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Musings of an Investment Banker ... Hey Lender, I’m Waiting For Your Call

Date: Apr 24, 2013 @ 07:00 AM
Filed Under: Current Environment

My phone should be ringing any time now. It happens like clockwork. I know I won’t be disappointed, like when I waited for calls in high school. It’s the right time for the phone to start ringing. Maybe I’ll just stare at it. I know it’s inevitable.

Let me explain lest you think I am just a lonely lunatic. A large portion of the investment banking transactions at my firm are deemed “special situations.” In other words, my clients typically have a story to tell, whether it be related to a fatigued stakeholder, liquidity crunch, erratic cash flow history or operational hiccup (or, in many cases, all of the above). More conservative bank-affiliated lenders tend to shy away from these stories. We often have much more luck placing our deals in the alternative lender universe, which occupies real estate further down the credit spectrum with yields that make a used car salesman blush. Traditional bank lenders may return my calls primarily because I am a nice guy (notwithstanding the creepiness of my introduction) and not because my clients can provide them with a couple of weeks run rate of historical fixed charge coverage.

However, there is always a time in the cycle when I miraculously become popular. It’s in the wake of a recession when the Federal Reserve tries to spur growth by flooding the market with liquidity. After a couple of years of hibernation, lenders begin raising origination targets to levels that just aren’t practical. If every lender were to hit their target, each company in the U.S. would have to refinance three times per year (which, by the way, is a recurring blissful dream of every investment banker). Unfortunately, there just are not enough deals to feed all of these institutions. Furthermore, the deals that are available are extraordinarily competitive, with pricing, structures and covenants that reflect a classic borrowers’ market. What is a lender to do? I know, let’s tell the world that our credit criteria has expanded. We like restructuring deals now. Let’s all call the special situations investment bankers. They must have deals for us. We can fill our barren pipelines and maybe even get some of that juicy pricing back. We are just about at this point in the cycle. Any minute now…

One can even argue that many macroeconomic factors that exist today will amplify this dynamic. The recession from which we recently emerged wasn’t just any old recession, it was The Great Recession. As a consequence, the Fed didn’t just prime the pump, it showered us with historic levels of liquidity. Interest rates aren’t just low, they are really LOW! The investing world is desperate for any kind of yield, resulting in the massive proliferation of alternative credit products, including collateralized loan obligations (CLOs), business development companies (BDCs) and credit-oriented hedge funds (COHFs –I admit I made this last one up but as a finance dork, I just love acronyms).

OK, so we have banks (with their newly healthy balance sheets and high origination targets) and new alternative lenders (fueled by the world’s desire for yield). There is plenty of supply. How about demand? Well, there’s the problem. The M&A market, usually the lifeblood of new originations, is stunningly quiet. All of the sellers motivated by tax rate changes have already sold. Many companies that experienced peak levels of EBITDA pre-recession would like to wait for those levels to return before selling so they can maximize valuation (News Flash: it ain’t happenin’!). At the very least, potential sellers would like to see more robust revenue growth so they can at least try to justify their hockey stick projections, but that is a challenge when the overall economy’s rate of growth is tepid (I have just used the words “tepid” and “robust” at least once, thereby satisfying my obligations as a finance writer).

The current slow growth economy is also suppressing the number of lending opportunities driven by a potential borrower’s expansion of working capital or capital investment needs. Finally, it is limiting deals compelled by another big driver of new loan opportunities, restructuring (and as a special situations investment banker, this one particularly stings). The resultant equation is simple: lots of supply (liquidity) plus limited demand (new deals) inevitably will equal a deterioration in credit quality (stupid loans).

I don’t believe we have reached the realm of stupid just yet. Bank-affiliated lenders have certainly loosened considerably since the depths of the recession. For example, asset-based lenders in the middle and lower-middle market don’t hang up the phone anymore when you request a term loan collateralized by real estate. Arbitrary permanent availability blocks on the borrowing base are dissipating, as are LIBOR floors. These changes are just reversions to rational lending rather than the pendulum swinging into la-la land. Perhaps one area where things have already started to get overly frothy is pricing. Competition has very quickly compressed overall yields (goodbye L+450 and 2% closing fee, we hardly knew ya). On a cashflow basis, lending multiples are definitely creeping up, especially for larger deals, but have yet to revert to pre-recession insanity.

However, when my phone rings, it will be like a giant church bell ushering in the age of eight times leverage on restructured/pro forma/projected EBITDA (or probably just my wife asking me to pick up dinner on the way home, but I like being dramatic). Special situations investment bankers will parade in the streets, rejoicing that their future pipelines are being booked and I will lead the way with a fife and briefcase (did someone slip something in my coffee this morning?). Air balls for all! Step right up and get your overadvance! You want a Term Loan B? How about a C and a D? Here’s seven turns of EBITDA. Please have another. I insist.

With this dramatic supply and demand imbalance, the table is certainty set for a return to the lending standards that caused such a great mess just a few years ago. I guess the lesson is that in lending, much like my weekends, the drunker you are, the worse your memory the next day. Perhaps one constraint on a repeat of history will be a more stringent regulatory environment. We all know financial institutions have a lot more paper to file with the government, but will that prevent cycles from keep on cycling?

I hate to cut this article short but is that my phone (ring, ring)? Oh, it’s not my office phone but my cell phone (One Direction ring tone, One Direction ring tone). I wonder who’s calling.

Michael S. Goodman
Managing Director | SSG Capital Advisors, LLC
Michael Goodman is a managing director at SSG Capital Advisors, LLC, a leading independent boutique investment bank that assists middle market companies, as well as their stakeholders, in completing special situation transactions.
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