Bank Lending Troubles – Continued Uncertainty

According to a recent article in CFO magazine, the Bank for International Settlements, “the bank for central banks,” issued its annual report published Monday. The article “Banks Not Out of the Woods“ highlighted several points about the state of banks in the US:

1) Concerns over the impact of new regulations on the health of banks

2) Writing down losses – balance sheets are generally weaker than reported, as banks have not been forced to write down the real value of many assets.

3) Commercial real estate portfolios: In the US, more than 100 community and retail banks have a ratio of commercial real estate to total loans of more than 50%. Delinquency rates on these loans rose to more than 8% in the U.S. last year, double the rate a year ago. Congress is even considering inserting a provision in the financial reform bill that gives 7,800 banks permission to spread their losses on real estate loans over a 6-to-10-year period.

4) The BIS is doubtful that banks will be able to refinance their huge funding needs, given that funding maturities for banks are at their shortest in 30 years. In the United States, hundreds of small banks have yet to repay Troubled Asset Relief Program funds, and some have also failed to make required dividend payments to the government.

5) The Spread between the interest rates that banks can borrow at and the rates that banks are actually charging consumers for mortgages represents one of the largest profit margins banks have had for a long time. However, this may be providing false support as it cannot continue forever.

Oklahoma perspective

As we have written before, we are fortunate in this state that most of our banks have had more conservative lending practices and have therefore been less susceptible to the scope and scale of banking problems elsewhere. However, the entire banking system is linked together, so we need to keep our eye on the big picture.

Business Bank Lending Declines

Current state of Bank Lending – Business Lending

US Bank lending (Commercial & Industrial Lending) as reported by the Federal Reserve Bank continues to decline and was down 18% in May year-over-year. This 18% decline is twice as severe as the previous worst decline in history of 9.3% in 1949. And the monthly declines show little signs of slowing. See chart in this story, which shows percentage year-over-year declines in lending.

Current state of Bank Lending – Real Estate Lending

The picture is even worse for real estate lending at US banks. For the first time on record, we are seeing annual declines in real estate lending, down 4.6% over the same period last year. Until 2009, there had never been a year-over-year decline in real estate lending in the US and this may continue to worsen.

All rights reserved. Copyright: ClearRidge Capital, LLC, 2010. About ClearRidge Capital ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midldle market businesses, banks and law firms. ClearRidge’s Team have completed M&A transactions, provided restructuring advice and secured new and replacement capital for midsized companies across the US and Canada. Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values. For further information, visit www.clearridgecapital.com.

Cost of Debt and Equity Capital in 2010

Source: Pepperdine University Private Cost of Capital Survey

Pepperdine University, along with research contributor Robert Slee, conducted the first ever private cost of capital survey (PCOC), which was the first survey of its kind to provide information on the capital markets for small to midsized US companies.

They surveyed senior lenders (typically banks), asset-based lenders (ABLs), mezzanine capital, private equity and venture capital as they relate to midsized private companies.

This survey may be useful for your business, as the results highlight the benchmarks that must be met to qualify for capital, along with the required investment returns for the capital providers.

Armed with this information, you should be better able to plan your budget, your ideal capital structure and determine the likely cost of capital in 2010.

We are going to summarize what we think are some of the most important points, but would also encourage you to download the full 67-page survey.

At the end of this email, we provide a link to go to Pepperdine University's website to download the complete survey.

BANKS (Cash-Flow Lending)

Interest Rates

According to Pepperdine's survey, over half of banks responded that their current all-in interest rate (including spreads over prime and LIBOR) is between 6% and 6.5%, with the remainder lending at rates between 6.5% and 7.5%.

44% of loans were refinancing existing debt as opposed to loans for working capital, acquisitions, new equipment and other purposes. While they didn't expect lending rates to increase significantly, most banks expect lending to become more restrictive through the middle of 2010.

ClearRidge: Please take action early in preparation to refinance debt. A major concern is the number of business owners that are going to be surprised by higher loan costs and tighter credit requirements when it comes time to replace debt. That, coupled with declining bank lending levels throughout 2010 will likely lead to liquidity problems for thousands of US businesses.

Fixed or Variable Rates - 38% use fixed rate and 62% use variable rates, of which most are pegged to prime.

Median Credit Ratios

Fixed-Charge Coverage (Min): 1.2

Funded Debt to EBITDA (Max) 3.0

Debt Service (Max) 1.25

Debt to Net Worth (Max) 3.0

Covenant Thresholds

Max Debt/ Total Assets 3x

Min Cash Flow Percentage 125%

Min Fixed-Charge Coverage 1.2x

Max Debt/EBITDA 2.75x

You will notice that these ratios and thresholds are more restrictive than in recent years when many businesses last refinanced debt.

