Trends in the Commercial Loan Market
Corporate & Finance Alert
December 9, 2008
It has been widely reported that the credit crisis has greatly reduced the volume and types of loans being made by banks and other financial institutions. Two recent surveys, one of senior loan officers, and the other of CFOs and other finance executives, confirm this fact. This article highlights recent changes in lending practices and provides some guidance on what to expect in the commercial loan market.
The October 2008 Senior Loan Officer Opinion Survey on Bank Lending Practices conducted by the Federal Reserve Board addressed changes in the supply of, and demand for, bank loans to businesses over the past three months. This survey found that a large percentage of both domestic and foreign lenders continued to tighten their lending standards and terms over the previous three months. Approximately 85% of domestic banks reported tightened lending standards to large and middle market firms over the past three months. This is up from 60% in the July survey. Similarly, approximately 75% of these banks reported tightening lending standards to small firms over the same period. In addition, almost all domestic banks reported increased costs of credit lines, increased spreads of loan rates over their cost of funds and increased premiums charged on riskier loans. A large majority of banks reduced both the maximum size and the maximum maturity of loans for lines of credit and approximately three-fourths of the respondents tightened covenants on their loans.
Similar results were found in the survey of 115 CFOs and other top-level finance executives who responded to a CFO survey conducted in early November. A majority surveyed reported increased costs to borrow and the inability and inflexibility of banks to make lending decisions and commitments. 84% stated that lending institutions will require stricter debt covenants and other business terms in the future which is consistent with the results of the loan officers’ survey discussed above. The financial executives surveyed are not optimistic that the credit crisis will abate any time soon. 32% reported relations with lenders will not reach normalcy until the fourth quarter of 2009 or later; 4% believe normalcy will never return, and 15% thought it would occur by the third quarter of 2009.
Many lenders who are willing to make loans, in particular regional and community banks and finance companies, report their volume of lending is down because many businesses, particularly smaller businesses, reflect diminished demand for credit. Many of these potential borrowers are staying on the sidelines to determine what develops with the economy. They are not willing to take a chance by expanding their business during an economic slowdown. For these potential borrowers, fear has seized the borrowing market discouraging small business owners who might otherwise elect to take on new debt.
For those lenders and borrowers who do wish to proceed with a lending transaction in this environment, the question is what can they expect. As stated above, regional and community banks and finance companies are continuing to make loans, as compared to national commercial banks. Most of these institutions did not participate in the sub-prime mortgage market and have fewer risky loans on their books. Venture capital firms and mezzanine funds are still providing capital, however, pricing, equity, and security requirements have increased.
For those borrowers looking for financing, they will find that there are much tighter lending standards and terms including higher price and non-price terms. Stricter financial covenants, higher interest rates and fewer interest rate options are typical. The decision-making process by lenders in committing to a loan has gotten much more drawn out and requires more extensive underwriting and due diligence by lenders. Lenders are insisting on detailed business plans from profitable and experienced businesses which must demonstrate projected positive cash flow and ability to meet debt service. Most lenders will only make revolving asset backed or collateral based loans and are reluctant to consider cash flow based loans. Typically real estate collateral, if available, is required as well as personal guarantees. Lenders are also requiring financial statements on a more periodic basis, often monthly or quarterly as opposed to semi-annually or annually, and will condition the loan on receiving a full banking relationship with the customer, including all deposit accounts and other treasury management services. Lastly, loan commitment letters are less detailed, expressly nonbinding and subject to more conditions precedent to the lender’s obligation to close the loan or make advances under revolving credit facilities. Loan commitments for M&A financing will likely contain express disclaimers of third party beneficiary rights or the ability of the borrower to waive material adverse change events on behalf of the lender.
Companies in the market for financing must be aware of this new lending environment and act accordingly. Borrower must be willing to look beyond their traditional lending sources and loan structures to achieve their financing goals. Financings will take longer to complete and will be more expensive but can be accomplished.