In a roundtable discussion focused on chief credit officers, panelists from Edge Capital, Horizon Technology Finance, SLR Business Credit, Marco Financial and Wingspire Capital discuss the important role of the CCO and how they are leading credit teams through the economic turbulence of 2022.
As their C-suite titles indicate, chief credit officers play an exceptionally important role for all specialty finance companies, including those in the asset-based lending space. However, CCOs don’t always get the “glory” reserved for those on the business development side. To get a better handle on the role of CCOs and how they are traversing today’s challenging credit environment, ABF Journal spoke with Stephen Butler, chief operating officer at Edge Capital; Diane Earle, chief credit officer of Horizon Technology Finance; Betty Hernandez, executive vice president and chief credit officer of SLR Business Credit; Fred Leder, chief credit officer and senior vice president of operations at Marco Financial; and Ken Wendler, chief credit officer of Wingspire Capital.
Some think of chief credit officers as “deal killers.” Why do you think this is an unfair assessment?
STEPHEN BUTLER: This may be an unpopular opinion, but I think the moniker “deal killer” is apt but not negative. In most cases, they are killing deals that need to be killed, where a prospective borrower is presented and just on their edge of their respective credit box. Unfortunately, the unfair connotation is often the result of CCOs relying on their biases to kill a deal. We have all heard someone say, “I’m never financing a deal in the XYZ industry ever again” because of one bad experience.
DIANE EARLE: While there are some credits that I’ve seen presented that I have viewed as simply poor opportunities, I’ve found that the vast majority of successful originators bring deals that are either down the fairway or close to it. That means that most of the time the challenge is to find the appropriate structure and pricing that will win the deal while at the same time managing risk.
BETTY HERNANDEZ: If a CCO is a deal killer, then that person is not an effective CCO. It’s a bad stereotype. We are in the risk business. If we don’t take any risks, then we don’t make any money. Our job is to balance that risk and make sure the risks being taken are manageable and that we are compensated appropriately for the amount of risk involved. If the amount of risk is too much and/or not in compliance with the policies and procedures we are tasked with, then we shouldn’t proceed.
FRED LEDER: Sometimes, CCOs have the unfortunate responsibility to “kill deals.” However, not all obstacles become reasons to kill a deal. There are certain lines they can’t cross, usually found in the lender’s underwriting rules and regulations, but, ultimately, the credit team is responsible for turning prospects into borrowers and that aspect of a CCO’s job is always present in their mind. It is the ability to balance the hard lines and the gray areas that makes a CCO a deal killer or deal maker.
KEN WENDLER: A great CCO will never be viewed as a “deal killer.” While CCOs “guard the gates” to protect their firms, they are in business to make loans, so the best CCOs figure out a way to make the loan if a deal is there. It is important for CCOs to always explain why the risk is acceptable or unacceptable and facilitate a culture of consistency so there aren’t surprises when the ultimate answer to a credit is to pass.
How do chief credit officers enhance the ABL process and help lenders and borrowers find solutions?
BUTLER: Many borrowers have never been or have limited experience with ABL and truly don’t understand the product, requirements or the risks for the lender. The CCO and anyone else in a customer-facing role needs to create an open dialogue with each borrower. The goal should not be to explain every aspect of a deal structure, but to explain the purpose of various provisions in a loan security agreement.
EARLE: Again, I think consistent and clear communication of the firm’s credit appetite is vital. Successful originators need to know what they are looking for and whether a given deal is worth pursuing in order to be efficient. It’s my job to help make that easier.
HERNANDEZ: A CCO should try to work collaboratively with team members to find creative ways to mitigate and manage risks whenever it makes sense to do so. I like to meet with clients and prospects at the very least using Zoom to listen and understand their concerns firsthand. If we can find a solution, I try to do so. If there simply is no way around the credit issue, it is best to be honest with the borrower or prospect and let them know immediately why the deal doesn’t work and possibly offer outside solutions.
LEDER: A talented and dedicated credit team led by a strong CCO is a group that is creative and can use mitigating strategies to bring a complex transaction to closing. A creative and positive approach to credit approval is the way to maintain the balance between lenders and borrowers.
WENDLER: Experienced CCOs can bring their deal experience to each deal and have a keen understanding as to what has worked in the past and what hasn’t worked. This experience can be used to help structure a transaction to get to an approval instead of a declination. Changes to structures sometimes might entail finding additional equity capital from the owner, adding a “B” piece to the structure behind the senior “A” lender, or possibly stretching for a certain time frame, assuming the company has the ability to get the lender back into formula.
How would you describe the current credit environment?
BUTLER: Uncertain is the word that first comes to mind. We have seen several lenders cut back on new originations, but there is still a lot of liquidity on the sidelines.
