In this new ABL Advisor feature article series, Charlie Perer, of SG Credit Partners, meets with commercial finance industry participants to discuss the state of the asset-based lending (ABL) industry and general market dynamics. The purpose of this series is to hear from a group of leaders who cover the spectrum of lending, turnaround advising and capital raising to hear their views and how they are positioning their businesses in the current environment. Here to tell the story are Doug Winget of Huntington Business Credit, Bianca Barredo of MidCap Financial, Mark Seigel of Crown Partners and Mark Fagnani of PKF Clear Thinking. Charlie Perer: Please briefly introduce yourselves and tell us a bit about your business. Doug Winget: I am President of Huntington Business Credit (HBC), the Asset Based Lending Group of Huntington National Bank. HBC is focused on ABL financing opportunities spanning the middle market and large corporate markets. HBC has vertical specialties within ABL retail and ABL metals. Bianca Barredo: I am Managing Director of MidCap Financial’s ABL Group where I lead a team focused on originating and underwriting ABL stretch products, which include first out facilities, Revolver + FILOs, enterprise term loans and cash flow tranches. Mark Seigel: I am Co-Founder and Managing Partner of Crown Partners, a capital markets advisor focused exclusively on the asset-based lending market. We arrange senior credit facilities for middle-market companies seeking to maximize their liquidity and financial flexibility, and we advise specialty finance companies on their strategic plan and capital structure. Mark Fagnani: I’m Senior Managing Director of PKF Clear Thinking, a turnaround, restructuring and advisory firm. Perer: How would you describe the current market environment through the lens of your own business?
Barredo: Quite unpredictable. Volume is robust and there are a number of interesting opportunities for ABL stretch driven by the leverage loan market pulling back, FILO lenders pushing for first dollar at their relatively higher cost of capital and regional banks retrenching on certain strategies. This capital markets uncertainty leads sponsors and advisors to go wider in their search for financing which has created opportunities to provide solutions-oriented structuring. But, as a lender, the competitive landscape is tough to predict and uncertainty in the general economy makes it challenging for investment committees. Against this backdrop, lenders are leaning into specific, higher conviction opportunities.
Seigel: The ABL market is functioning efficiently with both banks and non-bank ABL lenders actively pursuing new financing opportunities – stretching less than previously on structure and opening liquidity. A consistent theme in the non-bank market is groups are curtailing their maximum hold sizes – increasing their reliance on pre-close syndication. Frequently, the top 4 to 7 players are clubbing on transactions. Outside of one or two names, any transaction over $75 million is being pre-close syndicated. Winget: The ABL market slowed in 2Q 2023 subsequent to the bank failures at the end Q1, as companies became cautious bringing new opportunities to market or amend/extend. However, we have recently seen an uptick in the ABL financing market opportunities over the last month, as companies have made the decision to move forward with strategic initiatives and financings. Fagnani: On the one hand, our firm has gotten much busier as have many of our competitors, the size of loans with issues has increased and the nature of the problems we are seeing are more complex than in the recent past. Most lenders are reporting an uptick in their problem loans or accounts on their “watch list.” In addition, bankruptcy filings are on the rise. On the other hand, many lenders report that their loan portfolios continue to perform very well. This is somewhat surprising given inflationary pressures, rising interest rates and a perceived change in lender risk appetite as a result primarily of the recent bank failures. We have seen an uptick in refinancing activity, and I think this is primarily driven by the aforementioned change in risk appetite. Perer: What will be the lasting effects from the most recent regional banking crisis? Barredo: Widely syndicated bank deals will be tougher to place for a while and I am seeing more hung bank syndications. Capital is precious to regional banks so deploying it in widely syndicated deals with no cross sell is much less interesting. We are generating deal flow for $150 million plus facility requests with Borrowers’ willing to pay a premium for a single lender and money centers are calling for $30 to 50 million allocations in deals they are unable to place. We believe this type of environment will continue for the next couple of years.
