The Secured Lender
Specialty Lending Expertise Offers A Path To High Performance In Today’s Lending Market
Michael C. Slocum
The competitive landscape for commercial and industrial lending is a challenging one, and financial institutions are working to find strategic approaches to address these challenges. Specialization and a national footprint are two keys to maintaining an edge as the abundance of capital attracts new players to the market.
The competitive landscape for making commercial and industrial loans is a challenging one. The low-interest rate environment of recent years, coupled with the overabundance of investment capital (from banks and non-banks alike), has become a long-term feature of the marketplace. This environment has resulted in a relative shift in bargaining power from lenders to borrowers in the middle market.
One of the oft-cited consequences of this shift is the high level of issuance of so-called “covenant-lite” leveraged loans, which lack many of the standard early warning trip-wires (in the form of financial maintenance covenants) that lenders would typically utilize. Standard & Poor’s Leveraged Commentary and Data unit reported that covenant-lite loans totaling approximately $240 billion were issued in 2014. This far exceeded the 2007 peak of $96.6 billion prior to the financial crisis. In addition, covenant-lite loans made up approximately 60% of total institutional leverage loan issuance in 2014.
Building specialties, growing nationally
Commercial lenders are working to find strategic approaches to address these challenges. For example, we identify large, underserved markets and bring to bear a national origination team focused on specific sectors, all guided by a “credit first” approach. Specialization is the key — provide value to customers by understanding the nuances of a sector well, and loans in those specialized verticals will lead to better credit outcomes for both lender and borrower — a “win/win,” if you will. Moreover, in an increasingly competitive lending environment, the ability of specialty businesses to demonstrate deep expertise in focused sectors to borrowers is a key differentiator.
A specialty lending platform that is national in scope is equally important, as it provides a more comprehensive picture of competitive structures, subtle changes in market conditions and pricing than a strictly regional presence. As an example, if you put pins in a map of our customer locations, you will see small- and intermediate-sized cities throughout the country, in addition to major metropolitan areas. This national scope and reach dramatically increases the funnel of transactions, allowing a lender to choose its customers carefully.
Forming a specialty platform is a huge challenge – the task requires an investment in credit, underwriting and portfolio management personnel. Many firms claim to focus on several sectors, but it’s important to determine if they “live and breathe” the sector, or if they are simply calling themselves specialists to gain access to deal flow.
Healthcare lending provides a useful example of how companies can leverage specialized knowledge to create a competitive advantage in the marketplace. Lending in the healthcare space is particularly challenging; it requires navigating a framework of federal and state regulations, and managing pay orders can be difficult, as providers deal with Medicare, Medicaid, and commercial and private insurers. Given its complexities, the term sheet for a healthcare company is significantly different and more detailed than one drawn up to finance a manufacturing company’s accounts receivable.
Lenders who build long-term relationships with clients understand the importance of seeking out companies that have strong management teams operating in their specialties. Successful lenders also look for companies that have reached an inflection point in their life cycles – whether they are making an acquisition, expanding into new geographies or rolling out a new service or product, these companies need a strong financing partner with the industry knowledge and lending expertise they need to reach their ambitious goals.
Holding the line on credit standards
Major players in C&I lending keep a sharp eye on the impact of the current wave of credit availability on lending standards. The regulatory environment is ever evolving, and I believe that we are in the early stages of a regulatory response to the liquid environment and this response will only intensify over time. It is essential to maintain perspective and discipline, particularly in the frothy lending environment we are witnessing currently. There is an old lending maxim: never fall in love with a deal – no single deal is worth getting too emotionally involved in its pursuit. Origination teams are the first line of defense and must exhibit the discipline to pass on opportunities where the risk-adjusted return is not attractive, particularly in this environment where structural aspects to deals are being used to differentiate lending proposals. Sometimes saying “no” to an opportunity is the right decision and being good stewards of the balance sheet is as important to closing the next deal.
Building for the long term
Any bank is only as good as its people, and a specialty finance business cannot succeed without a top-flight management team. Attracting a world-class group of industry leaders, with deep expertise in specialty sectors, is critical to growth.
However, industry expertise needs to be balanced with the ability to build strong client relationships. We lend to people as much as we lend to the companies they work for, and we look to create lasting relationships that reach beyond a single transaction or loan. We have found that both parties benefit when a lender can combine its industry knowledge with a comprehensive view of the borrower’s operations and strategic goals.
Finally, no bank can stand still as the market evolves, and we’re always looking for new lines of business to add to our commercial specialty finance offering. Even a difficult market environment can offer attractive opportunities for a specialized platform, and our experience has convinced us that a long-term approach is the key to success. It takes patience and discipline to build a specialty lending business that will last, but the rewards make the effort worthwhile.
As president of Capital One’s Commercial Banking business, Michael Slocum is responsible for leading multiple businesses including Commercial Real Estate, Middle Market Banking, Commercial & Specialty Finance, Capital Markets, Treasury Services, and Wealth and Asset Management.