Lending to small U.S. businesses is making a comeback on WallStreet, with 12 investment firms arranging $1.38 billion of initialstock offerings to funnel cash to the nation's biggest jobcreators.

Oaktree Capital Management LP, Crescent Capital Group LP andChurchill Financial Holdings LLC are forming so-called businessdevelopment corporations, which typically lend to businesses withannual revenue of less than $500 million, according to filings withthe U.S. Securities & Exchange Commission. The wave of BDCs isthe largest in at least seven years, based on data from IpreoHoldings LLC in New York.

While the Federal Reserve has flooded the financial system withtrillions of dollars over the past three years, obtaining creditremains a challenge for many borrowers that don't have access tocapital markets. A lack of credit is also hindering thelabor-market recovery, with unemployment hovering above 9 percent.Companies with fewer than 50 employees accounted for more than halfof new jobs created in the past decade.

“Capital needs to start getting down to the middle market andthen below to the innovators,” said Leon Wagner, who co- foundedGoldenTree Asset Management LP, a New York hedge fund focused ondebt markets. “That's what America needs to get deployed into theeconomy for significant growth to occur.”

Fewer Options
Small businesses have hadfewer financing options since institutions such as CIT Group Inc.and CapitalSource Inc. cut lending following the 2008 bankruptcy ofLehman Brothers Holdings Inc. Companies with annual earnings beforeinterest, taxes, depreciation and amortization of $50 million orless obtained $7.25 billion of syndicated loans in the U.S. thisyear, while banks and investors supplied larger borrowers with$229.4 billion, according to Standard & Poor's LeveragedCommentary and Data.

Banks, trying to rebuild following $2 trillion of writedowns andlosses since the start of 2007, continue to favor government andrelated bonds to making loans. Holdings of such debt has risen 44percent to $1.68 trillion since October 2008, while commercial andindustrial loans outstanding have fallen 31 percent to $1.26trillion, Fed data show.

Those that can get loans paid 1.79 percentage points more ininterest than large corporations in the first quarter, according toUBS AG, which is an attraction to Oaktree and the other debtinvestment firms faced with record-low yields on company bonds.

Backbone of Economy
Small businesses arethe backbone of the economy. Companies with fewer than 50 employeesaccounted for 64 percent of private-sector jobs created in 2006,according to Automatic Data Processing Inc. This year, it's 48percent.

Slow job growth poses a challenge to President Barack Obama,whose re-election prospects may hinge on bringing downunemployment. The jobless rate rose to 9.1 percent in May, and isup from 5.6 percent in mid-2008. Former Massachusetts Governor MittRomney, who announced his candidacy for the Republican nominationthis week, said June 3 in New Hampshire that the number of peopleout of work is “simply inexcusable.”

Small businesses have struggled to obtain credit since businessdevelopment funds were hit when credit markets seized up startingin 2008. CIT, the New York-based business lender, filed forbankruptcy in November 2009.

CapitalSource, the Chevy Chase, Maryland-based lender to smallbusinesses, reduced total loans to $6 billion in the year ended inDecember, from $8.1 billion in 2009 and $9.3 billion in the prioryear, according to data compiled by Bloomberg.

'Big Bubble?'
Allied Capital Corp., one ofthe oldest BDCs, sold itself to Ares Capital Corp. in 2010, afterits auditors said they had “doubt about the company's ability tocontinue as a going concern.” Apollo Investment Corp. fell 92percent to a low of $2.05 on March 20, 2009 from a high of $24.13on June 18, 2007. The company has since risen to $10.65 in NasdaqStock Market trading.

“I like the BDCs as a whole,” said Michael Turner, a commercialfinance analyst at Compass Point Research & Trading LLC inWashington. “The thing I'm always mindful of is, are we in themiddle of a big bubble?”

While recent reports on manufacturing and jobs indicate the U.S.recovery is slowing, the median estimate of 72 economists surveyedby Bloomberg is still for growth of 2.7 percent in 2011.

That is giving debt investors the confidence to target smallcompanies as they seek bigger returns than those offered onhigh-yield, high-risk bonds and loans. The only other period inwhich a comparable number of BDCs were being created was in 2004,when Apollo Investment and Ares were founded.

Riskier Assets
The Fed has flooded theeconomy with cash by expanding its balance sheet to $2.79 trillionfrom $892 billion in mid-2008. The move has prodded investors intoriskier assets, helping to drive yields on junk bonds down to arecord low of 7.19 percent last month from more than 20 percent inMarch 2009, Bank of America Merrill Lynch & Co. indexes show.Junk-rated securities are graded below Baa3 by Moody's InvestorsService and lower than BBB- at S&P.

“It's hard to find yield and these are yield-producinginstruments,” John Hecht, an analyst at JMP Securities LLC in SanFrancisco, said in reference to small-business loans.

Firms starting a BDC are typically able to double the amount ofmoney they raise by selling stock through borrowing an equal sum.Average annual yields on BDCs range from 8 percent to 10 percent,Hecht said.

There are 32 publicly traded BDCs, with the biggest being Aresand American Capital Ltd. They pay little or no corporate incometax in return for distributing at least 90 percent of taxableincome to shareholders.

Crescent, Oaktree
Los Angeles-basedCrescent, the leveraged-finance investment firm co-founded by MarkAttanasio, the owner of the Milwaukee Brewers baseball team, isplanning to raise $175 million to lend primarily to companies withyearly Ebitda of less than $40 million, according to documentsfiled with the SEC on March 10.

Oaktree, which oversees $85 billion and is seeking $125 millionthrough its IPO, is raising a fund to buy senior secured loans,mezzanine debt, subordinated debt and equities of companies withannual revenue of $25 million to $1 billion, according to a May 11filing by the Los Angeles-based firm.

Churchill's BDC, which aims to raise $150 million of equity,will target first-lien senior secured loans made to companiescontrolled by private equity firms with Ebitda of $5 million to $50million, according to an April 5 filing. The firm has offices inNew York, Chicago and Minneapolis.

'Accessing Credit'
Howard Marks, Oaktree's chairman, and Kenneth Kencel, Churchill'spresident and chief executive officer, declined to comment becausethe funds are in a quiet period before the IPOs. Bill Mendel, aspokesman for Crescent, also declined to comment, citing the samereason.

Financing for small companies may heat up as private-equityfirms invest the more than $300 billion they have raised over thenext three-to-five years, a portion of which may fund purchases ofbusiness with lower annual revenue, according to a JPMorgan Chase& Co. report published May 31.

While Fed data show commercial and industrial loans are downfrom the peak in October 2008, they are up 4.7 percent from thepost-crisis low of $1.21 trillion in September.

“Community banks and the large banks have really cut back thesupply of capital they put in the cash-flow based loan market,”Hecht said. “As companies feel better about their wherewithal, theystart accessing credit.”

Bloomberg News

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