey Campbell, Sr. Director, Strategic Initiatives, at Cerebro Capital. “We’re seeing limited bank participation, aversion to impacted industries even with the government guarantee and fewer loans passing credit committee standards.”

The problem with MSLP is that the largest banks registered for the program—but aren’t lending. Heavyweights like JP Morgan, Bank of America and Wells Fargo chose to sit on the sidelines. A September Fed survey found large banks are uncomfortable with the risk associated with borrowers’ pre-COVID financial conditions, and the planned use of funds, even with the government guarantee.

The program officially launched in July but as of the end of September, a single lender, City National Bank of Florida, funded 38% of the total loans, with 88% of their borrowers located in Florida. The Federal Reserve Survey didn’t indicate how many of the loans were given to existing customers versus new clients, but needless to say some companies just got lucky based on which lenders were in their backyard. PNC is the largest national bank to have funded loans under the program and yet they have only offered $25 million in MSLP loans though it has $450 billion in assets.

Despite the program pitfalls, Cerebro successfully landed close to $60 million in MSLP loans for its clients in October, with additional clients still in market. Borrowers that secured these loans have healthy balance sheets, strong revenue and very specific uses for the funds, such as for hard costs.

Specialty government loans pick up speed

Despite the limitations of MSLP, in Q3 the Cerebro saw a lot of traction with other types of government loans, such as the USDA’s Business & Industry CARES Act Program and SBA loans. “Banks are more comfortable with these specialty loans due to the collateral requirement and 75% to 90% guarantee,” says Matt Bjonerud, founder and CEO, Cerebro Capital.

Cerebro found that while the SBA programs were well known, a lot of bankers and borrowers didn’t know about the USDA’s program for rural businesses or how companies qualify for it. Contrary to what many believe, the program is not limited to agricultural businesses, either. In fact many of Cerebro’s clients who originally wanted an MSLP loan, found there were other choices that were a better fit and they would never have known about them if they had only called one or two banks. It’s another great example of how companies can miss out if they don’t leverage the power of market intelligence and a large lender network.

Cerebro’s loan transactions team builds all of these programs and qualifications into its data set when pitching the loan request to its network of 800 lenders. For example, in June Cerebro guided an energy company with a higher risk profile towards a USDA loan vs. an MSLP loan. The company was able to secure an additional $800,000 over their initial ask. The USDA loan terms were very attractive, with a 10-year term, no personal guarantees required and around a 6% interest rate.

In regards to the SBA 7a and 504 loans, mid-market borrowers sometimes overlook these programs but Cerebro has helped clients source millions in SBA loans so far in 2020. With COVID impacts on business, these government guarantee programs have been a better fit for certain company profiles. And they provide attractive terms: up to $5 million, low interest rate of around 6% (Prime +275) and up to 10-year terms.

Non-bank lenders step up to the plate

Borrowers that need more than $5 million, want higher leverage amounts and may or may not have tangible assets, can instead turn to non-bank lenders. Not surprisingly, many non-bank lenders are in a good position to help mid-market borrowers thrive through the COVID crisis. Capital commitments are healthy, with dry powder to burn—meaning there’s plenty of money to go around.

Cerebro is studying non-bank lending behavior and credit standards and how it changes quarterly. For the most part, non-bank mid-market lenders favor deal sizes over $5 million. Non-bank cash flow lenders offer higher leverage limits and there’s less of an emphasis on collateral or personal guarantees as long as a company has greater than $2 million EBITDA.

Rates for non-bank loans are Libor + 8 to 15% and terms are short—usually three to five years. Lenders offer interest-only structures and though they may require prepayment fees. Non-bank lenders are especially aggressive for companies that are sponsor-backed or have strong valuation upside.

This year, Cerebro helped a B2C company with $33 million in revenue and $13 million EBITDA secure a $50 million loan from a non-bank lender. Receiving a loan significantly larger than their revenue with no equity dilution proved that non-bank lenders are still aggressive even through this pandemic. The rates were Libor +9 % and the borrower secured an 87.5% advance rate on their Accounts Receivables—really high given their industry.

“The bottom line is that if you get turned down from a bank it doesn’t mean you can’t get a loan, it means you might be fishing in the wrong pond. There is great diversity in non-bank lenders and what they might view as attractive for their book of business,” Campbell says. “While non-banks are more expensive, they are more flexible and should definitely be considered an option in today’s environment.”

The economy holds the cards

While nobody has a crystal ball, the near-term economy can only go one of two ways.

If things continue to worsen, Cerebro expects post-election stimulus and a potential expansion of MSLP, SBA and other government-backed loans. New stimulus may increase guarantees, loan sizes and subsidies, and will increase lender interest going forward.

If the economy improves and the pandemic subsides, credit markets will thaw and banks will return to pre-COVID lending. While Cerebro has already seen Q4 lending activity pick up, there’s a backlog for some loans. And if MSLP is extended beyond 2020, there will be a rush among borrowers.