ASSET-BASED LENDING (includes some banks)

Asset-Based Lending focuses mainly on collateral and liquidity; whereas a traditional bank loan focuses mainly on cash flow. An ABL is a loan secured against the assets of a company - mainly inventory and accounts receivable, but sometimes also machinery and equipment, intellectual property or trademarks.

[Banks also operate within this category and sometimes offer a blend of cash flow and asset-based loan.]

Asset-based loans are typically categorized into three tiers depending on loan dollar amount:

Tier 1 loans : >$10M; Tier 2 loans: $3-$10M; Tier 3: <$3M

Interest Rates

According to Pepperdine's survey, variable interest rates in 2009 and 2010 are ranging from prime plus 0.5% to prime plus 16%. For larger loans typically pegged to LIBOR, rates range from LIBOR plus 3.5% to LIBOR plus 6%.

Other fees

ABLs may also have closing fees ranging from 0.5% to 4% of the loan amount; modification fees from 0.1% to 3%; commitment fees from 0.5% to 1.5%' collateral monitoring fees from 0.1% to 12%; unused-line fees from 0.25% to 1%, as well as audit fees, attorneys' fees, insurance, annual and due diligence fees.

ClearRidge: In other words, it's important to look beyond the headline rate and determine the all-in cost of an ABL, which will likely cost you north of 10% and can be as high as 35%.

Over half of Asset-Based Lenders expect prime rate to increase, LIBOR to increase and credit spreads to widen through mid 2010.

Median Credit Ratios

Fixed-Charge Coverage (min): 1.0

Funded Debt to EBITDA (max) 4.25

(compared to bank lending max at 3.0)

Debt Service Ratio (min) 1.2

Lending Advance Rates

Accounts Receivable: 85.0%

Inventory - Low quality: 22.5%

Inventory - Intermediate quality 35.0%

Inventory - High quality 55.0%

Equipment 67.5%

Real Estate 65.0%

Land 50.0%

Firm's Cash Flow 65.0%

Marketable Securities 80.0%

Refinancing accounted for over half of ABLs, followed by acquisition and growth financing. In spite of rising costs, almost every asset-based lender expects demand for ABLs to increase through 2010.

ClearRidge: When traditional bank lending becomes too restrictive or is unavailable, many businesses will turn to ABLs to refinance their debt.

MEZZANINE CAPITAL

According to Pepperdine's survey, all-in interest rates for mezzanine loans are currently running at around 18%.

Mezzanine is most often used to fund a management buyout, growth or acquisition financing, with only about a third for refinancing.

Most mezzanine capital loans would be made to firms with more than $10M in annual sales and for loan amounts between $1M and $10M. One in three mezzanine loans are straight interest, with two thirds comprising interest plus stock warrants.

Pre-funding Median Ratios

Total Debt to EBITDA (max) 3.75

Senior Debt to EBITDA (max) 2.5

Fixed-Charge Coverage (min) 1.2

Median Financial Ratios

Maximum Multiple of Recast EBITDA 4.0

Maximum Multiple of Operating Cash Flow 4.0

Maximum Total Debt to EBITDA 4.0

Maximum Senior Debt to EBITDA 2.5

Minimum Fixed-Charge Coverage 1.2

PRIVATE EQUITY

According to Pepperdine's survey, Private Equity in today's market has an expected annual rate of return of between 20% and 30% on new investments.

Only 7.5% of private equity funds will consider an equity investment of $1M or less, but around 40% will consider an investment smaller than $5 million. Two-thirds are control investments and one third are non-control.

The median targeted equity ratio as a percentage of invested capital in each deal is 41%, with a range between 20% and 50%.

ClearRidge: This equity ratio is in contrast to the easier credit days in 2007 and 2008 when private equity would rarely need to contribute much more than 20% equity to the capital structure.

VENTURE CAPITAL

According to Pepperdine's survey, VCs currently have an expected rate of return on investment of 40% to 43% for each investment they make. However, the average rate of return for realized investments in prior funds is between 24% and 29%.

Below is the Pepperdine Survey's summary of VC investment stages:

Stage 1: 22.5% of VC investments fall into this category.

No product revenues to date and limited expense history, typically an incomplete management team with an idea, plan, and possibly some initial product development. Expected exit by VC in 6.2 years.

Stage 2: 17.0% of VC investments.

Still no product revenue but substantive expense history, as product development is underway and challenges are thought to be understood. Expected exit by VC in 5.8 years.

