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Lending Where Banks Fear to Tread

Nonbank lenders and other sources of private capital will often provide financing to small and midsize companies when banks won’t.

There have always been lenders that play in the places where regulated financial institutions fear to tread. When leveraged buyouts took off prior to the financial crisis, structured vehicles provided the capital, not banks. Now that lending to corporations is back in vogue, nonbank capital providers are again underwriting loans that banks can’t or won’t. Specifically, they are providing capital to middle-market and small companies that banks’ credit committees flag as too risky.

“We have found that banks are simply not providing capital or only providing it at the most senior levels of the capital structure, and don’t have the structuring flexibility or desire to provide more services beyond capital,” says Peter Seidenberg, CFO of MVC Capital, a business development firm that makes private-equity and debt investments.

Below the bulge-bracket banks like JPMorgan Chase and Wells Fargo and second-tier players like PNC and SunTrust, “the ability to lend on a collateralized basis falls off a cliff,” says Darren Latimer, chief executive of Gibraltar Business Capital, a business development company. “There are a lot of local and small banks that don’t do it well, come in and out of the space and don’t hire the right professionals.”

Although banks have grown their commercial and industrial loan books aggressively in the past year and have eased loan terms to large companies, they are still conservative with their capital in other areas. Jeff Pfeffer, managing partner of CapX, a specialty finance company, says a private-equity manager recently called him about financing some acquisitions. “He said banks are favoring certain structures and are not as open or aggressive lending to certain industries,” says Pfeffer.

Regulatory capital rules are also weighing on banks, making it particularly difficult to finance unrated or highly leveraged credits, or businesses with hiccups in their financial performance.

Capital for “Positive Things”

Private capital providers are lending especially to companies those with less than $100 million in revenue that don’t have access to the public debt markets. Such firms are often overlooked by traditional lenders and investment banks.

Gibraltar’s Latimer, for example, says he is looking for companies that need capital for “positive things,” such as investments in inventory and technology, as opposed to “bad uses,” like paying judgments and liens or payroll taxes. CapX’s Pfeffer says his business development company focuses on growth- and liquidity-driven capital needs, “where are there are one or two irregularities [with the company], something that gives banks pause.” Those “irregularities” could be a severely constrained balance sheet or recent earnings losses or cash-flow troubles.

Senior and subordinated debt, mezzanine loans, equipment and buyout financing, asset-based loans — there are a host of ways these alternative lenders supply companies with capital. They also often invest in equity alongside a debt financing. They can lend to less-than-ideal credits for a number of reasons, not least because these transactions often have downside protection from being secured by the borrower’s assets or receivables. They also earn high risk-adjusted rates of returns for investors, in part because they charge higher interest rates than banks and have unique business models.

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