There is a jump ball right now for middle and lower middle market ABL generally defined as facility sizes between $10 million and $100 million. For purposes of this article though it is really focused on $10 to $30 million. The mega-banks are finding it a challenge to make money on smaller facilities, the regional banks are continuing to get aggressive and the non-banks are flush with cash. Let’s be clear that this is driven by the mega-banks, as always, being market makers and right now they are not making the market for several reasons. COVID and bank cost cutting measures and restructurings have the big banks very much focused on more profitable and larger clients. The syndicated market is frankly liquid, profitable and doing well. The smaller-end is fraught with risk, lack of liquidity, myriad competition and takes just as much internal resources to manage. COVID presented a catalyst for regional and non-banks to grab share from the mega-banks.
The mega-banks recognize the market opportunity, but are struggling to find ways to make money on small ABL facilities. This is not a new phenomenon. Same group of people originating, underwriting and managing credits both big and small or in several instances there are banks with two separate ABL groups to focus on facility sizes from $10 mm to $30 mm and $30 million to $1 billion. There is no easy way for mega or super-regional banks to manage this segment. Smaller facilities require same overhead as larger loans with skinny pricing while at the same time it is harder to cross sell the higher yielding platform products, etc. There are few compelling reasons for money to be a loss leader when you can’t cross sell enough of the higher margin products. The big money is upmarket in the large syndicated and agented facilities, but the actual clients are in the lower middle market that still need to be served. It’s especially a challenge for one trillion dollar balance sheet banks regardless of the structure.
There is real white space here where the regionals and non-banks are trying to assert themselves. What made this market segment so competitive is the desire of mega-banks to double down and in some cases triple down on the lower middle market. The need to retain clients or gather assets led to the need to service smaller clients. At the same time, mega-banks thrive and survive off the platform model, which entails selling many services to one bank client. It’s harder to do and the needs are just not the same with smaller businesses. This space is easier to target and serve in a boom market, but less so during a down one. These factors plus the headaches of dealing with smaller clients during a pandemic has been felt by the mega-banks and they are adjusting by shedding smaller clients.
As a result, the regional banks are having more success profitably acquiring, servicing and maintaining ABL clients with smaller facility sizes, especially ones that are sub-$20 million in size. What makes this market dynamic so interesting is that neither constituent expected to see so much competition. The regional banks invested heavily to go after a segment that the mega-banks all but abandoned a few years ago and the non-banks did not foresee so much competition from regional banks. What led to the true jump ball is the fact that several years ago the mega-banks realized the hole they were leaving in the lower middle market and restructured their groups or formed sub-groups to focus on smaller facilities. So the past several years have seen the mega-banks competing against both regional and non-bank ABLs. At the same time, each of these groups have also been competing against their respective commercial banking groups. A fair amount of this can be attributable to a longer than expected bull market, which one could argue is now at a critical junction due to COVID.
Due to COVID and change in economic cycle, the wind is going to push the ball in the direction of regional banks and non-banks who are well equipped to aggressively compete on sub-$30 million facilities. The mega-banks are once again very pre-occupied with regulators, capital bases, cost-cutting. This does not bode well for the least profitable and hardest to serve segments of ABL – smaller facilities. So what started out as a true jump ball among three constituencies’ should turn into a real tug of war between regional banks and non-banks. It’s a pretty fair fight as one group is competing solely on rate and the other on structure. To add to that, many non-banks pilfered the BDO staffs of mega-and-regional bank-ABLs purposely so they could be competitive on a region-by-region basis. The non-banks have the regional staff who have the relationships to go out and be aggressive.
Tune in to watch the next level of competition between regional bank-ABLs and non-banks. It should make for good TV as the market is there for the taking.
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