Instructions
· Read the following:
"Slow Economic Recovery Could Squeeze Smaller Lenders" by Kristin Broughton, The Wall Street Journal, May 31, 2020
· Answer both of the questions listed below.
· Cite at least one additional article and include in text citation.
Discussion Questions:
· Describe why nonbank lender growth comoves with the credit cycle.
· What challenges did non-bank lenders face during the Covid-19 crisis in securing sources of funds?
11/8/2020 Slow Economic Recovery Could Squeeze Smaller Lenders - WSJ
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CFO JOURNAL
Slow Economic Recovery Could Squeeze
Smaller Lenders
Nonbank lenders might need to raise capital in the months ahead to support the small- and medium-size
usinesses who bo
ow from them
‘When the virus hit it was like everything stopped in one day,’ said an analyst who covers nonbank
lenders.
PHOTO: STEVEN SENNE�ASSOCIATED PRESS
By
May 31, 2020 9�00 am ET
Kristin Broughton
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11/8/2020 Slow Economic Recovery Could Squeeze Smaller Lenders - WSJ
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A slow economic recovery could test the strength of nonbank lenders, forcing many to
aise capital if the businesses that have bo
owed from them struggle to recover or shut
down after the lockdown enforced during the coronavirus pandemic.
Business development companies that lend to small- and medium-size companies
expanded rapidly over the past decade, with publicly traded BDCs increasing total assets
y nearly fourfold to $83.6 billion as of the first quarter of 2020, according to Refinitiv, a
market data provider. Several of these companies, including FS KKR Capital Corp. , New
Mountain Finance Corp. , and Oaktree Specialty Lending Corp. , this month reported
quarterly losses, largely due to markdowns on their loan portfolios.
In the coming weeks and months, these private-credit lenders will be looking to maintain
enough cash to fund loan commitments, pay down debt, and keep their financing options
open, analysts said. But for some lenders, that could prove to be challenging, particularly
as a large number of bo
owers are expected to draw down credit lines to weather the
slow pace of economic recovery.
“In good economic times, they were harvesting the gains,” said Mitchel Penn, an analyst
who covers the industry for Janney Montgomery Scott LLC, pointing to strong liquidity
generated by prepayments on loans, as bo
owers found better deals or sponsors sold
portfolio companies. “But then when the virus hit it was like everything stopped in one
day.”
Already, lenders such as FS KKR Capital and Golub Capital BDC Inc. have announced
capital raises of $250 million and about $300 million, respectively, in recent weeks.
“We want to use the proceeds to fortify liquidity and to create more flexibility,” said David
Golub, chief executive at Golub Capital, during a May 11 earnings call when asked how he
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plans to use the new capital.
BDCs have taken steps to shore up cash since the pandemic began to unfold, in some cases
increasing their credit lines from traditional banks or slashing dividends.
Harvest Capital Credit Corp. , a lender whose portfolio includes a pawn-store operato
and a hand-tool maker, said it has shifted its strategy from increasing investments to
preserving capital, and has suspended future dividends. Harvest Capital, which posted a
$3.7 million net operating loss for the quarter, said it might not be able to extend its bank
line of credit that matured on April 30.
“We do have an active dialogue going on, and we’re all hopeful we’ll be able to extend it,”
William Alvarez, Harvest Capital’s chief financial officer, said during the company’s May
13 earnings call. “But again, these are unprecedented times, and everybody is treading
water very cautiously.”
The pandemic marks a major test for these nonbank lenders, many of which were formed
after the last downturn and moved into higher-risk areas of commercial lending that
traditional banks shunned. Credit losses are expected to increase in the coming months,
highlighting the underwriting standards that these development companies used when
the economy was strong, analysts said.
“We haven’t seen underwriting through a full cycle,” said Chelsea Richardson, an analyst
at Fitch Ratings who covers the sector.
Another pressing factor for these lenders is the need to keep up with regulatory leverage
atios, analysts said.
Maintaining a debt-to-equity ratio of below two-to-one is critical for CFOs who want to
keep their financing options open as they move through the downturn, according to Lisa
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Kwasnowski, an analyst who covers the industry for DBRS Morningstar. Anything highe
could put companies in violation of their bank loan or debt agreements, and potentially
take a number of financing options, such as obtaining an additional loan, off the table, she
said.
But staying below the regulatory limit—or below lower targets that BDCs set internally—
could be challenging. BDCs mark their loan books at fair value, meaning the value of thei
loan portfolios can fluctuate. If loan values continue to drop as businesses struggle to
eopen, leverage ratios could tick higher as a result of equity values declining.
That could push more BDCs to raise capital from equity investors, analysts said. And
demand for lenders with a solid understanding of niche markets, and a strong record of
lending to distressed companies, could be strong, Ms. Kwasnowski said.
“There’s a reason why these entities exist, and the strong ones may find ways to benefit,”
she said.
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