Seigel: Non-banks will continue to increase their market share. Already, in recent months large credit managers such as KKR, Carlyle, Angelo Gordon and Comvest have announced new $1 billion plus funds, which as those managers state in their marketing materials, are meant to fill the gap in bank lending capacity. Among regional banks, there will be less appetite to remain as non-agent co-lender in transactions for which there is no treasury management opportunity.
Winget: Banks (and subsequently ABL groups within banks) have become more focused on capital ratios and thus pricing and the appropriate ROE of their portfolio credit facilities. Fagnani: As noted above, we have seen some banks take a more conservative approach to risk and portfolio growth in recent months. It is not clear that this will be a long-term situation. Banks have notoriously short memories and love growth. I think a more lasting effect will be a more disciplined approach to deposit taking focused on consumer versus commercial deposit percentages, more focus on levels of uninsured deposits (i.e., over $250,000) as a percentage of total, avoidance of extreme concentrations and an extreme focus on capital levels. This may have an indirect impact on lending activities for some banks as limited available capital should be allocated to those products that provide the greatest yield. Perer: Have banks finally shifted to a risk-off mode that should benefit the ABL market? Barredo: I’ve been calling it the tale of two banks. It seems like on one side you have banks that are risk-off and worried about capital ratios. They seem to be running off loans and not actively pursuing new opportunities. On the other hand, you have other banks that are looking at this as an opportunity to grab market share and even get some yield out of their loans. Seigel: There has been a more active pipeline for asset-based lending because more middle-market companies are focused on bolstering their liquidity now that the government stimulus era is over. Companies that currently are borrowing within bank C&I groups – which are EBITDA and fixed charge covenant driven – are not in a position to access greater proceeds and are therefore more interested in asset-based solutions. Winget: Given banks’ heightened focus on ROE and capital ratios, I do believe a risk-off period will result and benefit the ABL market. Fagnani: We have seen this “de-risking” activity from a few banks, but I would not describe it as widespread. Some of our non-bank referral sources have reported more incoming requests for financing from borrowers being pushed out of banks (some gently, some shoved), but I think it would be premature to describe that as an industry-wide occurrence. Perer: Where is deal flow both in terms of quality and quantity compared to this time last year? Seigel: There is a greater number of opportunities in pipeline, with opportunities being “harder” in terms of the pieces that need to come together in order to be successful. Barredo: We’ve seen deal flow pick up moderately as advisors, companies and sponsors are casting a wider net for debt reads and term sheets. That dynamic is keeping pipelines robust at non-banks and there are definitely interesting opportunities to pursue. However, I see two problems. One is that there are fewer high-quality deals, so you have more lenders aggressively chasing a smaller subsegment of quality deals. Second, the M&A market has slowed, and that flow has been replaced by refinancings and restructurings. I think good ABL M&A deals with top tier sponsors are still receiving strong bank interest, so it is really the refinancings and restructurings being driven into the non-bank market, and I have found the deal quality to be challenged.
Winget: In 2023 the quantity of ABL financings is down versus the prior year, but the quality of opportunities has remained relatively consistent.
Fagnani: As a consulting firm we are not as close to new deal activity as perhaps some of my colleagues on this panel, but we are in constant communication with lenders. Deal activity appears to be very good for those organizations willing to actively participate. It does appear that some may be sitting on the sidelines at present. Perer: Is there enough supply to meet the pent-up finance company demand, especially given there are more new entrants? Seigel: Lenders that have clarity around their product box and are meeting the market in terms of eligibility and pricing will have a lot to work on. Lenders whose credit teams want better-than-average fundamental credit and are focused on large opening availability figures will have trouble winning opportunities. At least, that has been our experience of late. Winget: This is an interesting question, but I believe banks’ focus on capital and ROE will continue to impact hold levels as well as appetite for new financings, which will likely benefit finco demand. However, whether there is a sharp downturn is likely the equation needed to fulfill pent-up finco demand. Barredo: Non-bank ABL club deals are much more common today. As I mentioned earlier, the bank syndication market is struggling and the tale of two banks has also shrunk the universe of potential participants. That has created some interesting opportunities for non-bank ABL clubs that may help with the pent-up demand issue, but it is a bit soon to tell.
