Many banks have warned that loan growth is slow. What kind of loan growth are you seeing?
We have seen a general slowdown in our lending markets. We currently focus on the corporate middle market, which we define as loans between $50 million to $200 million in size. The fourth quarter has been unusually slow, which is surprising given the market conditions. Although there is a good deal of liquidity in the market and many companies are flush with cash, we are not seeing much transaction activity. We have, however, seen many borrowers recapitalizing their balance sheets by refinancing their existing debt. Given the general liquidity in the market, we would typically expect to see much more transaction activity among middle-market companies.
What is the competition like for commercial loans?
If a loan is bank eligible, then there is going to be significant competition. For example, many asset-based loans currently have very low yields as a result of increased competition. We are seeing inventory-based or receivables-based loans priced at 150 basis points above LIBOR, and that’s probably a loan that we’d prefer not to do right now. That said, there are areas that are a bit under the radar, and there are some very attractive lending opportunities in those areas.
Where do you see more attractive lending opportunities in a competitive market?
We are seeing some attractive loans to enterprise software companies and in health care. Let me speak for a moment about [lending to software development companies.] Software businesses are no longer the high growth technology businesses that many people think of when they hear software. These are established businesses with many attractive earnings characteristics for lenders. Consider the business model: A software company sells the license for its software to a client. In addition to the license fee, there is an agreement to pay a recurring annual maintenance fee for service and upgrades. The maintenance fee is typically 20 percent of the license fee and the costs associated with that fee are negligible. Regardless of the duration of the maintenance contract, these fees are rarely cancelled because the software typically becomes the operating backbone of that business. Replacing enterprise software is costly and disruptive to the business, so these products typically stay in place for a long time, even as better products may come along. If you’ve ever lived through a software transition, you know how hard it is. Mature software companies can have as much as 60 percent of their revenue derived from maintenance revenue, which is very predictable, durable and financeable. As a lender, we have visibility on those future earnings. We seek out and participate in a number of middle-market loans in that sector.
Where do you see opportunities in health care finance?
We are looking forward to expanding our footprint in the health care arena, focusing on senior housing, assisted living and ambulatory surgery centers. You want to be on the right side of the cost containment curve, as there have been efforts for years to curb the growth in health care spending without compromising quality of care. We’ve seen a number of companies that exhibit those qualities, and think that we will continue to see attractive loans in this area.
There is also a significant real estate component to these businesses that provides some downside protection. Because the real estate cannot typically be repurposed for use other than as a health care facility, the quality and performance of the operator is the key to underwriting health care real estate loans. Moreover, identifying operators with multiple sites and significant scale often results in a stronger credit profile. Larger operators may mitigate the risk from a loan at a single site, and their size allows the business the ability to invest in better systems, operations and management, which often results in a stronger underlying business model.