BANK LENDING UPDATE
October 2009

Non-Bank Credit Market
Liquidity in the non-bank credit market continues to improve, helping to offset the capital-constrained bank credit market. Through October, the corporate bond market has outpaced the syndicated loan market for the first time ever, with record issuances reaching close to $950 billion year-to-date, 90 percent higher than the same period in 2008. October year-to-date issuances of syndicated loans have slumped to $95 billion from $225 billion, down by 58 percent from a year earlier.

Non-investment grade bond issuances have surged, largely from the need to refinance bank debt or secure working capital. Looking ahead, it is expected that refinancing will be the primary cause of new issuances, especially in the non-investment grade market.

Spreads on corporate bonds have declined 50 percent since January 2009 (refer to figure 1). In September, the S&P non-investment grade composite spread was 823 basis points, well off the highs of 1,700-plus in late 2008, but 440 basis points above its historical average. Defaults of junk debt and continuing credit downgrades may keep rates elevated for the foreseeable future. With these bonds yielding between 11 percent and 12 percent on average, borrowers are paying an extra four to five percentage points above traditional loan costs for the ability to refinance and extend maturities.

Bank Credit Market
In recent years, regulated lenders were the source of approximately 60 percent of all credit in the U.S. Banks continue to curtail lending due to their significant exposure to Commercial Real Estate (CRE) loan portfolios. Complicating the situation, banks continue to face accounting rule changes and capital requirements next year that could further restrict their ability to make loans. According to weekly figures from the Federal Reserve, bank loans to business have dropped at a 24 percent annualized pace.

The market for securitization has collapsed, (refer to figure 2), except for those that have been issued by government-sponsored agencies or are being bought by the Federal Reserve and the Treasury. Securities backed by home mortgages have dramatically dropped from $744 billion in 2005, at the peak of the housing boom, to $8 billion during the first half of this year. The market for securities backed by commercial real estate loans is in worse shape. No new securities of this type have been issued in two years and an estimated $50 billion of securitized commercial property loans are due to mature in the next year. If refinancing of these maturing real estate securities does not occur, a round of new losses will occur at many banks. The majority of new lending by banks today is asset-based loans fully secured by accounts receivables, inventory, net orderly liquidation value of plant and equipment. For bank lending to revive beyond asset-based loans, the syndications market described above must begin to function again.

Conclusions:
For companies dealing with tight bank covenants, principal amortization and declining collateral value, bond financing may offer some relief. Bonds offer issuers more manageable financial covenants that tend to be incurrence-based (measured at an event, such as an acquisition) rather than maintenance-based (continuously measured), bonds have longer maturities than bank loans (generally 7 to 10 years) and in most cases are a fixed interest rate. Bond financing usually has 2 to 3 years of no-call protection for the lenders and a redemption premium when the no-call expires.

As bank lending remains tight, companies at the lower end of the credit spectrum who traditionally relied on bank financing are accessing the public and private corporate bond markets. This provides them with greater financial flexibility than is available from banks and pushes out their debt maturities, allowing them to weather the current economic environment with a more permanent capital base. For companies able to access the bond market, this could prove a better alternative than relying solely on bank credit availability. For companies which because of size or credit profile have historically relied on the bank credit market, GCP recommends considering accessing the non-regulated senior and subordinated debt market. The non-regulated lenders/investors, primarily insurance companies, specialty finance companies and mezzanine lenders, have available committed capital to refinance or extend debt maturities.

Growth Capital Partners would like to emphasize its continued commitment to assist entrepreneurs and middle-market companies in evaluating any financing/renewal needs during these turbulent times. We are committed to building long term, mutually beneficial relationships with our clients. Please feel free to give us a call if we can be of assistance in evaluating liquidity and capital market alternatives.

Growth Capital Partners is a privately owned advisory firm that focuses exclusively on providing corporate finance and investment banking services to middle-market companies. Since 1992, we have completed in excess of 250 transactions, raised more that $1 billion of institutional capital through private placements and completed M&A transactions with an aggregate value in excess of $4.0 billion. We have attracted an outstanding team of senior and junior professionals who are client-focused. Our professionals are creative, flexible and believe that our clients come first.

We have also attached supporting data related to interest rate trends and middle-market lending.

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