The SEC’s Beef With Shadow Banks Could Be Bad for Some Businessesby
Capital directive would crimp business loans, they say
Firms like Apollo, Ares, THL Credit lobbying for rule reversal
Apollo Global Management has a reputation for buying wounded companies, not lending to them.
UniTek Global Services Inc. was different. In 2013, banks abandoned the Pennsylvania-based hardware installer for Comcast Corp. and DirecTV, pulling a credit line when the company needed it most.
“We had a lot of doors slammed in our face,’’ said Kathleen McCarthy, UniTek’s general counsel. “This company was on the brink of default. We tried every bank but no one had the risk appetite.”
Enter one of Apollo’s lending units. It provided a lifeline to UniTek, which employs 2,100.
Now the U.S. Securities and Exchange Commission is considering a rule that could make so-called shadow banking safer. Nonbanks argue the rule will make it tougher for them to lend to small and mid-size businesses. Small businesses account for more than six out of 10 new private-sector U.S. jobs. But the SEC is wary that business development companies, like the one run by Apollo, will get in trouble by using too much borrowed money to boost returns.
Shadow banks have been picking up the slack since international regulators saddled traditional banks with stricter capital constraints following the 2008 financial crisis. Lending by nonbanks such as BDCs to small and middle-market businesses, which is considered riskier than loans to big corporations, has mushroomed to more than $70 billion, according to the Small Business Investor Alliance.
Debate over the SEC rule, proposed in December, is reaching a crescendo. It could require BDCs, when calculating their level of indebtedness, to count the entire amount of revolving credit lines they offer to businesses, even if the borrowers have only used a fraction.
As it stands now, BDCs count only what borrowers have already accessed from credit lines. Because the new rule adds to BDCs’ level of indebtedness, or leverage, they would have to maintain a bigger cushion against losses, making less money available to lend.
The effect would be higher costs and smaller financing facilities that would harm domestic businesses, according to Brett Palmer, president of the Small Business Investor Alliance, an industry group that funds and advocates for small businesses.
“If the SEC applied the rule as has been interpreted, there are dire consequences for the BDC industry,” said Manuel Henriquez, who runs Hercules Capital Inc., a BDC that works with companies backed by venture capitalists. “There’s an immediate impact on the capital formation of developing companies. They need to know they have access to capital to hire, to invest, to grow.”
Henriquez said he met SEC officials in recent weeks to convince them to reverse course on the rule. Other firms, such as Apollo, THL Credit Inc. and Ares Management, have joined a lobbying effort on the same rule.
Yet, the SEC is right to be concerned about the lending of BDCs, said Rajay Bagaria, a money manager at Wasserstein & Co. in New York, who says he bet against BDCs earlier this year. Revolving credit lines can be tapped by borrowers whenever they want, so the SEC’s rule would more closely reflect reality, he said.
The rule tightening is part of an SEC effort to crack down on the use of derivatives and leverage by investment firms. Last year, SEC Chair Mary Jo White spoke out against proposed legislation that would allow BDCs to double their leverage, among other concessions.
“They’ve taken advantage of this idea of helping small businesses grow and this pitch of ‘give us more money because we are a unique source of capital,’” Bagaria said. “The SEC seems to be saying that they need to protect investors and protect the lenders from themselves.”
The SEC declined to comment.
Bunny for a Bobcat
BDCs pay out most of their earnings as dividends and get tax exemptions. They usually lend to private companies and hold the debt to maturity. Their leverage cannot exceed a debt-to-equity ratio of 1 to 1. The equity typically comes from retail investors.
“The SEC is mistaking a bunny for a bobcat,” said Mike Terwilliger, a money manager at Resource America Inc., which invests in BDCs. “It isn’t taking systemic risk out of the marketplace, but taking responsible, capital-structure lending out of the picture. This is just an overzealous first round of drafting that shouldn’t become the rule of law.”
Mike Stephens agrees. When Ministry Brands, which provides software for churches, asked lenders to fund its growth in 2012, more than 10 turned it down. The company couldn’t convince a bank to extend its credit line beyond $5 million.
Then Ministry Brands was introduced to a BDC run by Ares Management.
Today, the company has expanded its business to a network of 55,000 churches with the help of $400 million in loans made possible through its relationship with Ares.
“The banks thought we were too risky,” said Stephens, the company’s chief financial officer. “When we were introduced to Ares, we didn’t even know this source of capital existed.”