November/December 2012

2012 ABL Volume Drops; 2013 Dealflow … ‘Questionable’

Asset-based lenders have found deal opportunities rather slim so far this year, with Q1/12-Q3/12 ABL volume dropping 45% over year-ago levels. Where dealflow will come from for the rest of the year and into 2013 is questionable, as the refinancing cliff has been pushed out to 2017, leading most lenders to dismiss hopes for a meaningful pipeline in 2013 absent a pickup in M&A.

Asset-based lenders have found themselves far less busy in the last several months than they would have hoped — largely a reflection of the slimmer deal pickings that they have had so far this year. At $57 billion, Q1/12-Q3/12 ABL volume represented a 45% drop over year-ago levels (See Figure 1).

Issuance totals were not the only measure of the market slowdown. Lending activity based on deal count also showed a 25% decline from year-ago levels to close out the first nine months of 2012 with 242 syndicated credits, compared to 302 deals in 2011.

“It’s hard not to think of this year as slow,” said one lender. “But really it is a more normalized year coming off such a high in 2011.”

Providing a bit of perspective, at $101 billion, 2011 issuance represented record volume for the market, and at $82.85 billion, Q1/11-Q3/11 issuance was already $30 billion greater than the previous market peak for the nine-month period in 2007.

“Certainly the level of activity that we are seeing isn’t unexpected,” said an arranger. “Last year, we saw so many deals that issuers would have done in 2009 and 2010, but they did not, due to price points. So, last year we had repricings.”

New ABL volume came in under $15 billion in Q1/12-Q3/12, or 26% of total issuance for the year. Although the proportion of new lending activity is up from the 18% observed in 2011 and on par with 2010 levels, it is a far cry from levels hovering near or even above 50% of total issuance between 2006 and 2008 (See Figure 2). In many cases, the 2012 new money transactions were only offered to smaller groups of relationship lenders at the expense of broader, retail syndications.

Despite some cautious optimism registered among leveraged cash-flow lenders in Q3/12 — especially in the context of a robust high-yield bond market, cash inflows to retail funds and over $34 billion of new CLO formations — there were limited opportunities for the market to soak up excess liquidity in the absence of a meaningful M&A pipeline.

ABL, in particular, occasionally found itself competing with bull market cash-flow structures, thus facing additional obstacles.

“Sponsors are pretty active,” said one lender. “And there is a decent pipeline, but there has been a shift to covenant-lite revolvers for [some] sponsors.” Although this is a bull market phenomenon and does not typically last, “it is a negative driver for ABL right now.”

M&A volume for the first nine months of 2012 totaled just over $4.5 billion (See Figure 3). Of this total, 60% represented financing that backed sponsored takeovers. The vast majority of these deals came in the form of clubbier transactions marked by larger hold positions and fairly aggressive terms and conditions.

In Q3/12 specifically, two out of the three sponsored M&A credits that closed were for existing ABL issuers — Party City (previously under the name Amscan) and Interline Brands — which underwent sponsor-to-sponsor buyouts. Each of these credits came with relatively thin spreads. Interline Brands secured pricing of LIBOR+175 on the credit, and Party City saw slightly richer spreads of LIBOR+200 with 25% draw down under the revolver.

Although demand for these assets was high, lenders were not indifferent to structure and pricing. “It feels like we are in a market where doing something silly could be a key behavior,” said one lender.

In the early spring, anticipated financing backing the buyout of Pep Boys Manny, Moe & Jack came to market. Although the deal did not ultimately close following a withdrawal by the private equity sponsor, the credit, which included an ABL component, was structured with aggressive terms and conditions, according to several sources. One of the biggest areas of concern focused on the application of a grace period for the issuer to correct should availability fall below specified levels or should the springing fixed-charge coverage ratio be breached.

Arguably, the example of individual deals could reflect market aberrations suited to the specific issuers in question. Nonetheless, a number of ABL credits have seen pushback.

