Navigating Today’s Debt Capital Markets
For mid-size retail companies — those with anywhere from $10 million to $1 billion in revenue — the combination of today’s steady growth and affordable capital is rare indeed. There is also ample liquidity as traditional middle-market lenders are being joined by institutional investors with deep pockets and a strong desire to participate in these loans. What’s more, new products are available that give borrowers more flexibility. In short, it’s a near ideal environment for midsize company borrowers.
However, that doesn’t make navigating the debt capital markets any easier. New products and more lenders give borrowers more flexibility, but it makes the marketplace arguably more complex. There are new senior debt options available from banks, financial companies and institutional investors that can be structured as either asset-based loans (ABL) or cash-flow-based loans. Junior debt offerings in the form of second liens and mezzanine funding remain widely available in the private market.
Institutional Investors return
CEOs and CFOs looking to take advantage of the current environment to ramp up borrowing should keep a few developments in mind.
In the past, lending to mid-size retailers was dominated by banks and finance companies. But today, large institutions such as pension funds, hedge funds and bank-run mutual funds account for 60% to 70% of senior lending at the higher revenue end of the middle market.
A big reason for this increase in lending is institutional investors’ desire to diversify their holdings from fixed-rate debt to include more floating-rate debt, which offers some protection should interest rates start to rise. Plus, the yield is relatively good.
More products and flexibility
Historically, the long-term financing available in the bond markets has only been open to larger mid-size companies with revenues closer to $1 billion. Most middle-market companies have had to settle for bank loans that amortized in five years. But following the financial crisis, institutional investors are re-emerging to offer bond-like loan facilities with virtually no amortization to smaller middle-market companies. They’re offering loans with virtually no amortization, as low as 1%, so these loans function more like bonds.
Other borrower-friendly products include “delayed draw facilities” and “incremental draw facilities.” In a traditional loan, the company gets all the money up front and immediately begins paying interest on the whole loan. For a fee, delayed draw facilities give a company the flexibility to draw down the cash and begin paying interest when they need it — often over a one-or two-year window. It’s similar to a revolver but in the form of a term loan. This can be a cost-effective option for borrowers.
What’s more, as banks and institutional investors compete for assets in a slow growth economy, “covenant-lite” loans have also returned. Loan covenants are certain measures that serve as early warning signs should a borrower run into trouble. Covenant-lite loan agreements have fewer restrictions and allow the borrower greater flexibility and often fewer reporting requirements.
CEOs and CFOs should remain attuned to the regulatory issues that lenders face, which have become more burdensome since the financial crisis. This year, the Federal Reserve released new guidance for highly leveraged transactions (HLTs) directing all lenders to be extra vigilant when underwriting loans and to demonstrate adequate capital to withstand losses. It’s too early to know the effects of the new guidance, but it could dampen some bank lending in the future.
Overall, the environment for mid-size company borrowers has rarely been brighter. According to the National Center for the Middle Market, retail executives expect a 4.2% increase in revenue in the next 12 months. More lenders, new products and good terms mean that quality companies have access to capital to grow and take advantage of the country’s economic recovery. By keeping a few key developments in mind, CEOs and CFOs can successfully navigate today’s debt markets and build a long-lasting relationship with the right lender.
Jim Hogan is senior managing director at GE Capital, Corporate Retail Finance, a leading provider of senior secured loans to retailers in North America, supporting working capital, growth, acquisitions and turnarounds.
Today, large institutions such as pension funds, hedge funds and bank-run mutual funds account for 60% to 70% of senior lending at the higher revenue end of the middle market.