State of the Capital Markets: Excess Liquidity & Low Interest Rates
Howard Brod Brownstein interviews three active participants on the current state of ABL capital markets. While market conditions remain extremely competitive, destabilizing factors around the world continue to create uncertainty and will likely provide challenges for syndicated ABL lenders down the road.
As 2015 nears its end, the capital markets continue to reflect an excessive amount of liquidity as well as an unprecedented long period of very low interest rates. Asset-based lenders are typically “close to the ground” when it comes to our country’s economy. Recently, a common sentiment has been shared by lenders and private equity firms alike: “Too much liquidity chasing too few deals.”
Many lenders were also chastened by the Great Recession, and continue to chafe under the increased regulatory burdens that have arisen post-downturn, the expense of which is made all the more difficult by the meager spreads caused by historic low interest rates. Despite these challenges, as the economic recovery has slowly but steadily continued, many lenders continue to increase “hold” limits, and — for those that act as syndicate agent —raise their sights in terms of overall deal size.
With the Fed’s steadfast refusal to raise interest rates, overall ABL market conditions remain soft in terms of pricing and structure, and every day a new nonbank lender seems to be offering ABL products. Everyone is looking for deal flow.
These continuing trends led ABF Journal to once again survey leading capital markets executives about market conditions. What are the current conditions for agents and participants? What has changed? Have conditions returned to the pre-downturn environment? This time around, ABF Journal called upon Dorothy M. Killeen, managing director of Wells Fargo’s Loan Sales and Syndications group, Anthony J. Foti, managing director at PNC Capital Markets and Neil Wessan, group head and managing director at CIT Capital Markets.
WHAT’S HAPPENING IN GENERAL IN THE CAPITAL MARKETS? HOW WOULD YOU DESCRIBE MARKET CONDITIONS AND TRENDS?
Killeen notes that volatility has returned to the capital markets at a level Wells Fargo hasn’t seen in many years. However, while the market has experienced a correction in equities and seen weeks where debt market activity has slowed to a crawl, Killeen doesn’t expect liquidity in any particular market to dry up entirely for a prolonged period of time. Historically, during these periods, Wells Fargo sees investors become more selective and credit-focused, resulting in bifurcation between the “haves” and “have nots.” This theme emerged in early 2015 as it relates to the impact of regulatory changes on asset-based borrowers, and Killeen believes that bifurcation will be more pronounced during periods when liquidity tightens in the broader fixed income markets.
Foti says that middle market M&A activity has not been as robust as PNC would like, so ABL market forces are very aggressive on price and structure, as demand far exceeds supply. ABL lenders are benefiting from leveraged lending guidelines, since corporate cash flow transactions are morphing into ABL structures with springing dominion and covenant provisions. These transactions may never get to be syndicated, since ABL players typically have larger “hold” positions relative to their cash flow lending counterparts, and there are an abundance of banks with existing borrower relationships ready to meet the balance of the borrower’s needs.
Wessan says that loan capital markets are still quite vibrant and “open for business.” He feels that the market maintains strong liquidity, but is showing some signs of caution. “Long-story” deals require more time to clear and investors are being a bit more cautious, not just “waving all paper in.” CIT emerged from the recession with a well-capitalized balance sheet and a more competitive cost of capital, having become a regulated bank.
HOW HAS THE GE CAPITAL EXIT AFFECTED SYNDICATED ABL MARKETS? IS THIS A HARBINGER OF THINGS TO COME, WITH MORE BANK ABL’S FINANCIALS EXITING DUE TO LEVERAGE LENDING GUIDELINES?
Killeen says GE Capital has been a very unique entity and hard to compare to traditional banks when it comes to leveraged lending and business strategy. In 2014, GE served as left lead arranger for 23 syndicated asset-based credit facilities totaling $2.6 billion in volume and representing 2.3% market share. In Kileen’s opinion, redistribution of this size of market share over the course of 12 to 24 months will most likely not result in a visible shift in the alignment of asset-based lead arrangers.
Wessan notes that it’s still too early to tell what effect GE’s exit will have on the syndicated ABL markets, and so far, the rest of the market has been able to absorb its exit. He expects fewer banks will play in the ABL market of special mention credits, and predicts that we will begin to see nonbank lenders begin to fill that void, albeit at higher spreads.
HAS THE MARKET TURMOIL CREATED BY DEVELOPMENTS IN CHINA’S ECONOMY AND STOCK MARKET BEEN AN ADDITIONAL SOURCE OF PERCEIVED RISK? HOW ABOUT THE DECLINE IN OIL AND GAS PRICES?
Wessan has found that the market turmoil created by developments in China’s economy hasn’t directly impacted the middle market, where CIT mainly plays. With regard to the decline in oil and gas prices, he says that there’s much less appetite for paper among CIT’s syndicate distribution clients, and thinks that the market is still looking for a new level or definition of what is “normal.”
Foti confirms that the decline in oil and gas prices has clearly affected lending to the energy sector, and as a result, the lending market is selectively allocating capital to transactions in this space.
