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Despite Recession, Lenders Want to Put Money to Work

WhiteHorse's Stuart Aronson offers a positive outlook for middle-market businesses financing M&A

Despite Recession, Lenders Want to Put Money to Work

With inflation running at a 40-year high, and the Federal Reserve committed to raising interest rates to cool demand and rein in inflation, it’s no surprise that the U.S. economy tipped into a recession in the second quarter.

The big question is how deep the downturn will become, as many recall with trepidation the Great Recession from 2007-2009.

The economic backdrop today differs markedly from the Great Recession. During the Great Recession, there was a near shutdown of liquidity.

This section of the report is sponsored by WhiteHorse and originally appeared in Middle Market DealMaker’s Fall 2022 issue. Read the full story in the archive.

In comparison, many sectors of the direct lending market remain open and functioning today. We believe strong middle-market and lower mid-market companies will continue to have access to financing for strategic acquisitions and other priorities. Some key trends to consider include:

Significant long-term committed capital in the direct lending market: One of the hallmarks of the Great Recession was a liquidity crisis. Lax lending standards and massive leverage froze financial markets. Only because of unprecedented government intervention did the markets eventually unfreeze. So far in this economic downturn, regulated entities are not as overextended. In addition, there are tens of billions of dollars of committed long-term capital controlled by direct lenders, which are providing liquidity to the leveraged finance markets at pricing 50 to 200 basis points above the 2021 lows.

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Aggressive lending practices: A mistake lenders have repeated through multiple cycles is heavily adjusting EBITDA by adding cost synergies, revenue synergies and cost take-outs. In the past, many of these synergies and add-backs did not materialize, resulting in overleveraged companies. Prior to the Great Recession, most of the lending market was controlled by financing firms that did not hold the long-term credit risk and therefore were looser with these add-backs and synergies. But over the past 10 years with the emergence of long-term direct lenders, more intense credit scrutiny has been given to these adjustments and add-backs, resulting in credits that are likely to perform closer to projected levels.

Robust employment: In many ways, today’s recession is a “textbook” recession— an overheated economy creates inflation, and the Fed steps in to cool the economy by raising interest rates and tightening monetary policy. That said, each recession is different and so far, this one is characterized by a strong job market. There are many theories for why the economy remains at essentially full employment and that could change, but whatever the reason, the strong labor market could maintain support for consumer spending and keep the recession comparatively shallow.

In short, while we do expect the economic downturn to continue for the next 12-24 months, middle-market executives should look upon today’s economic circumstances with less trepidation than the Great Recession. Direct lenders have liquidity and continue to actively put that money to work in support of solid credits.

Stuart Aronson is executive managing director and CEO of WhiteHorse, which provides senior and second lien debt for refinancing, growth capital, acquisitions, buyouts and balance sheet recapitalizations for middle-market companies in the United States, Canada and Europe.