Fagnani: I would say emphatically yes. I cannot recall any time in my career when there has been such an abundance of funds available. Mind you, it is not all in the hands of banks or even non-bank ABL lenders, but if a borrower is willing to pay the higher rates some lenders require, I would say there is no limit to their ability to borrow.
Perer: Are we in unchartered waters or are there examples from past cycles to point to? Winget: I have been telling my team that every downturn is different, and the current market has not disappointed. The current focus on banks’ balance sheet management, liquidity and ROE has impacted pricing, hold levels and new financing appetite in a way we have not experienced. Seigel: For anyone who started in the business after 2008, the “unchartered waters” are interest rates. ABL pricing is based on a spread over LIBOR (now SOFR). With SOFR at 5.3% today versus practically zero for 14 years, deal math is a lot harder for capital intensive businesses. In many cases, the cost of incremental funds just doesn’t make sense relative to their return on assets. Fagnani: Economists cannot agree on whether we are in a recession, will be entering a recession, or if we will have a soft or hard landing. Inflation was high but is coming down, interest rates are higher than they’ve been in years, growth has slowed, and despite all this unemployment is low, there has been some wage inflation and consumer spending while not necessarily robust, has been maintained. The stock market is also presently on a run. So, no, I don’t think this is like any other cycle I have seen. We have trouble even saying what it is. One thing is clear – our economy is resilient and while some sectors experience weakness, others flourish. As such, basic best practices should prevail (as always) – expense discipline, margin maintenance, inventory optimization, strategic planning, etc. This is how we survive any cycle, uncharted or otherwise.
Perer: Who is poised to take more share between bank and non-bank ABL and why?
Barredo: We believe those who are best-positioned have big balance sheets to refinance and hold the SNCs, as well as those who aren’t afraid of taking a chance on a riskier credit with less than 12 months of runway. I remember how during the Great Recession GE Capital took down large holds AND leaned in hard to the retail restructurings with no real fear of liquidating some of the largest retailers at the time. That strategy served them well. I think we will see this again; the question is a matter of who takes those risks.
Seigel: In the market Crown tracks, which is $20 to $200 million ABL transactions, we believe the bank share of the market is 80 percent. Then, there are 40 non-bank ABL platforms that are battling for 20 percent of the pie. Banks will always dominate the market based on inherent pricing advantages, with non-banks continuing to grow their share modestly. Banks are not going to lean into turnarounds, low opening availability, or situations where speed is paramount, and in aggregate I’d expect that share of the market to grow.
Winget: I believe the answer will depend on the depth of a potential future downturn/recession. Bank ABL portfolios are generally of good quality. Pricing will dictate whether non-bank ABLs can compete and/or participate in Bank ABL financings.
Fagnani: Most bank-owned ABL shops appear, with a few exceptions, to be more risk averse. There was a time when the industry sought to finance turnaround situations and even bankruptcies. I do not see the banks actively participating in these activities at this time and believe they have ceded this part of the market to non-bank ABL shops and alternative lenders. So, if the economy actually does falter, I think we will see non-bank ABL shops take market share as banks seek to exit deals and companies seek refinancing. Non-bank ABL shops, in general, are also nimbler and faster to make decisions with fewer layers to navigate. Again, this helps borrowers that need speed and closer access to decision makers. That said, banks will always be able to offer the lowest rates and all the ancillary bank services which are so vital to every business. In addition, only the larger banks can underwrite and syndicate a very large transaction. In that sense the market is bifurcated. The large deal market will always rely primarily on banks to get the deals done while the non-bank ABL shops can effectively compete in the middle market and lower middle market. We should note that there is a newer breed of alternative lenders, the private credit funds, that have entered the ABL space and I believe they are poised to take market share from the banks on very large syndicated deals. They are far more costly, particularly now, but appear to be much more risk tolerant and generally faster to get to a closing.
