NP Connects brings together leaders from a variety of backgrounds to share real-time perspectives on the coronavirus (COVID-19) pandemic. Below are highlights from our June 25, 2020 conversation.
As in past weeks, Morgan Nighan answered questions related to the CARES Act and the PPP.
The remainder of the program focused on the Main Street Lending Program (MSLP), accessing credit and the private credit markets. In our conversation, guests Oliver Smith, CEO of O. & Co. and member of the New England Advisory Board of the Federal Reserve Bank of Boston; Marc Pressler, a Managing Director with Monroe Credit Advisors; and Dan Strzalka, a partner with Nixon Peabody LLP, discussed what business owners need to know about the private credit markets, current market terms, and the fine print in loan agreements.
Regarding the Paycheck Protection Program (PPP):
- Many borrowers are trying to decide whether to choose the eight-week or 24-week forgiveness window for PPP. Before deciding, give thought to whether salary reductions or layoff are forthcoming as they will carry through the window. Thus, you may get more forgiveness and greater flexibility if you take the shorter period. Model your decision using the calculators provided by the SBA.
- There are now three loan forgiveness application forms, including a long form and easy form, which may be preferred if you have no salary reductions. Plus, your bank may have its own form too. Look on the Treasury website for the current forms.
- If your business is denied forgiveness or if you receive follow-up correspondences seeking clarification and documentation from your bank, the SBA, or another government agency, then you should get counsel and do not liaise or respond directly.
Regarding the Main Street Lending Program (MSLP) and the Federal Reserve:
- The Boston Fed, which is leading the program, consulted with banks across the U.S. and has extended terms, raised limits, and made other adjustments to ensure a smooth process, broad access, and equal access to this stimulus program. Under the MSLP, banks will retain some risk, now limited to 5% of each loan. However, banks are concerned that the permitted deferral of P&I payments, the low interest rate environment, and economic uncertainty will lead to increased losses, requiring increased loan loss reserve, all contributing to a slow start of the MSLP.
- The Fed is watching unemployment numbers across the country and the challenge is trying to figure the real numbers given the 5% error margin.
- Mortgages are a big concern too, recognizing that 90% of U.S. mortgages are in forbearance. The effects on the real estate and banking industries remain to be seen.
- Looking at the two hardest hit sectors, New England is fairing worse than the rest of the country when comparing employment growth in April 2019 to April 2020:
- In leisure and hospitality, New England saw -64% growth compared to -43% for the U.S.
- In construction, New England saw -28% growth compared to -11% for the U.S.
Regarding access to credit and the private credit market:
Bank lenders are approaching credit with a defensive risk mindset, leaving banks reticent to underwrite new opportunities. However, there remains a robust private credit market, but it is markedly different from traditional bank lending.
Private lenders’ underwriting committees are nimbler than banks’ and can be more creative in structuring. The biggest difference is the diligence process, with private lenders’ processes more similar to what is involved in selling a business, especially since they will seek equity or warrants.
- The cost of private credit is significantly different too. Banks seek LIBOR+150-200bps. Private credit lenders target mid- to high-teen returns given the higher risk they assume. Recognizing that companies are unable to generate enough cash flow to support those interest payments, private credit lenders use success fees and equity kickers to generate the added return.
- Underwriting scrutiny is higher in private credit. For instance, you will be asked about demand characteristics of your goods or services and the sustainability of demand today and going forward as they look to measure your sales pipeline and its impact on your ability to grow.
- Loan documentation will look similar but there will likely be other creditors involved, thus intercreditor and triparty agreements will add time and cost to the loan closing.
- Loan documentation trends include a concern among all lenders with cash leakage, i.e., distributions, principal and interest deferment (usually as a response to the senior lender offering a similar concession conditioned on the subordinate private credit lender agreeing to do the same), and the inclusion of anti-hoarding provisions to prevent borrowers from drawing down their full lines.
- It is a lender’s market so solicit multiple bids and compare the terms—they will vary widely. Utilize a professional advisor to run the process for you to find the best lender for your needs.