The market has been aggressive on structure. “But banks are definitely reading documentation and depending on how oversubscribed a deal is, there will be pushback and some negotiation,” said one lender.

The Albaco Scottsman deal required a pricing step-up due to its international component. AOT Bedding likewise got pushback on its pricing thresholds, dominion and fixed-charge springs, although it ultimately secured competitive terms including a pricing grid with spreads cuffed at LIBOR+150-200.

Most recently, an LBO financing for David’s Bridal raised eyebrows. The ABL credit, which has large over advance provisions, comes in combination with a covenant-lite term loan and high-yield bond. At $125 million, the ABL tranche is relatively small and did not require a true retail sell down, thereby providing the platform for arguably looser terms.

For several lenders, this begs the question: If the market had to sell those deals down, would it be able to? And do these clubbed relationship deals effectively become the standard or comparison for the next ABL credit?

In the context of smaller, clubbed transactions structured for sponsored credits, most lenders agree that specific deals have limited relevance as a comparison for the next deal. “David’s Bridal becomes a comparison for a clubbed, sponsored deal,” explains one lender. “Not necessarily for the broader market.”

Still, lenders point out that there are more new sponsor-driven asks being put forth. More fixed assets have emerged in borrowing base deals, including reserve lending and equipment lending. This raises some initial questions about whether they would dry up lender capacity, but they were ultimately sold down successfully. The waiving of change of control provisions and concerns around increased moves toward agent discretion provisions (including waivers, inter-creditor agreements, certain rights) have also prompted a number of investors to walk away from a few deals.

“Negotiations are very difficult with sponsors,” said one arranger. “We will go above and beyond with a core group of sponsors, but we try to hold the line to the extent possible. The other thing that makes it difficult working with sponsors is that you are working with or dealing with their lawyers and often, you don’t have the opportunity for negotiations directly with them.”

In a number of cases, this situation gave way not only to issuer-friendly structures but the limited retail syndication strategies that have defined the market. “Sponsors have taken an active role in who our partners are in deals,” said one lender. “They want friendly faces at the table [and depending on the deal size] they want to self syndicate.”

Furthermore, depending on the size of the deal, sponsors do not want retail syndication because they have too many mouths to feed. Unsurprisingly, in this context, lenders said that hold levels are increasing and reverse inquiries on deals are up.

What is less clear is where dealflow will come from for the rest of the year and into 2013. The refinancing cliff that cast a long shadow over the loan market in 2008 and 2009 has successfully and easily been pushed out to 2017 and even 2018, leading most lenders to dismiss hopes for a meaningful pipeline in 2013 absent a pickup in M&A (See Figure 4). Several said they have seen an uptick in dividend recaps — Leslie’s Poolmart came to market earlier this month — and they expect more to tap the market.

Despite their appetite for paper, lenders said the ABL market will be aggressive but disciplined. “LIBOR+200 with some usage is a good standalone credit,” said one arranger. “Will banks be more aggressive for cross sell? Yes.”

Of course, a significant chunk of demand will only be there if the capital business opportunity is there. Nevertheless, for the moment there is abundant liquidity and this still comes at a price. Spreads for pro rata asset-based loans averaged just north of LIBOR+225 in Q3/12, although lenders said that depending on the credit, they are pitching well south of that on recent deals (See Figure 5).

The regulatory environment has “had the impact of creating a spread floor,” said one arranger. This leads to decisions about how much lenders are willing to commit or how much they are willing to stretch, rather than competing on price.

“I would question what true capacity would be if we went out to syndicate a deal with some of the competitive terms that we have seen on deals,” said an arranger. “We may need to do a bit of that to get new business.”

Maria C. Dikeos is a vice president and senior market analyst at Thompson Reuters LPC in New York, and has been with the company since 2001. Her focus is primary market analytics including the production of league tables and industry analysis, as well as the enhancement of data collection and expansion of produst offerings. Previously, she worked as an associate at a major investment bank.