November/December 2016

The World of ABL: Still Flat After All These Years

2016 has been a roller coaster year fueled by a contentious U.S. Presidential election, sinking energy costs and the surprise British vote to exit the European Union. Yet, for a second year, the ABL front remained quiet. Too quiet, some might say. As we prepare to say “good riddance” to 2016, ABF Journal contributor Lisa Miller speaks with ABL leaders about the state of the industry. Spoiler alert: They don’t see much change for 2017.



Janet Jarrett, Managing Director & Head, Asset Based Lending, SunTrust Robinson Humphrey

Janet Jarrett, Managing Director & Head, Asset Based Lending, SunTrust Robinson Humphrey

The ABL product continues to play an important role for banks and other financial providers to help clients manage cash flow, prepare for economic cycles and use assets productively. It can be the ideal product in a lagging economy or a critical piece of the overall financing solution in a growing economy.

However, with too much supply and too little demand, today’s economic conditions challenge ABL lenders as they strive to reach volume targets. We asked four ABL executives to give us an insider’s view of supply and demand, market dynamics and performance outlooks.

“There is very little if any change in the balance of supply and demand from one year ago,” says Sam Philbrick, president of U.S. Bank Asset-Based Finance. “With this continued oversupply, pricing is still aggressive and the competition is intense. When you bid on a deal, you have to put your best foot forward and everyone realizes you have to bid to win.”

“Deal volume is essentially flat year-over-year,” says Janet Jarrett, managing director and head of Asset-Based Lending for SunTrust Robinson Humphrey. “The volume in our market generally hovers between $80 billion and $90 billion per year, and this year we are on track for approximately $85 billion. The deal count has been down modestly year-over-year and has been consistently moving downward over the last couple of years. This tells us there are more very large deals being executed in the ABL market each year.”

“New deal supply has been relatively limited this year,” says Dorothy M. Killeen, managing director at Wells Fargo Capital Finance. “More than 85% of ABL volume for the first half was refinancing. New money opportunities are not driving substantial new supply. For the first half, new issuers brought about $4.6 billion of volume to the asset-based market, and there was only one deal of $1 billion or more that came from a true new issuer to this market.”

“The ABL market remains very active, although some regions of the country are less busy than others,” says Seth Benefield, senior vice president at Bank of America Business Capital. “We see the most activity in the sole lender, core middle market space for facility sizes less than $100 million. In the large deal space, we have seen no shortage of investor demand.”

“Pricing continues to deteriorate, but the rate of decline has slowed dramatically,” says Philbrick. “Certain market participants cannot meet their return hurdles at today’s pricing levels and have to walk away from opportunities. This mostly affects some regional players that have a relatively high funding cost that causes them to be more selective than they were before. We have also seen capital pressure on the European banks that are stepping back from the U.S. loan market. If lenders don’t have revenue opportunities other than a loan, it is often hard for them to make the economics work.”

“During the recession, companies aggressively managed working capital to improve liquidity,” says Jarrett. “They continue to be disciplined about it, and despite top line growth, that discipline has kept the facility sizes fairly consistent for most companies. When an upsizing or increase in the facility is necessary, the existing lenders in the bank group absorb the deal.”

“The number of participants in the ABL market is near an all-time high, with more than 100 banks committing to a syndicated asset-based deal in the last 12 months, and more lenders are committing to higher hold positions,” says Killeen. “There are more than 50 banks that have been allocated $50 million or more on an ABL deal this year; 30 banks have been allocated $100 million or more. This helps explain the huge liquidity in our segment of the debt capital markets, and it’s part of why we see more and more cheap deals in the asset-based space.”

When it comes to M&A activity, Benefield observes that there appears to be tremendous interest from the buy-out community and strategic buyers for strong-selling companies in defensible industries. “This has driven up multiples and ratcheted up expectations for all sellers coming to market. As such, I think many buy-out sponsors are oftentimes faced with valuations they are not comfortable with or with sellers not willing to trade unless there is a compelling event to do so. Nevertheless, for 2016 we have seen solid M&A deal flow. M&A activity has been strongest in the small-to-mid cap space, and we are seeing deal activity pick up in the large cap space over the past 30 to 60 days. We are optimistic that this will continue and drive increased ABL volume as we head into 2017.”