Perer: What are the primary market drivers your team focuses on the most?
Seigel: We extensively track the lenders within the ABL market. For bank ABL, we track and have now released publicly our summary of the 50 most active bank ABL lenders. Within nonbank, we track 40 finance companies that have announced $20-plus million ABL transactions, also publicly released. We track these companies by deal announcements, deal size, and for those who fund public companies, we track the asset eligibility definitions and financial covenants contained in credit agreements pulled from SEC filings. In our quest to bring transparency to the ABL market, we are in the process of finding compelling ways to share this research publicly.
Winget: HBC remains focused on growth as we have hired talented and experienced ABL people in new offices and markets in 2023 in the Southeast, Midwest and West. We have also focused on growth within our ABL retail and metals verticals.
Fagnani: Many of our referrals come from lenders, lawyers or sponsors. We work with both healthy companies and companies in distress. We tend to focus on industries showing specific weaknesses (as it impacts overall performance) as well as macro events such as interest rates (inability to service debt or margin erosion), supply chain issues (as it relates specifically to inventory and delivery issues), shifting consumer buying habits (bricks and mortar versus e-commerce) and technology (those companies that harness data and how to effectively use it to win most of the time). We try to shift our focus as industry and macro events evolve.
Perer: Have you changed your strategy in reaction to where the market is today and where you think it is heading?
Winget: At HBC we have not changed our growth strategy. The challenges of the current banking market have actually provided us with better candidates to grow geographically and within the verticals.
Barredo: I am spending a lot more time looking at in-court and out-of-court restructurings. Businesses are over levered right now, but we are seeing attractive opportunities to work with companies in the early stages of turnaround efforts to optimize their balance sheets with fresh liquidity. We’ve been leaning in on these opportunities by putting them on ABL-lite or asset coverage covenant structure instead of traditional borrowing bases and charging a higher yield for that accommodation. This allows them to feel more like cash flow revolvers that these companies are used to but still allow some of the structure and appraisal discipline of an ABL.
Fagnani: We have always tried to go where the deals are and that means getting to know all the lenders in the marketplace including new entrants. We have also sought to bolster our talent in those areas where we see weakness so that we are prepared to take on any assignment regardless of industry. We merged with a very large accounting firm, PKF O’Connor Davies, about a year and a half ago. They provide us with additional industry expertise and bench strength. We think this will provide a long-term advantage.
Seigel: We honed our focus heading into 2023 exclusively on the market for $20 to 200 million asset-based loans. We did so because we believe we have a strong value proposition in this niche, and decided we would be most successful and happiest focusing on what we know best when trying to compete with the many well regarded investment banking firms that are much larger than us.
Perer: Do you face more competition from banks or non-banks?
Barredo: It is still a mix of both depending on the type of deal. One major difference I’m noticing this year is that a lot of deals just aren’t transacting. Seller price expectations remaining high have put lots of processes on hold. Incumbent commercial banks aren’t getting refinanced out and are not interested in liquidating right now so we are seeing them kick the can until Q4 with maturity dates getting extended. The stasis across the market right now doesn’t seem sustainable.
Seigel: One of the best decisions my partner Evan Nadler and I ever made was to launch a capital markets business that serves both banks and non-banks rather than competing with them. Our capital markets business has been 60 percent non-bank execution, and 40 percent bank. We try to appeal to both groups by being a source of market knowledge, presenting them with all of the information they will need in order to make an informed credit decision, and not wasting their time on deals they aren’t going to win.
Winget: HBC competes primarily with bank ABL groups. Non-bank competition remains primarily cash flow and structured finance credit facilities for the purpose of acquisition financing. Bank ABL continues to have a pricing advantage over non-bank.
Fagnani: Not relevant to PKF Clear Thinking.
Perer: How is the turnaround consulting industry evolving?