Killeen notes that the syndicated asset-based market has proven incredibly stable and liquid during short-term market disruptions. She points out that the largest domestic banks are generally flush with cash and, for some, regulatory initiatives may provide more capital for banks to funnel back into the lending system. Slowing global growth and the prospect for rising rates will continue to impact markets, particularly equities, but Killeen doesn’t expect a broad-based trickle down to asset-based lending. Instead, she expects heightened deal-by-deal evaluation of increased credit risks for certain sectors and cyclical industries.
ALTHOUGH THE GREAT RECESSION IS IN THE REARVIEW MIRROR, REGULATORY CHANGES CREATED IN RESPONSE TO IT ENDURE. HOW HAVE THESE REGULATIONS AFFECTED THE CREATION AND MANAGEMENT OF SYNDICATED LOANS?
Foti says regulatory pressures created by leverage lending guidelines have resulted in an inflow of deals into bank ABL from cash flow lending, increased focus on leverage guidelines, the potential need for premium pricing, and newly-created finance companies, or established ones, to fill in the market gaps created by banks that are taking a more conservative approach to structuring transactions.
Wessan observes that, as the result of the increased regulations following from the downturn, there is clearly less willingness by banks to violate the new guidelines. Nonetheless, he believes that total leverage, for the most part, has come from where one would expect the market to be at this point in the cycle.
Killeen thinks that regulatory changes have had a bigger impact on which deals are underwritten and syndicated, than on how deals get syndicated. “Leveraged loan” designation presents new requirements in the underwriting process and approval chain for most banks, she says, but there remains a deep universe of buyers for those asset-based leveraged loans which are not expected to be criticized when it comes time for the annual Shared National Credit Review.
WE HEAR PHRASES LIKE “DÉJÀ VU” AND “LENDER AMNESIA.” DO YOU BELIEVE PRICING AND/OR STRUCTURE IN THE MARKETPLACE ARE PROPERLY ALIGNED WITH RISK?
Killeen reminds us that asset-based lending is often a relationship-oriented product for lead arrangers and for many participants. Similar to syndicated credit facilities for high grade borrowers or leveraged pro rata facilities, asset-based pricing is often affected by the competitive landscape and opportunities to play a role in other pieces of the capital structure. In this context, she says, it’s hard to assert that risk/return is always evaluated at the asset level. Structures clearly have been impacted by competitive pressure as well as the transparency of structural precedents provided to borrowers via counsel and public filings. However, Wells Fargo has witnessed very few instances of structural deterioration which they believe truly undermine the basic principles of asset-based lending.
Wessan agrees that, for the most part, pricing and structure in the marketplace are properly aligned with risk. Foti comments that it feels like pricing and structures are even more aggressive than before the financial crisis. There are too few “new money” transactions coming into the market, which has created very favorable terms for the borrower. He feels that risk does not seem to be properly compensated by interest rates and upfront fees, and there needs to be ancillary business booked with the ABL loan in order to justify committing dollars to these aggressively priced and structured deals.
IN WHAT WAYS DO YOU THINK YOUR OWN FIRM’S EXPERIENCE OF CURRENT MARKET CONDITIONS MIGHT DIFFER FROM THE EXPERIENCE OF OTHERS?
Foti says that PNC’s product mix of credit and non-credit products allows it to compete across the spectrum of secured transactions, and that PNC can readily adapt to changes in market conditions.
Wessan says CIT takes a prudent approach to lending, and has been willing to pass on some transactions that other lenders have accepted due to leverage and inability of the borrower to amortize the debt over time. He says CIT has succeeded in raising awareness among equity sponsors with which they work that, “Just because the leverage is available doesn’t mean that they should take it.”
Wells Fargo’s scale and scope provide it with a perspective that its competitors may not have on pricing, structure and the competitive landscape across geographies and sectors for deals of all sizes. When market conditions change, Killeen notes that Wells Fargo is able to identify trends quickly through its portfolio and origination teams.
WHAT IS THE OUTLOOK FOR SYNDICATED ABL IN 2016 AND BEYOND?
For Wells Fargo, refinancing of the current asset-based market portfolio is the largest driver of syndicated volume. Given broad-based market volatility, limited visible M&A activity oriented towards asset-based lending and an uncertain outlook for interest rates, Killeen doesn’t see indicators that 2016 will be any more eventful than 2014 or 2015. Wells Fargo also doesn’t necessarily expect 2016 to bring an outsized share of “jumbo” transactions of $1.0 billion or more, which typically represent 25% to 30% of total volume. Heading into 2016, Killeen notes that there are 14 current jumbo issuers with less than $20 billion in asset-based facilities facing maturities within three years. Event-driven financings always account for a meaningful segment of jumbo volume, Killeen says, but it’s hard to identify drivers of increased M&A or LBO activity for the asset-based market in 2016, especially given the current regulatory environment.
For CIT, the outlook for syndicated ABL in 2016 and beyond includes very tight markets and a competitive landscape for deals that are bank eligible. For other deals, it looks rather sloppy, meaning that the markets reflect a state in which there are insufficient numbers of buyers and sellers to keep orderly pricing.
Foti continues to see ABL as part of the mainstream capital markets, and that the flexibility provided by the ABL product will continue to offer ongoing opportunities.
