March 2012

Asset-Based Lending Hits Record High in 2011, Expectations of Normalized Issuance Levels in 2012

Asset-based lenders began 2011 with roughly $30 billion of volume in each of the first two quarters and a record-worthy $24 billion in Q3/11. Amid heightened market volatility in Q4/11, fueled by fears around the euro-zone debt crisis, volume slowed to $18 billion in line with the broader leveraged loan market pullback in August and September.

Asset-based lenders kept busy in 2011. Busy enough, in fact, to push record issuance through the syndicated loan market. At $101 billion, total 2011 asset-based loan volume set a new volume for the asset class and a 25% increase over the earlier record set during the peak of the credit cycle in 2007 ($76.1 billion) (See Figure 1).

More significantly, each of the first three quarters of the year marked quarterly highs unobserved in the market since Q2/07. Combined, quarterly issuance for the first nine months of 2011 outpaced historical full-year asset ABL volume figures.

ABL began the year with roughly $30 billion of volume in each of the first two quarters, and a record-worthy $24 billion in Q3/11. Amid heightened market volatility in Q4/11, fueled by fears around the euro-zone debt crisis, volume slowed to $18 billion in line with the broader leveraged loan market pullback in August and September.

In contrast to cash-flow lending, the market volatility that rattled both the high-yield bond and broader loan market — contributing to wild swings in retail fund flows and dramatic outflows of funds — had minimal impact on asset-based lenders. In fact, liquidity among asset-based lenders remained doggedly robust.

The slowdown — limited as it was in terms total lending activity — stemmed from the fact that asset-based issuers still required access to the high-yield bond, institutional or mezzanine markets to round out their financings in combination with ABL. With windows of opportunity to tap these markets far less certain, both corporate and private equity sponsors were less likely to systematically come to market — especially if they required underwritten credits.

Some of the market fickleness, of course, reversed itself by mid-October, when a series of new financings (largely in the form of high-quality LBOs) came to market. Ultimately, despite fitful issuance and little visibility into a steady or predictable pipeline, asset-based lending represented 18% of total leveraged volume in 2011, the largest proportion of leveraged lending on record.

Much of this came in the form of refinacing activity. At 82% of total ABL, refinancings eclipsed new money issuance (See Figure 2). But more notably, at just over $83 billion, 2011 refinancing volume was over 84% greater in terms of dollars raised than that of the previous high set in 2010.

Among deals of $100 million or greater, 80% of issuance represented corporate (i.e., non-event driven) transactions and these were dominated by refinancing (See Figure 3). In fact, lenders made significant headway chipping away at the near-term refinancing cliff throughout the year. Drilling into the maturity calendar at the end of 2010, roughly $126 billion of existing ABL credits were slated to come due between 2011 and 2013. At the end of 2011 this figure was reduced to less than $60 billion (See Figure 4).

An incremental 7% of total issuance represented amend and extend activity while a comparatively thin 9% of total issuance represented M&A activity; this was up from 7% in 2010, but still far below the historical peaks set between 2005 and 2008. In a testament to improved corporate credit profiles, DIPs and exit financings, which made up a meaningful 15% of 2009 ABL volume, retreated to 9% in 2010 and, further in 2011, to close out the year at about 2% of total issuance.

Restructurings may pick up in 2012, however, if the DIPs and exit financings for Kodak and Great Atlantic and Pacific Tea Co. are any indicators. Sources said there may be a few more such deals being prepared for launch in early 2012 — although most lenders agree that a number of sub-standard credits may struggle if arrangers are unable or unwilling to book weaker credits.

Ultimately, the overriding concern for lenders for much of 2011 and certainly into the start of 2012 was how much lending was left to do in the absence of new loan assets.

“We have done [about] three deals a month since May,” said one participant lender in December. “But BJ’s was the only new ABL deal. There were 15 amend and extends. Given the state of the capital markets, it’s hard to see how the LBO/M&A markets will heat up in 2012. [We are] hoping for cash flow to ABL conversion — more flexibility, fewer covenants — as long as companies can get over maintenance issues.”

“Obviously it has been all refis,” added another lender. “It was great year in terms of issuance and lousy in terms of spread. There is probably some more refinancing activity out there but assuming that the [maturity] cliff is correct, you can see that there is nothing going out in the next few years.”

In this context, unsurprisingly, competition among lenders heated up while hold levels increased at the expense of traditionally smaller-ticket holders. “Twenty-five-million-dollar ticket holders are largely gone,” said a lender.

Broad retail syndications were occasionally displaced in favor of clubbier deals where $150 million tickets represented the low end of commitment tiers. Among deals of $150 million and below, some arrangers held onto the entire credit themselves, or at best, they brought in one or two other lenders. Deal upsizings on existing lenders were often bridged by the arrangers themselves.

Despite lender liquidity and the supply-demand in balance in 2011, market capacity was not limitless. “If you are a big borrower with a big ABL but no other business to spread around, you won’t have a deep lender group,” said an arranger.

In contrast, for issuers with ABL needs that are supplemented by capital markets and treasury opportunities, liquidity was available.

It followed that as competition for assets picked up, lenders stepped up to displace one another in syndicates. Unsurprisingly, this often came in the context of offering thinner spreads. Having started off 2011 at just under LIBOR+270 on average, pricing dropped to south of LIBOR+225 by year end.

After Slow Start, Q1/12 Lending Picks Up

The intensified competition remained in place early in 2012, as the pipeline of deals slowed meaningfully in the first few weeks of the year, ahead of a February uptick in activity. Lenders “were more downbeat about prospects for M&A and LBOs,” noted one lender, “and just about everyone that had higher priced deals has [already] come to market.” By mid-February, the pick up consisted of LBOs (including PepBoy), takeover financing (Bi-Lo) and cash flow to ABL refinancing for a fallen angel (JC Penney) among others.

Nevertheless, most lenders concede that volume will not be what it was last year.

Indeed, a normalized year for asset based issuance, would be in the range of $50 to $65 billion — off about 30%-45% from 2011 figures. The number of deals that get done however, may not be off as much.