Lending to small U.S. businesses is making a comeback on Wall Street, with 12 investment firms arranging $1.38 billion of initial stock offerings to funnel cash to the nation’s biggest job creators.
Oaktree Capital Management LP, Crescent Capital Group LP and Churchill Financial Holdings LLC are forming so-called business development corporations, which typically lend to businesses with annual revenue of less than $500 million, according to filings with the U.S. Securities & Exchange Commission. The wave of BDCs is the largest in at least seven years, based on data from Ipreo Holdings LLC in New York.
While the Federal Reserve has flooded the financial system with trillions of dollars over the past three years, obtaining credit remains a challenge for many borrowers that don’t have access to capital markets. A lack of credit is also hindering the labor-market recovery, with unemployment hovering above 9 percent. Companies with fewer than 50 employees accounted for more than half of new jobs created in the past decade.
“Capital needs to start getting down to the middle market and then below to the innovators,” said Leon Wagner, who co-founded GoldenTree Asset Management LP, a New York hedge fund focused on debt markets. “That’s what America needs to get deployed into the economy for significant growth to occur.”
Small businesses have had fewer financing options since institutions such as CIT Group Inc. and CapitalSource Inc. cut lending following the 2008 bankruptcy of Lehman Brothers Holdings Inc. Companies with annual earnings before interest, taxes, depreciation and amortization of $50 million or less obtained $7.25 billion of syndicated loans in the U.S. this year, while banks and investors supplied larger borrowers with $229.4 billion, according to Standard & Poor’s Leveraged Commentary and Data.
Banks, trying to rebuild following $2 trillion of writedowns and losses since the start of 2007, continue to favor government and related bonds to making loans. Holdings of such debt has risen 44 percent to $1.68 trillion since October 2008, while commercial and industrial loans outstanding have fallen 31 percent to $1.26 trillion, Fed data show.
Those that can get loans paid 1.79 percentage points more in interest than large corporations in the first quarter, according to UBS AG, which is an attraction to Oaktree and the other debt investment firms faced with record-low yields on company bonds.
Backbone of Economy
Small businesses are the backbone of the economy. Companies with fewer than 50 employees accounted for 64 percent of private-sector jobs created in 2006, according to Automatic Data Processing Inc. This year, it’s 48 percent.
Slow job growth poses a challenge to President Barack Obama, whose re-election prospects may hinge on bringing down unemployment. The jobless rate rose to 9.1 percent in May, and is up from 5.6 percent in mid-2008. Former Massachusetts Governor Mitt Romney, who announced his candidacy for the Republican nomination this week, said June 3 in New Hampshire that the number of people out of work is “simply inexcusable.”
Small businesses have struggled to obtain credit since business development funds were hit when credit markets seized up starting in 2008. CIT, the New York-based business lender, filed for bankruptcy in November 2009.
CapitalSource, the Chevy Chase, Maryland-based lender to small businesses, reduced total loans to $6 billion in the year ended in December, from $8.1 billion in 2009 and $9.3 billion in the prior year, according to data compiled by Bloomberg.
Allied Capital Corp., one of the oldest BDCs, sold itself to Ares Capital Corp. in 2010, after its auditors said they had “doubt about the company’s ability to continue as a going concern.” Apollo Investment Corp. fell 92 percent to a low of $2.05 on March 20, 2009 from a high of $24.13 on June 18, 2007. The company has since risen to $10.65 in Nasdaq Stock Market trading.
“I like the BDCs as a whole,” said Michael Turner, a commercial finance analyst at Compass Point Research & Trading LLC in Washington. “The thing I’m always mindful of is, are we in the middle of a big bubble?”
While recent reports on manufacturing and jobs indicate the U.S. recovery is slowing, the median estimate of 72 economists surveyed by Bloomberg is still for growth of 2.7 percent in 2011.
That is giving debt investors the confidence to target small companies as they seek bigger returns than those offered on high-yield, high-risk bonds and loans. The only other period in which a comparable number of BDCs were being created was in 2004, when Apollo Investment and Ares were founded.
The Fed has flooded the economy with cash by expanding its balance sheet to $2.79 trillion from $892 billion in mid-2008. The move has prodded investors into riskier assets, helping to drive yields on junk bonds down to a record low of 7.19 percent last month from more than 20 percent in March 2009, Bank of America Merrill Lynch & Co. indexes show. Junk-rated securities are graded below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.
“It’s hard to find yield and these are yield-producing instruments,” John Hecht, an analyst at JMP Securities LLC in San Francisco, said in reference to small-business loans.
Firms starting a BDC are typically able to double the amount of money they raise by selling stock through borrowing an equal sum. Average annual yields on BDCs range from 8 percent to 10 percent, Hecht said.
There are 32 publicly traded BDCs, with the biggest being Ares and American Capital Ltd. They pay little or no corporate income tax in return for distributing at least 90 percent of taxable income to shareholders.
Los Angeles-based Crescent, the leveraged-finance investment firm co-founded by Mark Attanasio, the owner of the Milwaukee Brewers baseball team, is planning to raise $175 million to lend primarily to companies with yearly Ebitda of less than $40 million, according to documents filed with the SEC on March 10.
Oaktree, which oversees $85 billion and is seeking $125 million through its IPO, is raising a fund to buy senior secured loans, mezzanine debt, subordinated debt and equities of companies with annual revenue of $25 million to $1 billion, according to a May 11 filing by the Los Angeles-based firm.
Churchill’s BDC, which aims to raise $150 million of equity, will target first-lien senior secured loans made to companies controlled by private equity firms with Ebitda of $5 million to $50 million, according to an April 5 filing. The firm has offices in New York, Chicago and Minneapolis.
Howard Marks, Oaktree’s chairman, and Kenneth Kencel, Churchill’s president and chief executive officer, declined to comment because the funds are in a quiet period before the IPOs. Bill Mendel, a spokesman for Crescent, also declined to comment, citing the same reason.
Financing for small companies may heat up as private-equity firms invest the more than $300 billion they have raised over the next three-to-five years, a portion of which may fund purchases of business with lower annual revenue, according to a JPMorgan Chase & Co. report published May 31.
While Fed data show commercial and industrial loans are down from the peak in October 2008, they are up 4.7 percent from the post-crisis low of $1.21 trillion in September.
“Community banks and the large banks have really cut back the supply of capital they put in the cash-flow based loan market,” Hecht said. “As companies feel better about their wherewithal, they start accessing credit.”