COVID-19: 3 Real-Time Impacts to Middle Market Lending
Learn how lenders are responding to the threat.
As the COVID-19 outbreak continues to manifest itself in all corners of the financial markets, many current and prospective corporate borrowers are looking for real-time information about how bank and non-bank lenders are identifying and incorporating risks in their review of potential lending opportunities. This desire for information is driven by a flood of interest from borrowers in shoring up in-progress searches, as well as borrowers who have been slow to enter the market and are now worried that lenders may suddenly pull back.
As a data-driven online platform focused on corporate debt search, Cerebro Capital is tracking the impacts for prospective and current clients. While we have not identified a material reduction in risk appetite, we have noted three key impacts of the outbreak that borrowers are likely to face.
1) Demand-side concerns:
While limitations on the movement of people and goods has not been encouraged nor mandated here in the United States, there is strong evidence that many businesses and consumers are “self-quarantining” to various degrees. A quick scan of the news indicates that foot traffic is down in many centers of commerce, demand for travel related services has declined precipitously, and many employers are encouraging employees to work from home if able. As a result, underwriters are scrutinizing downside scenarios and potential impacts on top-line forecasts to ascertain the degree of debt service cushion indicated by a borrower’s projected financials. While many underwriters would expect these effects to be transitory and normalize in time, defaults-- even when cured quickly thereafter-- demand significant time, resources, and attention, creating a situation that lenders would rather avoid altogether.
2) Supply-side concerns:
In the earliest days of the COVID-19 outbreak, much of the focus was on the potential impact to global supply chains. In a world of just-in-time supply practices, small disruptions, particularly at the beginning of a supply chain, can have significant downstream impacts. With this knowledge, many underwriters have sought to better understand the nuances of a prospective borrower’s supply chain, its concentration, and the manner by which working capital is being financed. Supply chains that show susceptibility to disruption can create operating cash flow issues that can impair debt service, either through delays in fulfilling customers or outright loss of customers that seek more reliable service.
3) Bandwidth constraints:
The issues noted above are not isolated to the consideration of new lending opportunities. When potentially systemic impacts to the business cycle present themselves, risk management practices of existing loans are also intensified. As a result, many credit portfolio managers must engage in a comprehensive review of their existing books of business to answer these same questions within their portfolio. These reviews, in turn, create a significant strain on time and resources that limits the bandwidth for the consideration of new opportunities. For transactions in progress, the strain on capacity slows down the underwriting and closing processes. For borrowers facing critical deadlines to refinance, access growth capital, or close an acquisition, these delays represent an increased execution risk and can lead to significant losses.
Now more than ever, it will be imperative for borrowers in the midst of financing processes to be extremely organized, responsive, and well-prepared as lenders adjust their internal processes to rapidly changing market. We expect that as the situation unfolds, lenders will continue to evolve their underwriting criteria and diligence process to better assess the credit risk against COVID-19 impacts and other similar threats.
Cerebro Capital's new approach to credit search:
While there is no way to completely mitigate the impact of an event such as the COVID-19 outbreak, there are processes that can limit downside probabilities. Cerebro’s data-driven debt search process was designed specifically to increase the efficiency and effectiveness of debt search. By matching a client’s unique financial and business characteristics to the underwriting criteria collected from our lenders, Cerebro’s primary objective is to ensure a comprehensive search of the market that identifies and evaluates all potential debt structure which may be available to serve our clients’ financing objectives.