May/June 2011

Asset-Based Lending and Leveraged Finance: The New Chapter

Well capitalized banks that over-reserved for bad loans are now seeking the type of yields that ABL deals can generate with perceived less risk. Some banks are going full bore, with new offices and staffing announcements every day. Here Hugh Larratt-Smith and Ted Galovan check in with six executives from various institutions to gain their perspectives on today’s ABL marketplace.

Andrew Mellon was a financial prodigy. In 1880, at the age of 25, he joined his father, Judge Mellon, in his banking firm, T. Mellon and Sons in Pittsburgh, and two years later took over ownership of the bank. During the next four decades, Mellon pounced on new opportunities in emerging technologies such as railroad braking systems, abrasives, aluminum, coking ovens and oil. In the late 1800s, recessions, financial panics and depressions occurred with regularity and no one truly understood the root causes. In spite of the ups and downs of the banking industry and because of their aggressiveness and lending acumen, by the turn of the century T. Mellon & Sons grew into the largest bank outside of New York City.

Fast forward to today. After the punishing credit crunch, new players are emerging in leveraged finance and asset-based lending, looking to pounce on new opportunities. And some of the legacy players are aggressively building on their past successes and franchises to claim a big slice of the pie.

“There’s a great thirst for credit with middle-market companies,” says Michael Sharkey, executive vice president of Cole Taylor Bank. “We’ve closed 80 transactions in 25 states in the two-year period since we started the ABL group at Cole Taylor. That should tell you any ABL shop that has the right people will do well in a tough economic environment — and get paid for the risk”

“Loan losses on ABL deals have been relatively low in this past recession” says Michael Haddad, chief executive officer of NewStar Business Credit in Dallas. “Recognizing the low default rates, banks are now beginning to enter the market. We may be six to nine months away from an increased level of competition in the marketplace, but it’s coming for sure. In recessions, the banks are referral sources for ABL players; in good times, the banks are our competitors.” He adds, “True ABL players never left the marketplace in the credit crunch — the structure of the deals got tighter, but we continued to lend money. Using a golf analogy, the fairways got tighter, but we continued to tee off.”

“Lenders are seeking transactions where loan utilization will be heavy,” according to Burt Feinberg, managing director and group head, Commercial and Industrial of CIT in New York. “The ABL industry has experienced lower utilization of working capital loans because many companies have focused on enhancing their working capital efficiency to maintain liquidity, a lesson learned from the Great Recession. The stronger credits in the marketplace have very low loan utilization rates and the companies that borrow more tend to have a more traditional asset-based borrower profile. Lenders are hoping that as the economy recovers companies will invest in growth initiatives across all credit spectrums resulting in higher utilization of ABLs.”

Jeffrey Knopping, managing director, William Blair & Co. in New York, notes ”We’re seeing a dearth of utilization in existing portfolios across the board. Consequently, on new deals for good credits, we’re seeing springing cash dominion, springing liens and even borrowing bases that are tested according to financial performance.”

Well capitalized banks that over-reserved for bad loans are now seeking the type of yields that ABL deals can generate with perceived less risk. Some banks are going full bore, with new offices and staffing announcements every day. Other banks are hiring one or two people to mine their commercial loan portfolio, in order to move tougher credits out into a full dominion borrowing base environment. “Lots of deals in the market are turnarounds. Companies that had losses in 2008-2009 started to see the light in 2010 but were not profitable for the year, but they are now trending in the right direction in 2011,” says Haddad. “For these types of companies, pricing and structure are holding firm.”

New ABL and leveraged finance players on the scene since the credit crunch ended include Cole Taylor Bank, The Private Bank in Chicago, NewAlliance Bank in Boston, Golub Capital BDC, First Capital, BrightWay Capital in Dallas, Berkshire Bank in Massachussetts, Crystal Financial in Boston, Garrison’s new fund in New York, NXT Capital in Chicago, Amalgamated Capital in New York, Fifth Street Finance in White Plains, Avanti Capital in Los Angeles, MM Venture Funding in Palo Alto, Monroe Capital in Chicago and Victory Park Capital in Chicago.