Stage 3: 17.8% of VC investments.

Significant progress in product development; key development milestones met and development is near completion, but generally no product revenue. Expected exit by VC in 5.1 years.

Stage 4: 28.3% of VC investments.

Additional key development milestones met and some product revenue, but still operating at a loss. Expected exit by VC in 4.8 years.

Stage 5: 10.9% of VC investments.

Product revenue and operating profitability or breakeven/positive cash flows. Expected exit by VC in 4.0 years.

Stage 6: 3.5% of VC investments.

Established financial history of profitable operations or generation of positive cash flows. Expected exit by VC in 3.5 years.

Summary of Capital for Business in 2010

To reiterate what we said in 2009, we would urge you to be thoroughly prepared when it comes time to refinance or recapitalize debt. The credit markets and equity markets are open for business, but it will take better preparation than in the past to get through the loan committee and get your loan approved.

If you need to look at alternatives, raise some capital or replace debt, please give ClearRidge a call and we would be happy to talk through your options with you.

Tax Credits

If you would like to learn about business incentives and tax credits that may be available for your business, you may find the following useful:

www.clearridgecapital.com/taxcreditsoklahoma.htm

Pepperdine Survey

Download a PDF of the full Private Capital Markets report from Pepperdine's website:

http://bschool.pepperdine.edu/research/pcmsurvey/form/

All rights reserved. Copyright: ClearRidge Capital, LLC, 2010.

About ClearRidge Capital
ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midldle market businesses, banks and law firms.

ClearRidge’s Team have completed M&A transactions, provided restructuring advice and secured new and replacement capital for midsized companies across the US and Canada.

Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values.

For further information, visit www.clearridgecapital.com.

Signs Point to Tight Business Lending in 2010

October is when many companies are preparing budgets and business plans for the following year, so it seems a good time to consider the credit environment for 2010.

While there is no crystal ball, we do have 100 years of historical data from the Federal Reserve to give us clues to business lending levels and business failures coming out of a recession.

The good news is that there are some clear patterns that have occurred after every recession.

To apply historical data to the future, we need to know when this recession ended, and industrial production has proved to be a consistent marker. More accurately, a reduction in year-over-year declines in industrial production defines the end of a recession.

So, unless there is a "double dip" in the coming months, the recession likely ended in July.

Before we consider future business lending levels, we need to understand the current business lending landscape. In the last 30 years, even at the fastest pace of growth, it has typically taken 10 or more years to double commercial and industrial lending levels. However, it took less than half that time for C&I lending to double from May 2004 to a peak in November 2008, according to the Federal Reserve Bank of St. Louis.

C&I lending has been declining since December, and history suggests it will continue to decline - year-over-year - for up to three years after the end of this recession.

And not only is business lending declining, but the pace of the decline is increasing. Typically, the pace of declines has increased for up to 18 months after the end of a recession, so it is likely that this time we are going to break the 1949 record of a 9.3 percent year-over-year decline.

If C&I lending follows the historical pattern, lending levels could drop from $1.64 trillion in October 2008 to less than $1.3 trillion at some time in 2011. Assuming no change in supply and demand for loans, that would be a shortfall of approximately $350 billion.

The demand for new and replacement debt will likely increase in the next two years. Many stronger companies that previously carried little or no debt will start to take on new debt. Banks are competing for this business.

This will be combined with medium- and higher-risk business loans that were made to what appeared to be strong companies at competitive rates a year or so ago, when less stringent credit was available. At a minimum, these weaker companies are going to need to renew or replace their existing debt and there are not as many banks competing for this business.

The supply of new and replacement debt will likely fall over the next two years. As a result, there will be a widening gap between supply and demand, and it will be the weaker companies that will suffer when they are unexpectedly unable to replace or renew their debt.

This could trigger three things: a) Lenders will increase interest rates and fees to compensate for the additional risk of these medium to high risk loans, thus putting further pressure on companies' already weak balance sheets; b) some businesses will have to switch to more costly forms of debt; or c) a shortfall in supply will lead to an increase in defaults on C&I loans, which leads us to review historical business failures after a recession.

According to the American Bankruptcy Institute, U.S. Business bankruptcy filings have now risen every quarter for 13 straight quarters since the bankruptcy rules changed in 2005. To compound this trend, business bankruptcy filings have kept increasing for between two years to five years after the end of each previous recession.

Below is the data from the American Bankruptcy Institute.

