Posted on: March 29th, 2018
The US debt markets are the envy the world over. We have breadth and depth to our markets unmatched by other advanced economies.
The US debt markets are constantly innovating, providing borrowers increasingly bespoke and flexible structures, especially companies with non-traditional credit profiles.
The predominance of asset light companies, rich in margins yet short on hard assets, has given rise to alternative lending approaches such as cash flow lending to meet the growing demand for growth capital.
Cash flow lending as a discipline has been coopted by various middle market lending sectors, each with unique twist. Some lenders prefer cash flow deals backed by asset collateral.
Others prefer providing 100% one stop cash flow financing where they are both senior and subordinated lender, in a control position. Yet others, prefer loans to equity sponsored companies while others prefer yield attractive, independently sponsored deals.
The central underwriting theory revolves around multiple of EBITDA, but the execution of the credit philosophy varies from sector to sector. This results in an alphabet soup taxonomy of credit criteria across the middle market, especially for companies with < $10 million in EBITDA.
While leverage points generally persist across all sectors, there are bright lines of differentiation where one sector outshines another. When searching for debt capital, it pays to tap multiple debt channels, a discipline called cross sourcing, to find those outlier attributes whether it is quantum, flexibility, leverage or pricing.
When you reach across channels – Bank, BDC, Mezzanine or Private debt fund, you are able to get a holistic view of the market and find the optimal loan structure for your particular need. Here are 4 reasons why cross sourcing across credit channels works:
- Newer channels are more fertile channels– more recently evolved credit channels are usually more eager to put money out. The lack of a problems in a portfolio frees them to be more optimistic. Usually they have a volume target for the year and have to find deals to close.
- Credit Cycle Dynamics – origination intensity is often reflective of where the lender perceives the credit cycle. If the cycle is still up and losses are low, they will be more aggressive. Each lending sector has a slightly different interpretation of the cycle, so a broad reach is likely to gather more favorable term sheets.
- Credit Benchmarks are at play – if the lender is a public company, they may benchmark their portfolio credit statistics against public companies such as high yield credits. This is a more liberal lending standard than typical middle market lenders, and works to the benefit of the borrower in getting a more favorable term sheet.
- Each lending sector has favorite industries – one sector’s loathed industry is another sector’s loved industry. While there are general rules as to industry attractiveness, sometimes you can get a deal done with a bank at a high leverage multiple, simply because they have been successful in that industry.