EARLE: The current credit environment is a bit unsettled. In venture lending, we are still seeing a number of opportunities, but in some cases, we are seeing companies looking for venture debt in lieu of equity, which doesn’t make sense.
HERNANDEZ: We generally see more deals as the economy weakens and banks tighten up on credit. This seems to be the case right now, as we are starting to see more deal flow and have a robust pipeline.
LEDER: There are two sides to the current credit environment. Banks and traditional lenders are tightening their credit policies and remain very nervous when it comes to new loans, making it a “target rich” environment for non-bank asset-based lenders. On the other side, businesses are seeing deterioration on their balance sheets as inflationary and recessionary trends strengthen. This means that non-traditional lenders must price prospective transactions commensurate with risk and must also structure them with the protection of a “belt, rope and suspenders.”
WENDLER: The current credit environment is challenging due to volatility in the economic landscape. Coming out of a pandemic and into an environment of inflation, rising interest rates, a war in Europe, an inverted yield curve (which typically signals a near-term recession) and rising energy costs makes credit decisions a bit more challenging. The ABL community should do better in this environment because there might be more companies that need to restructure their debt and that is when the ABL product should shine.
How have economic fluctuations like inflation, rising interest rates and supply chain disruption altered the credit landscape?
BUTLER: While we have not seen interest rates as high as they currently are since late 2007, as recently as December 2018, the prime rate was at 5.5%. Plus, U.S. businesses have been dealing with supply chain issues for years. However, the magnitude and timing of these events is what has been jarring to some. We have seen lenders reexamine inventory collateral through changes in appetite and advance rates, as borrowers have oversupplies of product after stocking up when things were not available.
EARLE: Pressure on valuations has caused some investors to slow down the pace at which they are investing, making it much harder to raise equity. In addition, supply chain constraints have made it harder for many of our clients to source critical components and has resulted in much higher shipping costs.
HERNANDEZ: It is tough. For the last few years, we have been lowering our rates to maintain existing borrowers and now we have to go back and increase our rates to levels that borrowers aren’t used to seeing. However, we have no choice, as the market dictates rates and all of us independent finance companies have seen our cost of borrowing increase. As far as supply chain disruptions and inflation goes, I would say that most of our borrowers have been affected one way or another. They are passing along price increases as fast as they can and continuing to struggle with supply chain disruptions, whether it is missing components or the lack of drivers for the timely shipping of finished products. All of us could use additional help, but finding it is still difficult.
LEDER: This environment is not very familiar to today’s younger credit professionals. Interest rates, economic growth, supply chain breakdowns and inflation have not really been maters of concern for the average business throughout recent years. In general, the credit landscape is one of high risk for lenders who now have to lend on slower receivables, older inventories, product supply delays and weaker borrowers.
WENDLER: Specifically related to ABL, I feel that lenders are being somewhat more thoughtful regarding structure and pricing compared to 12 months ago, but I’m not seeing a dramatic impact as of yet. It appears the rising interest rates/economic concerns have impacted the cash flow lending community more than the ABL community so far.
Do you expect the credit environment to strengthen or weaken in the next year? Why?
BUTLER: I believe the overall credit environment will weaken in the coming year as companies prepare for a perceived recessionary environment, look to cut costs, pass along increasing pricing to customers and weather ongoing supply chain issues. This may hurt banks but should create additional opportunities for non-bank lenders.
EARLE: I expect the credit environment to weaken. We are already seeing our borrowers having difficulty raising equity to support operations. That is causing a shift in strategy from growth at all costs to rationalizing costs and moving towards profitability. That is a tough transition to make for most management teams and some will falter.
HERNANDEZ: I think the credit environment will continue to weaken over the next year, and the length of recession will depend upon recent election results, the war in Ukraine and continued inflation and low unemployment. All of these will continue to affect our borrowers and will influence banks on tightening credit and increasing reserves. This will create more opportunities for independent finance companies such as SLR.
LEDER: Next year’s economic environment is going to be shaped by the results of the 2022 mid-term elections. Without passing a value judgement, I can only say that the economic markets will react favorably to a Republican dominated House and Senate if the upcoming elections provide that change. Accordingly, I would expect stabilization in Q1 and by mid-year 2023, the start of a strong economic recovery. If the election results are other than those, 2023 will continue to show a weak economy.
WENDLER: I expect the credit environment to weaken over the next year as the Federal Reserve continues to raise rates. My sentiment is also driven by the inverted yield curve, with two-year bond rates higher than 10-year bond rates, which usually is a predictor of a recession. Furthermore, I anticipate some lenders will take losses due to more aggressive deals from the last few years and that bank regulators will be more aggressive in the evaluation of criticized assets. All of these factors taken in whole, in my opinion, will lead to some tightening in lending. However, I do believe these factors are good for non-bank ABL lenders if they can protect their individual portfolios in a softening business environment.