Sizing Up the Post-COVID Lending Landscape
The pandemic has catapulted companies into uncharted territory. Today, getting a loan in the post-COVID economy can mean navigating a challenging and quickly shifting landscape.
Lenders across the board are tightening their standards—reducing loan amounts and increasing collateral requirements. They’re giving preferential treatment to businesses with strong, predictable cash flows in stable industries. Banks are also bracing for loan defaults, which will turn more borrowers onto non-bank lenders. For these reasons, the exact loan and terms you want might not be as attainable as in the past.
Middle market businesses are still among the most resilient businesses to navigate the pandemic, with 2% growth expected in the next 12 months. Those confident in their ability to get capital foresee growth of 6%, according to the Q2 2020 Middle Market Indicator.
Cerebro has fielded $3.2 billion in Q2 loan requests from more than 1,000 middle market companies. As we help corporate borrowers assess their best loan options post-COVID, here’s what we’re telling them to look out for.
Landing a Main Street loan
The federal government has taken generous steps to bridge middle market borrowers through the economic uncertainty. The $600 billion Main Street Lending Program was launched in Q2 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. These loan types have generated a high level of borrower interest—Cerebro has received thousands of inquiries—but lenders have been slow to adopt the program.
Main Street loans really didn’t get going until July, when the Federal Reserve began to purchase 95% participations in eligible loans. These five-year loans have a floating rate of LIBOR + 3%, with principal payments deferred for two years and interest payments deferred for one year.
“Eligibility for Main Street loans isn’t a sure bet. There’s a disconnect between the program intentions and lender standards,” says Allan Smallwood, Sr. Director, Capital Markets, at Cerebro Capital.
The program has recommended criteria for lender participation, but lenders are not required to participate nor approve all loan requests. For instance, based on government terms, businesses might assume they can borrow up to 6x EBITDA, but Cerebro is seeing lenders show interest in loans only up to 4.2x leverage.
With Main Street loans, businesses must have strong cash flows and positive 2019 EBITDA, which, depending on how they chose to operate their business in the preceding years, may disqualify them. Lenders can originate new loans, but are being selective and only doing so for companies that align with their portfolios’ risk profile once MSLP has run its course, Smallwood added.
Take the conventional route
Other loan structures—such as conventional or SBA loans—may be better for your business.
Conventional cash-flow-based loans, which have shorter terms and interest rates of 4% to 8%, have similar cash-flow requirements as Main Street loans. The amount you can get is dependent upon EBITDA—and you’ll need to provide full collateral support if EBITDA is less than $10 million. The cash flow to debt ratio also must be below 3x.
Asset-backed loans might be a better fit if your EBITDA margins are thin or volatile. Since the pandemic, lenders have raised their collateral requirement by 10%. ABL interest rates are comparable to cash-flow loans—3% to 7%. The debt service coverage ratio must be 1.25x EBITDA to ensure you can cover your obligations. These loans work well for retailers, manufacturers and commodities-based companies.
For smaller loans between $5 million and $25 million, the Small Business Administration’s 7(a) and SBA 504 both have low origination fees and longer terms of up to 10 years. The interest rate is low, around 8%. Still, borrowers need a personal guarantee—and often fixed collateral is requested by lenders.
Go wide with a non-bank lender
The good news is that the universe of options is not limited to the bank and government loans. For example, private debt has become an excellent way to access the capital you need. Assets under management (AUM) have grown consistently each year and, as of June 2019, reached a record $812 billion. Over 4,100 investors now make allocations to the asset class.
You may be able to access private capital for any deal size over $5 million with a non-bank lender. These include asset-based lenders, mezzanine funds, venture debt lenders, private debt funds, small business investment companies (SBICs) and business development companies (BDCs).
Non-bank lenders have plenty of capital to deploy and aren’t burdened by regulation. As such, requirements are easier and more relaxed for borrowers that don’t have reliable financial projections or are uncertain about post-COVID reopening timelines.
Alternative lenders place less emphasis on collateral and personal guarantees as long as your cash flow is strong enough. Unlike Main Street loans designated for operations and payroll, non-bank proceeds can be used for M&A and dividend financing.
Still, a non-bank lender is looking for a positive risk/return opportunity for its investors. They’re interested in sponsor-backed companies or those with strong valuation upside. These lenders usually require EBITDA of at least $5 million pre- and post-COVID. Interest rates range from 8% to 15% with terms of three to five years. Some loans have interest-only structures.
Don’t forfeit your loan chances
As you weigh your post-COVID path, the time to start applying for loans is now. You don’t want to get left out in the cold when certain funding runs out. “Main Street loans may end up being delayed, but you should evaluate them soon, especially if you have a loan maturing in less than 12 months,” Smallwood says.
For longer term loans, do some scenario planning around your balance sheet. Identify opportunities to increase cash flow and assets so you can make your business more attractive to a wider pool of lenders.
Even with all these opportunities, some middle market companies are being left out, such as those severely impacted by COVID-19, like hotels, restaurants and retailers. Some companies are too big for SBA due to loan size but too small to attract a non-bank loan. But that doesn't mean that all hope is lost.
Cerebro can help middle market businesses evaluate all loan options. Our platform helps CFOs and business leaders leverage the power of 650 banks and non-bank lenders and provides access to our expert Capital Markets team. You can also use tools such as our Debt Capacity Calculator, complimentary Loan Assessment survey and Compliance Navigator.
The road to post-COVID recovery might be a long one, but the right corporate loan will make the journey a less bumpy one. For a more in-depth look at the post-COVID lending environment, tune into our recent webinar.
 The National Center for the Middle Market, Middle Market Indicator Q2 2020
 2020 Prequin Global Private Debt Report