Seth Benefield, Senior Vice President, Bank of America Business Capital

Seth Benefield, Senior Vice President, Bank of America Business Capital

“The capital markets were pretty choppy at the beginning of the year, which slowed M&A activity,” says Jarrett. “It’s coming back but is not as robust as it has been in other years. The M&A activity that we are experiencing is largely focused in acquisitions; we are seeing increases of existing credit facilities to accommodate tuck-in type acquisitions.”

M&A represented about 11% of first half volume but was on track for the lowest level of annual M&A volume since 2010. “We usually see about $10 billion to $12 billion of M&A volume a year,” says Killeen. “Third quarter shifted this dynamic entirely with the closing of the $4.5 billion Southern Glazers deal. Without that transaction, we’d still be below $10 billion. Fourth quarter looks to be about average for M&A. In terms of our pipeline, we don’t see a big push on deals that will close before year-end.”

“The hard part about the current M&A activity is that it often takes opportunities out of the ABL marketplace,” says Philbrick. “We have seen several clients purchased by investment-grade companies over the past year and that makes growing our business more challenging. Having said that, we have benefited from consolidation in the distribution sector that has brought several large companies into the ABL market for the first time. But overall, I would say that M&A activity has slowed our growth.”

Marketplace Challenges

When it comes to cash flow versus ABL, the 2015 market was described as “frothy,” and Jarrett notes the frothiness has continued. “It was there in 2015 and 2016 and will follow us into 2017. Until we see a retrenchment in the cash-flow market caused by declining EBITDAs or concern about the economy, we’re probably not going to see a real pick-up in ABL market volume.”

Benefield expects the market to remain competitive in 2017. “The pro rata cash flow market remains robust and competitive, particularly for strong credits with lower leverage.”

If you look at the total leveraged loan market, the ABL product continues to have a low market share. “A slow-down in the economy would put pressure on lenders’ portfolio quality and lead to a pullback by the cash-flow lender, thereby causing more borrowers to turn to the asset-based loan as a financing solution,” says Philbrick. “It comes down to the question of whether a borrower gets more debt capacity by leveraging the company’s cash flow versus leveraging its assets. ABL is more attractive as a solution when companies are looking for the additional flexibility that our product brings with fewer financial restrictions.”

“The debt capital markets are in a period of strong liquidity and tight pricing which leads to a borrower-friendly environment,” says Killeen. “The institutional loan and high yield markets had a strong start post-Labor Day, and pricing is near 2016 tights. The ABL market is no different. We’re seeing the highest percentage of deals open at LIBOR+150 or lower than we’ve seen since the recession.”

Unhampered by the stricter capital requirements and leverage lending guidelines that banks face, the market seems ripe for alternative lenders to step in. Benefield says such lenders fill a void, particularly for companies that cannot access traditional debt markets such as term loan B/high yield markets. “Typically these are highly leveraged situations and turnarounds. However, I do not believe we are losing market share to the alternative lenders. We will continue to partner with some of these lenders in providing solutions to our clients. An example would be a situation whereby we provide a revolver facility, and the alternative lender provides a first or second lien term loan.”

“Alternative lenders are not actively competing with us for asset-based loan products, because the yields we require are far below what they need to make it work for their business model,” says Philbrick. “They are typically providing the higher cost, higher risk part of the capital structure.”

“We talk about alternative lenders in terms of how they’re encroaching on the ABL market, but we don’t see them as much as we talk about them,” says Jarrett. “We see them participate in certain highly leveraged transactions, in asset classes that are not traditional to ABL, or with companies that have challenging operating stories where the ABL market prefers to stay tight to the assets. We also see them at the smaller end of the market with some of the smaller EBITDA companies.”

