By Kristin Broughton
A slow economic recovery could test the strength of nonbank
lenders, forcing many to raise capital if the businesses that have
borrowed 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 by 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 borrowers 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 borrowers 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 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 operator 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 ratios, 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 Kwasnowski, an
analyst who covers the industry for DBRS Morningstar. Anything
higher 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 their loan
portfolios can fluctuate. If loan values continue to drop as
businesses struggle to reopen, 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.
Write to Kristin Broughton at Kristin.Broughton@wsj.com
(END) Dow Jones Newswires
May 31, 2020 09:14 ET (13:14 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.