Fagnani: Fundamentally, what we do has not changed. Business and situation assessment, development of strategic options (which may include a debt restructure in or out of bankruptcy), development of budgets and supporting data, implementation, review and re-calibration, A/P and inventory management, etc., remain the backbones. However, we have seen some consolidation (much like our aforementioned merger) and we have seen the larger firms get very large and branch out into a whole host of specialized areas. I will say that turnaround firms are built to help fix companies, to improve performance, but all too often we are brought into situations very late – the borrower is in crisis, liquidity is completely gone, the lender is out of patience and that leaves very few options. In these cases, there is less “turning around” and more liquidation of assets. I am not sure I would say this is how the industry is evolving, but it’s a current phenomenon that is not necessarily for the best.
Seigel: My perspective, based on my friends in the industry, is that turnaround firms have been staffing up in anticipation of being increasingly busy on restructurings and cash flow improvement mandates. We work closely with several of these firms where there is a mutual appreciation of each other’s value-add.
Winget: HBC is a proponent and utilizes turnaround consultants with our portfolio customers. Our valued turnaround consultants remain a critical partnership to HBC’s success.
Perer: How does the prospect of a multi-year, higher interest rate environment affect your business?
Winget: A higher interest rate environment increases risk within leveraged borrowers, especially with thinner margins. A multi-year higher interest rate environment should benefit ABL as companies seek a more flexible financing structure and look for alternatives to a traditional cash flow, or MM, financing structure.
Barredo: I think this is generally viewed as a good thing for non-bank lenders. The main issue is that debt service may be unsustainable for some of these businesses if interest rates remain higher for longer. Middle market companies are dealing with the adverse impacts of wage inflation, rising input costs, and discounting/margin pressures all on top of elevated interest rates. This is part of the reason low amortization and PIK toggle options are becoming popular as they are giving companies flexibility to manage through the interest rate environment.
Seigel: The increased costs are obviously challenging for our clients as debt service coverage, and total leverage multiples have been the primary constraints in transactions we have arranged.
Fagnani: In theory that bodes really well for our business as high interest rates materially impact a marginal company’s ability to service debt or survive. However, I do not believe we will remain in a high interest rate environment for a sustained period. As/when the Fed objectives are met I think we will see rates decline.
Perer: What is a perception you have about today’s ABL market that is not widely shared?
Barredo: I think there are a lot of unrealized losses in both bank and non-bank ABL portfolios right now. It will be interesting to see how that will unwind but as a non-bank, we have more tools in our arsenal to manage through those situations.
Seigel: The ABL credit approval process in general is overly sequential and compares poorly to corporate cash flow-based financings. The reality is that in virtually all middle market ABL closings, there is a credit committee that contains one or more decision makers whose backgrounds are not in ABL, and this creates friction to the process at a time of uncertainty. I am not sure this is the hill that I should try to die on, but my number one advice to asset managers and bank executive teams that back ABL platforms is to stay off credit committee and let the ABL credit professionals approve the ABL transactions!
Winget: The current Banking market and focus on capital should have a positive impact on overall ABL market demand. ABL enjoys a favorable LGD history that benefits pricing and ROE models. This may create opportunities and a market that is more like decades past.
Fagnani: I’m not sure whether this is widely shared or not, but Dan Fiorillo and I co-authored an article highlighting the fact that many of today’s younger professionals entered and grew up in the industry during a long period of excellent portfolio performance and few challenges and as a result may lack the requisite experience if/when their portfolios take a real turn for the worse. Training is important and can help, but there is nothing like hands-on experience and there just have not been many opportunities for people to hone their workout skills. Another perception I have is that for many organizations, what they call ABL today is a watered-down version of the original. Taking a lien, getting a once-a-month BBC and doing one field exam a year may be fine for near-investment grade borrowers with lots of liquidity and a low fraud profile, but may not be appropriate for more mainstream borrowers. It is called “asset based” for a reason and detailed attention to the specific assets involved will serve lenders much better if we do experience a sustained downturn.
This article was first published at https://www.abladvisor.com/articles/36921/abl-industry-state-of-the-union-q2-2023
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