Dorothy Killeen, Managing Director, Wells Fargo Capital Finance

Dorothy Killeen, Managing Director, Wells Fargo Capital Finance

“The direct lending market has been a growth platform for several years, going back to 2008 when liquid credit markets were not functioning for a meaningful period of time,” says Killeen. “Direct lending is taking share from the institutional loan market and providing solutions for potential high yield issuers. They’re occasionally displacing typical bridge facilities, either due to leveraged lending concerns or to help issuers avoid market flex, and the size of the facility they can provide continues to increase. If you look at the Qlik Technologies financing led by Ares Capital, it’s a great example of how direct lending is no longer just a middle market solution. Direct lenders can provide a range of different structures that can bring a unique option to the table for more leveraged issuers or sponsors in certain situations.”

“We are very mindful of the environment in which we play, but the fundamental assessment of the asset quality and the liquidity of our borrowers haven’t changed,” says Jarrett. “Our fundamental underwriting basis hasn’t changed, either. ABL is a great tool for cyclical companies. We spend our time actively working with clients to help them align their business strategy with their capital structure, so they have ample liquidity in their business to ride through the cycle.”

“The increase in regulatory focus causes our associates to spend more time on compliance,” says Benefield. “However, this has not affected the way we approach going to market in any material way. We have always had a strong credit and compliance culture and will continue to do so.”

“The more sophisticated the client, the better their understanding of potential lending partners,” says Killeen. “While there are certain transactions and capital structures that make more sense for a non-regulated lender, the universe of leveraged borrowers with sizable capital needs that meet bank lending criteria in an ABL format is still very compelling for U.S. banks.”

Industry Dynamics

As is always the case, some industries are doing better than others, and energy prices have played a key role. “There has been significant decline in the underlying values of commodities such as energy, metals and agriculture,” says Philbrick. “Our clients with inventory based on those commodities have felt a meaningful decline in those values. The good news is, there has been some stabilization in commodities prices in general that has helped bolster their performance.”

“The stabilization of energy prices has helped banks work through some challenges in their energy portfolios,” says Jarrett. “Lower energy prices also help certain companies in the portfolio, because it lowers their cost of goods. Chemicals, plastics and industries that tend to be petro-chemical-dependent are benefiting from more stable pricing.”

“I see relatively nominal impact in 2017 on the broader ABL market from stabilized energy prices,” says Benefield. “In terms of energy-related ABL deals, the stabilization in oil prices is a positive versus the declines and volatility experienced in late 2014 through early 2016. We have always been very thoughtful and selective in providing ABL solutions in the oil and gas space. A strong emphasis on client selectivity will continue in 2017.”

Killeen expects retail to be a bigger driver of ABL activity over the next six months. “There’s a lot of activity among financial sponsors and potential corporate-to-corporate deals that make sense in retail. Certainly, there’s potential for more DIP activity and defaults in retail, but in terms of new asset-based transaction activity, we expect to see a number of new retail transactions announced and closed over the next six months.”

“Retail is under pressure, but the ABL market has always enjoyed strong asset quality in the retail segment, even in a distressed situation,” says Philbrick. “The structures have proven to be protected, so I don’t see the retail market as high risk. However, given the amount of available equipment in the marketplace, the equipment rental space could come under pressure.”

“We are closely monitoring the metals and retail spaces,” says Benefield. “In metals, we have seen significant year-over-year improvement in performance by many of our clients. For retail, the upcoming holiday season will be important, and we are monitoring the data closely.”

It’s smart to track industries that can be affected by commodity price volatility or asset revaluation. “The nature of the asset-based market is liquidity-focused, so we examine the liquidity of our issuers,” says Jarrett. “We want them to have sufficient liquidity to weather cyclicality in the business, asset value volatility or operating challenges. Steel is a good example of a commodity-based product whose liquidity may move as the pricing of that commodity moves. We are mindful about structuring facilities in a way that allows those companies enough of a liquidity runway to withstand the volatility.”