Legacy players in ABL and leveraged finance that are in a resurgence mode include NewStar, CapitalSource Business Credit, Ares Capital, Madison Street Capital, Union Bank of California, Liquid Capital, U.S. Bank and the CIT Group, a long-term major player in the market. Some are accelerating their trajectory through acquisitions: First Niagara Commercial Finance acquired NewAlliance Commercial Finance last month, and NewStar jumpstarted its ABL platform with the acquisition of Core Business Credit in 2008. Interestingly, two of the big, well-capitalized Canadian banks have intensified their U.S. efforts. TD Bank from Toronto is focusing on the middle-market ABL with its purchases of BankNorth and Commerce Bank in the past five years. BMO (Bank of Montreal) is devoting significant resources to its leveraged finance group in Chicago.

In an increasingly competitive marketplace, rates are the first thing that get pressure. “In single or dual lender deals, pricing has decreased more rapidly and competition is intense. In larger deals, where broader syndicates are required to get the deal done, pricing, while still under pressure, has not been impacted as much. This is because deals with single lenders include ancillary services for banks, so the all-in yield is buoyed by non-credit services like cash management and foreign exchange,” says CIT’s Feinberg.

Term lenders are becoming more aggressive in today’s market because the used equipment market has settled to pre-2008 levels in most asset categories. According to Tom Greco, CEO of Hilco Appraisal Services in Chicago, “End-users [companies] are now making the market at liquidations, and they typically pay a premium over used equipment dealers at liquidation events. Also, companies are purchasing used equipment rather than new due to long lead times and high costs of new equipment. We’re seeing the most robust M&E liquidation market in three years.”

Ray Kane, managing director and head of Duff & Phelps’ Private Debt & Equity Placement Group, adds, “The combination of new players in the market and what has been so far this year a relatively low level of new primary deal activity has resulted in one of the best issuer-friendly markets in the last ten years for ABL deals. Placement agents for borrowers can now insist on more term loan exposure from pure ABL lenders, tighter spreads and more availability under the borrowing base by running a competitive auction process.”

Most ABL players now regard the leveraged finance marketplace as overheated. The junk bond market has been the jet fuel in the meteoric comeback of this segment that was given up for dead in the credit crunch. Additionally, many private equity groups stood by their investments in the credit crunch, so this loyalty has paid off in the form of better terms, conditions and pricing on leveraged finance for portfolio companies.

“In a market where everyone is hungry for assets, consistency in the credit decision process will be critical to ensuring the staying power of new players,” says Andy Moser, president of NewAlliance Commercial Finance in Boston. “As players navigate new opportunities, they have to be mindful not to gravitate back to old industry habits, such as sacrificing a sound structure in order to win a deal. As well, stringent collateral monitoring and timely intervention in credits that are going sideways is always important to keep deteriorating situations from getting worse.”

Notwithstanding the encouraging economic headlines, “There is still a lot of uncertainty out there in the economy,” comments Sharkey. “Rising oil prices, pressure from China on building materials like lumber, copper and insulation, and skyrocketing metals prices still have people very nervous.”

Kane suggests “For borrowers, the message is simple. With all of the global uncertainty and capital availability, now is the time to access the markets. The consensus within the financing community is that it’s hard to imagine more upside opportunity than downside risk for businesses looking to access the capital markets.”

In their heyday, T. Mellon & Sons were aggressive and visionary financiers. In addition to lending money, they took equity kickers in a wide range of new businesses that were emerging in industrial America. The Mellons were quick to recognize and pounce on opportunities in many emerging industries such as aluminum, coke ovens, oil and gas, railroad braking systems and abrasives. These equity kickers turned into ownership of Alcoa, Koppers Corporation, Gulf Oil, Westinghouse and Carborundum Corporation. In 1929, Andrew Mellon was the third highest taxpayer in America after John D. Rockefeller and Henry Ford, with a fortune estimated to be $400 million. Indeed, he was a financial prodigy.

Hugh Larratt-Smith is a managing director of Trimingham in New York. He is on the board of directors of the Commercial Finance Association Education Foundation and The New York City chapter of the Turnaround Management Association.

Ted Galovan, CPA is a managing director of Trimingham in Denver. He was previously CFO of Basic Research, Deluxe Check, Collect America and EAS, VP Finance of Lowrey’s/Oberto Foods and controller of Eddie Bauer.