Next stop: Corporate Subprime?

As a player in the Venture Debt market, one cannot help but notice the impact of the subprime housing excitement (meltdown) on company valuations (see earlier post), investors’ willingness to take on newly syndicated loan packages and the overall access to credit enjoyed by the subprime lenders that relied on larger lending institutions to, themselves, lend money.

While some hedge funds stepped in to keep a couple of the better known subprime residential lenders from going bankrupt, it isn’t as though the capital markets have forgotten how all of that happened in the first place.

It is unlikely that access to borrowing will stay robust for firms that lend “higher risk” money over the coming months. Just consider the concerns voiced by Carlyle founder , and he’s talking about deals that aren’t likely at the high end of the risk curve.

It will be interesting to see how the risk managers at the various banks react to the events of the past few weeks. Will those banks that specialize in lending to Venture Debt firms (particularly with a tech and biotech bent) be as confortable with what might be called the “corporate subprime” market? Let’s hope they are, for the sake of the tech, biotech and venture capital industry.

As the Carlyle founder reminded us, its all about the loan agreements. And the same goes for the lenders who borrow money themselves to then re-lend. If they have loan facilities that are not secured against their loan portfolios, for example, perhaps risk managers will be more worried about lending to them than another firm in the space that had provided better collateral. Particularly if the cash balance at the publicly-traded specialty finance firm is dramatically lower than the bank loan they’ve drawn themselves.

Here are some numbers to conjur with involving certain of the smaller market cap. U.S.-based venture debt firms (all as of last reported quarter; these firms are just examples of the industry’s dynamics, and by using them as examples I’m not suggesting they are at any unique risk). Interesting that the amounts borrowed from banks relative to cash-on-hand ranges from 2x to 11x:

Hercules Technology Growth Company
(HTGC-NASDAQ)

Assets
Cash on hand: $27.4 million (inc. underwriters’ overallotment option post FYE)
Loans and investments: $283.2 million

Liabilities
Short term loan: $41 million
Operating line limit: $150 million with Citibank

S/H Equity: $255 million

Patriot Capital Funding
(PCAP-NASDAQ) – a BDC

Assets
Cash: $37 million
Loans and unaffiliated Investments: $252 million

Liabilities:
Borrowings: $98 million

S/H Equity: $195 million

Technology Investment Capital Corp.
(TICC-NASDAQ) – a BDC

Assets
Cash on hand: $5.2 million
Loans and investments (unaffiliated investments): $303.9 million

Liabilities
Loans payable: $58.5 million
Operating line limit: $100 million provided by RBC and BB&T

S/H Equity: $271 million

When you look at these figures, no single number jumps out to cause concern. The BDCs are, by law, unable to borrow more than 1:1 debt to equity, for example. That isn’t to say that the underlying portfolios don’t contain any inherent risk, with many names in the $10 to $15 million average deal size. As so many venture debt players have been built post 2000, one of our Advisory Council members reminds me that most firms in this industry only “know” a growing economic environment (although the dot-com meltdown counts for something).

No doubt that the harrowing experiences of the mortgage subprime lenders will be at the back of the collective minds of the corporate subprime lenders from hereonin.

MRM