IS YOUR FIRM TYPICALLY AN AGENT OR A PARTICIPANT? DOES IT FULFILL DIFFERENT ROLES IN DIFFERENT DEALS? IF/WHEN ACTING AS AGENT, WHAT DO YOU LOOK FOR IN SOLICITING PARTICIPANTS? IF/WHEN ACTING AS PARTICIPANT, WHAT DO YOU LOOK FOR IN AN AGENT?
Wells Fargo plays in every role across the asset-based market, from sole lender to left lead arranger to participant. In a lead role, Killeen reports that its best partners provide a quick, accurate read of the credit and their institution’s appetite — they proactively identify credit risks or return hurdles which may impact their approval process, but are also willing to dig in even if the opportunity presents challenges. As a participant, Wells Fargo has strong relationships with all of the active lead arrangers in the asset-based market. Its credit focus and level of business diligence are equally robust whether leading or participating, so it expects the left lead to present a comprehensive package and provide timely, thorough answers to diligence questions. Monitoring capabilities and back-office support are matters which Wells Fargo checks through due diligence in advance with any new lead partner.
At PNC, the Business Credit Group completes the preponderance of deals as sole lender or as the primary lead on a syndicated transaction. PNC participates in transactions where it is familiar with the sponsor, has a relationship with the company extending beyond just credit and, of course, where the returns make sense. PNC looks to partner with other lenders that view credit similarly, so that it can rely on the bank group’s support, both under a positive growth scenario and under more challenging credit scenarios.
Similarly, CIT typically acts as an agent and a participant, depending on the transaction. When soliciting participants, CIT looks for thoughtful partners who understand credit. Conversely, when acting as a participant, CIT looks for many of the same qualities, and a willingness to be open to the lending group.
ARE ANY PARTICULAR TYPES OF BORROWERS OR INDUSTRIES A BETTER MATCH THAN OTHERS FOR YOUR BANK’S CAPITAL MARKETS OFFERINGS?
PNC’s bank products, including capital market products, are geared towards middle market borrowers, and it is “industry agnostic.”
CIT has a nationwide lending platform and a team with expertise in a broad range of industries across the middle market, so it does not cite specifically favorite industries or types of borrowers.
Wells Fargo looks for a reasonable approach to lending in an asset-based structure against collateral which it can really understand and monitor, in which case it can find a product that will fit almost any industry. Similarly, with the extensive capabilities of its wholesale bank, there is a natural fit for most WFCF borrowers with additional product offerings, including capital markets.
WHAT ROLE DO EQUITY SPONSORS PLAY IN THE SYNDICATED LOAN MARKETPLACE?
Wells Fargo notes that, since 2010, sponsors have played a role in 30% to 40% of syndicated asset-based volume, on average. Through the second quarter of 2015, sponsor volume represented 41% of total volume, with 50% of this activity coming from only five transactions of $1 billion or more. Moreover, these statistics are a lagging indicator, since 25% of the first half of 2015 sponsor volume in ABL was actually underwritten and syndicated in 2014. LBO activity was down, by number of deals and volume, through the third quarter of 2015, and Wells Fargo expects leveraged lending guidance will continue to exert strong influence over sponsor activity in asset-based lending into 2016.
Wessan adds that equity sponsors are cobbling more deals together and reducing the underwriting requirements of the banks. The equity sponsors also show interest in knowing which institutions will be buying their paper.
Foti says that a large portion of PNC’s transactions involve equity sponsors, who take a very active role in determining which lending partners are chosen to participate in each transaction, since they need to feel that the agent and participants can work together to support them in good and bad times.
CONCERNING THE GOVERNANCE STRUCTURE OF AN ABL SYNDICATE, WHAT KEY FACTORS DO YOU WANT TO SEE IN PLACE? WHAT ISSUES, IF ANY, HAVE YOU EXPERIENCED WHEN THE SYNDICATE HAS INCLUDED NONREGULATED LENDERS, EITHER INITIALLY OR THROUGH PARTICIPANTS SELLING THEIR POSITIONS?
As Killeen reminds us, the vast majority of syndicated asset-based loans are not going to attract non-regulated lenders unless or until there is a distressed situation. The yield, relative value, lack of liquidity and lack of structural features such as call protection, just don’t appeal to this investor class. There have been a couple of situations during the past year where non-regulated lenders have presented both opportunities and challenges for revolving lenders, Killeen says, but it’s not something that the large market players face on a regular basis. Wessan adds that his institution is simply looking for a fair document that reflects sufficient structural protections for the various levels in the capital stack.
Your interviewer has seen distressed situations in which the original regulated participants have sold down or out, to be replaced by nonregulated funds that have a very different perspective, including their understanding that the syndicate members must live within the provisions of the loan documents. However, there’s not much distress right now, and so the specter of nonregulated loan syndicate participants may not be seen until economic conditions change.
ABL capital markets players concur that market conditions remain extremely competitive, and expect that to continue into the future and possibly intensify. However, destabilizing factors around the world — China’s economic plateau, ISIS and plummeting energy costs — continue to create uncertainty, and will likely provide challenges for syndicated ABL lenders down the road.