Approximately 197,000 American middle-market businesses generate millions of jobs across all industries, lending significant strength to the overall U.S. economy. They represent one third of private sector gross domestic product (GDP) and employ approximately 43 million people. Unlike large corporations and small businesses, middle-market companies operate without the influence of lobbyists or the protection of the Small Business Administration.
As a major middle-market lender, GE Capital realized that very little research was being done in this important sector. “Big and small businesses get a lot of attention, but the middle market doesn’t,” conveys Robert McCarrick, chief commercial officer at GE’s corporate lending group. “If you look at the GDP generated by these companies, it equates to the world’s fourth largest economy. They represent a critical engine for the U.S. economy and deserve more attention.”
In 2011 GE Capital joined forces with the Ohio State University Fisher College of Business to establish The National Center for the Middle Market. The center is a leading source of knowledge, leadership and innovative research on the U.S. middle-market economy. An important tool emanating from the Center is the Middle Market Indicator, a quarterly report of data collected through surveys of one thousand C-suite executives from U.S. businesses with revenues between $10 million and $1 billion.
This year’s second quarter survey reports that middle-market executives expect revenues to grow more than 5% for the next twelve months. This far outpaces estimates for the S&P 500 Stock Index. Sixty-five percent of those surveyed claimed positive gross revenue performance during the past 12 months, and 64% said they were ready to invest capital, compared to 49% a year ago. Forty-three percent said they were planning to add workers with employment expected to grow at a rate of 2.5% over the next 12 months.
“These companies feel good about growth prospects, employment and capital expenditures,” declares McCarrick. “They are willing to invest dollars that should lead to increased economic activity, which should in turn drive the need for more growth-related financings. It’s a very positive outlook and bodes well for lenders that focus exclusively within the middle market.”
The latest projections for GDP growth for 2014 are more than three percent; middle-market companies foresee a greater share of that based on their 5.1% revenue growth prediction. “Presumably a higher GDP rate means better things for the economy, with the middle market benefiting more than the overall economy due to its higher projected growth rate,” adds McCarrick.
While discussing how middle-market performance might affect the asset-based lending market place, McCarrick says he expects to see a much more active market as we head into 2014. “We are starting to see some areas, such as consumer retail, where there’s a bit more M&A. Consumerism should help generate GDP growth. If companies can put their dollars to work and find acquisitions that make sense, it will drive more loan activity. Hopefully that activity will translate into more new money coming in rather than the recycling of cash we’ve been seeing this year and last.”
With its focus on six vertical markets — retail, metals and mining, technology, energy, forestry, and food, beverage and agribusiness — Corporate Finance at GE Capital is in a good position to closely monitor the trends. McCarrick observes that an overall consumer demand for products and services is driving strength in the retail space, and his group is also experiencing a lot of activity in food and beverage.
“Commodity-driven markets seem poised for a comeback,” states McCarrick. “As natural gas prices fell, companies pulled back on drilling which resulted in some volatility among some of the associated services, but we expect to see improvement, driven by the commodity price of oil and gas. There are still challenges, however. The coal industry continues to feel the pain of commodity cost and regulatory oversight. They also suffer from the more affordable price of natural gas, a result of the shale gas boom.”
Despite the strong message that middle-market companies are poised to invest capital to add jobs, equipment and acquisitions, there are still concerns about rising healthcare costs, the ability to maintain margins and the uncertainty of how government actions will impact business. McCarrick notes that, since the 2012 presidential election, companies now have some certainty in knowing the regulatory and governmental environment they are operating in. He credits that knowledge with a slight increase in merger and acquisition activity and some economic growth that he expects to continue.
“There is still a lot of uncertainty around healthcare, however,” shares McCarrick. “I recently attended an Access GE event where about 60 of our customers were able to listen to knowledgeable presenters on many topics, one of which was the Patient Protection and Affordable Care Act and what it will mean for these companies. I was surprised by some of the questions that were asked, because it made me realize how much uncertainty there still is for these businesses around reporting, documentation and associated costs.”
Another concern is the likely return to more costly credit. “The cost of credit is driven by an increasing interest rate environment, and there is a much higher probability today than there was a year ago that rates will go up,” warns McCarrick. “Presumably interest rates begin to rise as the general economic environment begins to improve. Companies with higher margins, cash-flow and revenue may have to pay more in interest, but if the company grows faster than its cost of capital, that’s a positive circumstance. But if they are in an industry that is cycling even though GDP is growing, it could result in a credit crunch due to higher interest costs without the associated growth to cover those costs.”
If the Federal Reserve misses the mark and raises rates in an environment that fails to generate the predicted economic improvement, it could lead to an increase in default rates. “A lot of our borrowers, especially those with cash-flow credit facilities, end up swapping a portion of their interest-related cost, so they essentially lock in at a fixed rate over the term. As a result they have the ability to absorb rising interest rates. There are also ‘LIBOR floors’ that are built into existing credit facilities, so there is some cushion between today’s interest rates and tomorrow’s. We try to plan for these situations and work with our borrowers to get through them.”
The Middle Market Indicator suggests that middle-market companies might spur growth with superior customer focus, management culture, talent management, investment in innovation and geographic expansion. McCarrick says that these ideas are based on their interactions with management teams and private equity sponsors across all the industries GE Capital serves. “These are the factors that we have found differentiate the better performing companies from under-performing companies. For example, companies with global capabilities, operating in multiple countries, tend to have a more robust view of their growth potential over the next 12 months. Of the executives surveyed, roughly 60% have international operations and projected a 5.6% growth rate. Those that are U.S.-based only predict 4.3% growth.”
Choosing a Lender
It’s still a borrower’s market for those companies looking to invest. McCarrick strongly recommends middle-market companies choose a lender that understands their business. “GE Capital has built-in specialization around the larger industries in the market, and it is a huge benefit to customers when we can come in already understanding their business. We pride ourselves on understanding economic cycles and helping a business work through those cycles. Borrowers sometimes end up with banks that don’t understand certain industry cycles and how to lend through an industry downturn. In the middle market, where you have so many growth-oriented companies, you want a lender that can grow with you and continue to be your lender for years as opposed to a lender who reaches a certain growth parameter and has to back away.”
GE Capital strives to foster growth in the middle market through consultative services such as Access GE events where customers and prospects gather at conferences to hear experts talk about topics that pertain to their particular business needs. Closer to home, GE brings experts to the customer worksite to discuss concerns that range from leaner manufacturing processes and leadership development to eco-treasure hunts to lessen energy consumption.
“We receive consistent customer feedback telling us that we do more than any other lender to help our clients’ businesses,” affirms McCarrick. “It is not just about the numbers and financing — though that’s important and we do an excellent job at it — but we offer a lot more to enhance the relationship. That’s how we claim at GE Capital that we are builders and not bankers.”
Lisa A. Miller is a regular ABF Journal contributor who has worked in the commercial finance industry for more than 15 years.