The recession of 2008-2009 brought many lessons to the lending community; and the small independent finance companies were no exception. When looking back at that period, many of the lessons that we should all remember occurred in 2005-2007, during the lead up to the recession.

If you’ll recall, the economy was strong and business was booming. For small independent finance companies (that typically run counter-cyclical), new business was harder to come by and highly competitive. As is often the case, this led to aggressive structures and lower pricing, a bad combination.

Some lenders, (those focused on continued growth) were overly aggressive. “Stretch” pieces, higher advance rates on inventory, looser eligibility criteria, financing marginal credits that  might not normally be financed, and lack of proper monitoring of the more challenged credits all contributed to lenders’ aggressive stance to be competitive and keep their portfolios growing (or, at least, not shrinking). As it turned out, they paid a steep price for their aggressiveness.

When the recession hit, portfolio credit issues were more widespread than normal. Small independents, those with limited staff and without dedicated workout people, typically found themselves taxed in handling all that came at them. As an example, Celtic Capital typically has two to three liquidations in a normal year. The vast majority are friendly and easy. In 2008, we had 12. All were friendly and easy, but that was because we hadn’t strayed from our credit philosophy and our collateral-to-loan ratios held as the liquidations proceeded. As a result, we took no losses.

Many other lenders didn’t fare quite as well. Even if their losses were minimal, because of their prior aggressiveness, the liquidations were more time consuming and stressful, which negatively impacted new business. Many small independents’ senior management teams are small (one or two people). Pulling them into workouts pulls them away from focusing on new business opportunities.  Although we had 12 liquidations, we didn’t get distracted from new business.  In fact, from 2008-2010 our portfolio tripled in size. This was the best new business environment I have seen in my nearly 40 years in the industry.

Due to the severity of the recession, banks tightened their credit criteria and were not lending to marginal borrowers. Many borrowers, hurt by the recession, struggled and needed alternative financing options. With many of our competitors bogged down with workouts, the field was wide open for Celtic Capital and others who stuck to their credit criteria in the lead up to 2008.

To be successful in the asset-based lending space, especially small independent companies, you have to take the long view.  If you are constantly worried about growth, or are being pressured by your investors to grow, you will end up making poor credit decisions, which will hurt you at some point. By focusing on the long term, you learn to be patient when others are being overly aggressive. It’s easy to justify being aggressive when the economy is strong and businesses are doing well. But never forget, what goes up will come down. If you are smart enough to know when, have at it, but for the rest of us, sticking to your sound credit criteria during good times and bad will ensure you survive the next downturn.

Who among us would have seen a pandemic coming or understood the global impact it would have on all of us? Businesses were met with unprecedented challenges, many of which are still being dealt with a year and a half into it. I was amazed throughout the early months of the pandemic, when many businesses were shut down or certainly curtailed, how our clients’ collection trends never wavered. Initially I thought we would see widespread stretching of accounts receivable. In our portfolio, it never occurred. The Payroll Protection Program (“PPP”) saved many of our clients and, no doubt, contributed to the strong collection trend.

Here we are in the summer of 2021 and I see some similarities to what happened in 2005-2007. All of the government funding that has flooded the market, between two rounds of PPP and the Economic Injury Disaster Loans (“EIDL”), while keeping many needy businesses afloat, has wreaked havoc on the small end of the lending industry.

As they digest the impact PPP loan forgiveness is having on borrowers’ financials, banks are not moving out prior marginal credits; and borrowers now flush with cash are in no hurry to move lending relationships; and EIDL comes with a blanket SBA UCC filing which needs to be either paid off or subordinated to take out a senior lender. How many borrowers want to pay off a 30-year 3.75% loan? Not many.

All of this creates poor deal flow which, in turn, causes lenders to get aggressive in order to compete for the marginal deals they do see. Combine that with mid-market lenders coming downstream to find deals as their market has tightened as well, leaves small independents struggling even more to compete. For those who haven’t gone through the SBA EIDL subordination process yet, it can be painful and can take time depending on which SBA office handles the credit. Each office has its own subordination form, and many are take-it-or-leave it in nature.

Although today’s environment is much different than the recession years of the past, prudent lenders should remember what happened to them when they started bending their credit criteria to compete. Be patient, stick to your comfort zone and don’t act desperate.  You can’t monitor around ill-advised deals; they’ll always catch up to you in the end.