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07.29.20

NP Connects: Liquidity options for middle market companies

BY , Philip B. Taub

NP Connects brings together leaders from a variety of backgrounds to share real-time perspectives on the coronavirus (COVID-19) pandemic.

Our July 23, 2020 panel included Morgan Nighan, Partner at Nixon Peabody; Dan Head, Senior Vice President in the Corporate Advisory & Banking group of Brown Brothers; and Sheldon Hanau, Partner and the Chief Strategy Officer (CSO) of Proficio Capital Partners.

Paycheck Protection Program (PPP) update:

  • With demand for PPP loans abating, borrowers are looking to apply for loan forgiveness via a two-step process. First, the lending bank must approve the application. Second, the Small Business Administration (SBA) will review the application and approve or reject. For loans under $2 million, most commercial banks are looking to fast-track the application and approve them within ten days. The SBA has 60 days to review. Until now, the SBA has not made any determination regarding a borrower’s eligibility. During the forgiveness phase, we expect to see companies’ forgiveness applications rejected as having been ineligible to receive the loan in the first place.
  • Borrowers may be well served to submit their forgiveness applications early if their PPP loan is spent, especially if the borrower is looking at making staffing changes. The data, as of the application date, applies. Postpone any layoffs until you've applied. Any decisions made after submitting the application do not apply.
  • It is unclear how the SBA will handle borrowers that received PPP loans and now look to sell their company. There is no risk if a PPP loan is forgiven before a change in control is recorded. It becomes complicated when forgiveness hasn't occurred. For other SBA loans, the SBA must approve any change of control. The SBA has not said it has this approval authority for PPP loans, yet some bank lenders say the SBA will. Traditional loan documents note a change of control results in an event of default. Again, the PPP loans do not state this, but it is a risk. Consequently, many deals are requiring payoff of loan as condition of deal. There are some insurance products available to limit the risk of tax consequences.

Private investors thinking about the market:

  • The economy has been ambushed, and a v-shaped recovery is unlikely, with the gross domestic product (GDP) projected to decline 15% and unemployment at 11%. Recent mobility data indicate a stagnating economy, initial jobless claims are increasing, and continuing jobless claims remain high.
  • The various stimulus packages softened the financial impact of the pandemic but masked the impact too. The negative, long-term impacts of this stimulus are high, with the U.S. dollar likely weakening. However, there is little evidence of inflation on the horizon.
  • The traditional asset allocation of 60% stocks and 40% bonds may not serve investors well in the future with the ten year U.S. Treasury yielding 0.4%. The old guide means 40% of your portfolio is yielding 40 basis points. Investors are not getting paid to hold fixed-income assets anymore. Thus, family offices seek uncorrelated assets that can serve as a proxy for fixed income.
  • There is little consensus on holding gold. Some see it as a currency, traded globally and, with limited supply, a hedge against inflation. Others see it as a non-income generating asset with a cost to hold it. Some families hold it at 20% of their portfolio today, while others advocate hedging long-term inflation through a higher equity allocation.
  • Families are talking about taxes, expecting they will increase in the near future as a secondary derivative of the stimulus.
  • Owners of privately held businesses are looking to move transactions forward quickly, ideally within the first 90 days of next year, as they expect income and capital gains rates to increase.
  • Planning for future generations is a common conversation, using generation-skipping trusts and insurance to manage taxes.
  • Emerging markets have handled COVID-19 better than developed markets. Given their lower fiscal debt, family offices are thinking about increasing allocation to these economies.

Liquidity in the market:

  • The Federal Reserve created significant liquidity. Corporate bond issuance of $1 trillion came to market for investment-grade credit as a result of the Fed backstop. This allowed borrowers to increase their liquidity. Going forward, liquidity may disappear, but today strategic investors are flush with cash for acquisitions.
  • Banks are increasing loan loss reserves and loan standards, and application processes appear to be tightening. Today risk for leverage buyout (LBO) transactions has shifted to direct lender markets, away from banks. Direct lenders that have developed relationships with private equity funds are seeing more deal activity than commercial banks.
  • Direct lenders are a primary source of senior secured debt. Until recently, those structures have been very borrower-friendly. Today, underwriting is bifurcating between known and unknown borrowers. Loans to fund tuck-in acquisitions are easier than new platform deals, with restrictions on distributions and prepayments.

Tags: NP Connects

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Author

Christopher P. Keefe

Partner

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Author

Philip B. Taub

Partner

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