Post-financial crisis, an influx of alternative lending players emerged to accelerate business finance digitization and expand choices for borrowers. In many ways, it was great news for small businesses, whose owners sought ways to obtain a loan in the same digital-native ways they sought financing as individuals, and needed more options as traditional lenders pulled back from the SMB market.
The alternative finance boom impacted middle-market corporate borrowers, too, but in different ways. While access to capital can be the largest barrier to overcome for many small businesses, for the mid-market, many of the biggest challenges occur as a result of so much choice in providers and financing products on the market today.
And the challenges don’t stop after financing has been issued, either. According to Cerebro Capital Founder and CEO Matt Bjonerud, middle-market corporations can struggle to manage the loans they already have, a point of friction likely to ramp up as a result of current market volatility.
In a recent conversation with PYMNTS, Bjonerud noted that optimizing the matchmaking process between middle-market corporate borrowers and lenders means not just making connections based on loan values and risk appetites, but also keeping in mind how the entire lifecycle of a corporate loan is managed, with data-driven processes being key.
While choice is important for any borrower, the influx of players in the corporate lending market following the 2008 financial crisis made it more difficult for mid-market corporates to ensure that they make an appropriate choice of loan product and service provider.
According to Bjonerud, the sheer volume of choice between traditional and alternative providers can be overwhelming, and can make managing loans a challenge for mid-market borrowers.
“One thing that has driven a lot of variants in loan terms in the market over the last 10 years is that after the recession, there was a tremendous expansion of non-bank lenders servicing the middle market,” he said, noting that these alternative players make up about one-third of total mid-market loan volumes in the U.S. today. “It’s the result of having so many more private credit funds and private lenders in the space, offering mezzanine loans, asset loans, cash flow loans and more.”
Bjonerud said there are an estimated 1,500 lenders currently covering the middle-market corporate borrower segment, making it “extremely difficult and time-consuming” for businesses to sift through the choice of lenders, each with unique risk appetites, loan terms and target borrowers.
Finding the right loan product is only part of the middle-market borrowing puzzle. Once financing has been secured, managing existing loans remains a headache for many firms, said Bjonerud.
“Loan agreements can be very complex,” Bjonerud said. “They can be hundreds of pages long, a lot of fine print, and typically there are financial covenants, which essentially are financial tests the banks require to be passed every month or quarter.”
There are also often non-financial covenants, such as restrictions on mergers and acquisitions or other investment activities. Often, these covenants are managed in Excel spreadsheets, if at all, and as a result can be the part of the borrowing process that most trips up mid-market corporates.
When markets are as volatile as they are today, lenders can use even non-financial covenants to restructure debt, meaning mid-market corporates face a greater risk of facing a loan restructuring or being forced to exchange a portion of their debt for equity.
“When there is stress in the economy and crisis like the one we’re in, banks need to find ways to protect their portfolio,” explained Bjonerud. “This results in digging through loan agreements and covenants of borrowers to find any excuse to come back to the table to renegotiate and strike a better deal: take more collateral, or make other changes before things get bad.”
This means a lender can restructure a loan even if a borrower hasn’t missed any payments. Bjonerud recalled one middle-market firm that turned to Cerebro Capital after having a particularly negative experience with a traditional lender, which discovered the borrower has missed a reporting deadline by eight days and used that finding to take control of the borrowing company.
“This is a huge deal,” said Bjonerud, who noted that it’s important for automated and data-driven FinTechs to not only help mid-market firms find loans with the most appropriate terms, but to also support the management of that loan through its lifecycle to prevent such occurrences in a volatile market.
Wielding technology is an important part of middle-market corporates’ ability to overcome some of their biggest borrowing challenges. With pandemic-fueled market instability, many borrowers are likely facing a wakeup call regarding their legacy loan management strategies, which no longer protect them during times of market turmoil.
“Many middle-market firms were caught flat-footed,” said Bjonerud of the current disruption. “They did not have any type of additional revolver or line-of-credit capacity.”
As a result, borrowing behavior could change in the long term. Bjonerud predicted that mid-market firms may begin positing themselves to ensure they have access to more capital than they need. At the same time, data-driven technologies will enable borrowers and lenders to more quickly connect and more effectively mitigate risk.
The current climate is also fueling the formation of a mid-market lending ecosystem to better support participants and help borrowers not only understand what’s happening in the economy, but also to understand how those events impact their particular businesses.
“People today don’t always have good processes in place to reach out to lender networks and evaluate how the markets are changing,” said Bjonerud. “They can see these things happening in the news, but they have no idea what that means for their specific company. They’ll start using data-driven processes and technology to obtain a better understanding of the market.”