Quarterly Business Filings by Year (1994-2009)
















Our intention is not to spread doom and gloom, but to raise awareness that the economic battle is not yet over. As a CEO or CFO, you may want to consider professional advice, assistance or even a confidential sounding board to renew, raise or replace debt next year.

If you would like a confidential sounding board to discuss your debt and budget plans for 2010, we are happy to sit down and discuss any options. You don't have to hire us as your advisor, we just want to provide a structure and framework to shape your thinking. If you want us to advise you on restructuring or corporate finance, that's an engagement and we can talk about hiring ClearRidge. (918) 392-2900

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

About ClearRidge Capital
ClearRidge Maximizes Enterprise Value as a business, financial and strategic advisor to midsized US companies. ClearRidge’s Directors have completed over 200 MandA transactions, provided restructuring advice and secured new and replacement debt and equity for companies across the US and Canada.

Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies. Restructuring includes financial, operational and strategic restructuring. Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital. Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management. We provide top tier advice and relationships with Middle America values.

For further information, visit www.clearridgecapital.com.

New Mergers and Acuisitions Data: Fresh Wave of Equity Capital

Fresh Wave of Private Equity Capital Available
New Data from Preqin, Dow Jones, PwC and IFS

We bring you the latest industrial manufacturing M and A data from PwC further down the page, but we start today with breaking news and data from the Private Equity arena.

The last couple of months have seen private equity firms stepping up their marketing efforts to source new investment opportunities.

In response to the growing number of calls and emails we have been receiving from private equity firms, we thought we would dig into the numbers to see if the latest industry data confirmed our observations.

Dry Powder = Fresh Capital

According to Preqin, a London-based research firm, the global private equity industry's dry powder (uncommitted and available cash to invest) currently exceeds $1 trillion, or $1,000 billion.

So, the next time that someone tells you there is little money available to invest in companies, you can let them know that there is over $1,008,000,000,000 fresh cash currently looking for a new home.

Where has the money come from?

The principal investors (known as limited partners) are pension funds, university endowments, foundations, hedge funds and other investors who have continued to invest in new funds.

First Half 2009 Investment Levels

A report published on Monday by International Financial Services in London, estimates that only $189 billion of private equity was invested in 2008, down by 40% from 2007 (we picked this up from today's Financial Times blog: ft.com/alphaville).

Investment in the first half of 2009 was estimated to be down 80%, representing a 12-year low.

The chart below speaks volumes.



Look at the huge dollar difference between funds raised and funds invested.

US Private Equity has largest share of cash

According to Prequin, the US accounts for $609 billion of the $1,080 billion in dry powder, with the rest of the world sharing the remaining $471 billion. Of the $1,080 billion, $507 billion is specifically for acquisition targets, $194 billion for real estate and $153 billion for venture funds.

Returns for Private Equity

Returns for Private equity as an asset class are down 27.6% year-over-year, which reflects the impact of poor performance of the broader economy, bailouts, bankruptcies, credit tightness and company collapses.

It is important to note, however, that short-term performance has not dampened investor confidence in the sector. Most Private Equity investments will ride through the storm with a longer time horizon than other investments (typically 5 to 7 years).

New fundraising levels

According to a recent Dow Jones study, during the first 6 months of 2009, 179 private equity funds raised "only" $55 billion, 64% less than the $153 billion raised by 261 funds during the first half of 2008. The additional $55 billion joins the mounting pile of fresh cash.

Impact of Tight Credit Markets

Average debt levels in buyouts fell to 42% in 2008 from 47% in 2007 (the lowest level since 1994).

Banks have been more reluctant to fund leveraged buyouts with higher debt leverage and are also reluctant to offload distressed assets unless absolutely necessary.

Although banks continue to be the largest lenders to private equity firms, $500 billion in loans are due to be refinanced in the next few years, so other participants will be able to pick up some of that debt.

Best time to invest + Wave of fresh capital

Historically, private equity has made the highest returns from buyouts made through the down cycle.

Most firms are anxiously looking for healthy acquisition opportunities to deploy their cash and there is significant competition for investment opportunities in attractive middle market companies.

ClearRidge recommends that you consider planning the sale of your company if it has performed comparatively well through this down cycle. There are myriad creative ways to structure a deal to ensure you get a fair sale price for your company today and also benefit from upside over the coming years.

Sources: Dow Jones, Preqin, International Financial Services, Financial Times blog (ft.com/alphaville)

Industrial Manufacturing M and A Activity - PwC Update

Getting down to more industry specific data, PricewaterhouseCoopers released their latest "Assembling Value" quarterly report this week on Mergers and Acquisitions in the Industrial Manufacturing industry.