Now that GE Capital has essentially exited the financial services business, what sort of fallout do our ABL leaders foresee? “The ABL space remains competitive, and GE’s exit has not had a significant impact,” says Benefield. “GE had been less active in the ABL business over the past several years.”

“Market liquidity has been as strong as ever,” says Jarrett. “In fact, our market cleared a $4 billion transaction earlier this year, which is probably the largest ABL transaction I can remember. It hasn’t affected the demand side, either. There’s no outcry from companies wanting new financing sources, so it hasn’t affected access to capital.”

Sam Philbrick, President, U.S. Banked Asset Based Finance

Sam Philbrick, President, U.S. Banked Asset Based Finance

The wind down of GE Capital presented Wells Fargo with opportunities to build out its business. “We’ve announced sizeable acquisitions in real estate and commercial lending, and the integration of GE’s Commercial Distribution Finance business added approximately $13 billion in assets with 2,000 OEMs and 40,000 dealers. We also picked up several new left lead syndicated asset-based transactions that helped build out our core ABL business,” says Killeen.

“The sale of GE did not eliminate competition by any means,” insists Philbrick. “The competitors that bought significant pieces of the GE franchise are now aggressively using their improved share to take advantage of those markets. We will have to see if they can build upon the market share they bought.”

When asked about the effect of Brexit on the U.S. ABL market, all agreed that it was too soon to tell. Most suspect that any impact to issuers would be indirect. “It’s rare that we have a customer who doesn’t do some level of business in Europe, so Brexit creates a business uncertainty that each will have to figure out,” says Philbrick. “Time will tell what the real impact will be, but I don’t see it affecting ABL directly.”

2016 Performance, 2017 Outlook

When asked about performance for the first half of the year, Benefield says, “We are having a good year. Despite some headwinds that include lower commodity prices, our revenue and loan outstandings are up year over year, and asset quality remains strong. We continue to be well-positioned to compete in the marketplace.”

SunTrust Robinson Humphrey’s platform is growing, too. “We have an increased number of commitments, outstandings are up and the lead relationships in our portfolio are up considerably,” says Jarrett. “We like what we’re doing, and we hear that from our clients!”

“Our level of new business activity is consistent with prior years, but the headwind is twofold,” says Philbrick. “First, strong, strategic investors acquired some clients, and now the ABL line isn’t needed. Second, because the economy is slow and steady but not robust, utilization of existing lines of credit is down a bit over last year. That puts pressure on our loans outstanding.”

The GE acquisition and integration of the Commercial Distribution Finance business has been a key focus for Wells Fargo Capital Finance. “Our next milestone is closing the CDF Europe, Middle East and Africa purchase, but the real work around the integration and tapping into our new clients began with the March closing of the North American CDF business,” says Killeen. “In addition, we have seen measurable growth in our healthcare ABL business.”

As for the future, Jarrett says, “Absent a systemic shock of some sort, I don’t expect 2017 to be materially different from 2016. I expect continued steady measured growth. With an excess of supply and limited demand, we need to be thoughtful, align with our clients, execute on our strategy and deliver very high quality service.”

Benefield forecasts continued growth in 2017. “We have invested in regions that we felt were previously under-represented by hiring new business development officers. We will continue to provide best-in-class products and solutions that include credit, treasury, risk management and investment banking. Like most good businesses that have produced consistent returns, we expect the market to remain competitive.”

“In this environment, it’s all about execution and client selection,” says Philbrick. “For years I’ve been anticipating an economic downshift that might create more ABL borrowers, but the reality is that this economy is continuing to expand, however modestly, and we have to build our plans around that expectation.”

“ABL has been a relatively flat market for the past three or four years, which is not inconsistent with banking as an industry,” concludes Killeen. “Rates look to be on the rise but not in a rapid fashion, and that could help drive 2017 budgets up modestly. For the most part, we expect 2017 will just be more of the same in ABL Land.”