Relevant highlights are below:

Decrease in number of deals as well as their value

• Overall number of US deals declined from 27 in 1H2008 to 7 in 1H2009 for deals worth $50 million or more.
• Overall value of US deals worth $50 million or more has declined from $8 billion in 1H2008 to $1 billion in 1H2009, representing a decline of 88%.
• Average deal value during 1H2009 was $129 million versus $268 million in 1H2008, representing a 52% decline.

Decreasing Financial Investor Activity

• US-based private equity firms raised $55 billion in 173 funds in 1H2009, representing a 64% decline compared to $153 billion raised by 261 funds in 1H2008

US as a Proportion of Global Activity

• Deal Activity is still largely driven by North America, which accounted for 27% of all first half 2009 worldwide deals with a transaction value of $50 million or more.

Click the link below to download the full 24-page report:
PWC Report

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

Maximizing Enterprise Value as a business, financial and strategic advisor to midsized US companies.

ClearRidge’s Directors have completed over 200 M and A transactions, provided restructuring advice and secured new and replacement debt and equity for companies across the US and Canada.

Mergers and Acquisitions includes buying, selling, merging and valuing midsize companies.

Restructuring includes financial, operational and strategic restructuring.

Corporate Finance includes advisory for raising and replacing debt and equity to provide the lowest cost of capital.

Turnaround, Bankruptcy and Crisis Management services include debtor and creditor advisory, bankruptcy support and turnaround management.

We provide top tier advice and relationships with Middle America values.

Breaking News from Banks and the Credit Market

Banks have confidence in each other again.

Commercial Paper is trading again.

In this blog, we highlight and decipher this week's leading indicators from the credit markets.

The spread needs to drop below 0.5% (50 basis points) to really signal a healthy banking credit market, but we are sure getting close. And a lot closer than we thought possible just a few weeks ago. Volatility is the only thing that seems to be predictable right now.

Take a look at the chart below, which shows 12 months of the TED Spread and you can see for yourself.

TED SPREAD - LAST 12 MONTHS
















HOW DID IT HAPPEN?

In late 2008, Central Banks across the World were collaborating to end the crisis. They were slashing interest rates and lending cash at an unprecedented rate. And it worked!

That is not to say the credit crisis is over for good. And just because the banks are lending to each other doesn't mean they are lending to companies. There's no guarantee credit markets won't freeze up again, but it's certainly a very healthy sign.

Commercial Paper is trading at the highest volumes since Lehman Brother collapsed in September.

Investors are snapping up new corporate bonds at the fastest pace since May, driving down yields from record highs once they begin to trade.

Just this week, some companies are starting to take advantage while the good times last, most notable of which is McDonald's, the world's biggest restaurant company, which raised $750 million in 10-year and 30-year bonds this week.

In 2009, rising confidence in corporate bonds may help many companies that need to replace $135 billion of debt this year in the U.S.

We certainly need this increased confidence. Commercial lending to businesses has a lead time of many months and any increased confidence in corporate bonds will take time to trickle down to middle market companies.

Business owners may not witness the effects until late 2009, but at least there is something to look forward to.

OUT OF THE WOODS?

A normal TED Spread number would be around 0.25% (25 basis points), so at 0.98%, we're still 4 times higher than normal.

The rate on three-month Treasury bills was 0.06% (6 basis points) on Monday. One year ago, three-month Treasury bills were 3.16% (316 basis points).

Banks are still wary of lending to each other. Financial institutions held more than 300 BILLION euros ($400 billion) in overnight deposits yesterday with the European Central Bank. The daily average in the first eight months of 2008 was 427 MILLION euros.

Let's take time to digest that number. This weeks, banks in Europe were holding almost 1,000 times as much money overnight with the European Central Bank than they were this time last year. They want to sleep soundly at night. Better lower overnight rates than waking up with the bank you lent to last night in default.

So, here's the $350 billion question. What should our President-Elect do with the other half of the TARP dollars. Does he need to do anything with it at all?

All rights reserved. Copyright: ClearRidge Capital, LLC, 2009.

ClearRidge provides Merger & Acquisition, Restructuring and Corporate Finance services advice for midsize companies.

M&A includes buyer and seller representation for companies with $2 million to $25 million in EBITDA and $10 million to $500 million in revenues.

Restructuring includes financial, operational, strategic and pre-Sale restructuring.

Corporate Finance includes raising and replacing senior debt, subordinated debt, mezzanine and equity financing.

Bankruptcy and Turnaround services include debtor and creditor advisory, bankruptcy support and turnaround management.

http://www.clearridgecapital.com