September 2010

Despite Lender Hopes and Enhanced Liquidity, ABL New Money Remains Limited in 2010

The article title says it all … lenders were poised to do more business in the second quarter of 2010, yet there was limited dealflow to support a robust or even steady pipeline caused at least in part by the high-yield bond market, which pulled back mid-quarter. In short, lenders were left to their own devices to find enough deals to keep them active.

Asset-based lenders kept busy in Q2/10 and into Q3/10 amid steady pitch activity and robust lender appetite. But at $16.7 billion, Q2/10 issuance – while up 39% year over year – nonetheless fell short of lender hopes. Indeed, at $28.4 billion, H1/10 volume only slightly outpaced issuance for the same period last year (See Figure 1), a time, lenders say, when they could barely see how far the market would tumble.

Despite macro-economic concerns around a possible double dip in the U.S. economy, restrained consumer spending and periods of heightened global market volatility, lenders were ready to do business in Q2/10. The problem was there was limited dealflow to support a steady or robust pipeline.
“Where [was] dealflow to come from?” asks one lender. “There are no defaults, therefore no DIPs. The only time companies are doing deals right now is if they have to, or if they can opportunistically refinance.”

And if market conditions were not conducive to the largely countercyclical tradition of asset-based lending (ABL), the absence of M&A activity that had fuelled ABL issuance during the market peak in 2006 and 2007, was likewise largely absent in H1/10.

The robust high-yield bond market drove issuance in H1/10, allowing capital to return to the bank market and putting a lot of new deals on the runway by combining ABL loans with bond pieces. However, when the bond market pulled back in late May, larger financings that were reliant on bond components were put on hold in a bid to wait out the turbulence, thereby slowing prospects of larger, more transformative credits coming to market.

Case in point: In late July, Calumet Specialty Products cancelled its planned $450 million bond issue due to market conditions, and along with it, the proposed ABL financing fell away. Similarly, Accuride Corp. structured a bond and asset-based loan combination upfront, but held off launching the deal until the bond market had stabilized at the end of last month.

If macro market conditions put the ABL pipeline into purgatory, lender liquidity came off the table as a concern when it came to getting deals done in 2010. By all accounts, competition for the limited ABL loan assets that did come to market was intensified as a number of new lenders emerged and several existing players built out their lending groups.

Names including US Bank, Regions Bank, Barclays Capital, Sun Trust, Citizens Bank, TD Securities and Sovereign Bank (the latter, now part of Santander) all made significant hires in the last several months, in a bid to build out their ABL businesses. Even at the smaller end of the market, institutions such as Fifth Third and BB&T repositioned themselves to not only support arrangers on the buyside, but to compete with them head- to-head on smaller transactions.
The net effect has been – and this, according to several lenders, is a key theme of the 2010 ABL market – that all the lenders and capital that exited the market in 2008 and 2009 have been replaced. The issue now is finding enough deals to keep everyone active – a far trickier matter.

At the end of H1/10, ABL issuance represented 17% of total leveraged issuance for the year, down modestly from full year 2009 levels of 18% (See Figure 2). The significance of the ABL structure becomes even more notable when one considers that at $169 billion, H1/10 leveraged lending is up 62% over the same period last year. Nonetheless, only 37% of total leveraged loan volume represented new money loan assets. In this context, it unsurprisingly follows that less than 29% of H1/10 ABL issuance represented new money, down from peak levels of over 50% at the height of the market crisis in 2008 and off meaningfully from 2006 and 2007 levels of well over 40% during the peak of M&A (and more significantly LBO) activity.

“Q2/10 was very busy,” says one arranger. “But I think that the theme is 80% of volume was driven by existing clients, refis and extension of deals and 20% by M&A.”
“What we have seen is activity,” explains another lender. “But it is all the same deals getting redone, reshuffled. No one wants to lose the lead so they are fighting to do whatever is necessary to hold on to the lead.”

In this context, even the event-driven transactions for select names can represent qualified opportunities. In May, both American Tire and Spectrum Brands tapped the market with takeover financings that included ABL components. For example, the $900 million LBO financing for American Tire coupled $450 million in notes with a $450 million asset-based revolver of which $185 million (or over 40%) will be drawn. With expectations of outstandings under the facility providing added incentive for hungry investors, the financing represents a high note in an otherwise slow pipeline. Nonetheless, lenders point out that American Tire is not a new borrower to the ABL space.
This is also the case with Spectrum Brands, which brought to market over $1 billion in bank loan financing – including a $300 million asset-based revolver – in conjunction with its acquisition of the small appliance brands from Russell Hobbs.

Although lenders did not see the level of activity they desired or the emergence of new customers, the market did appreciate the limited pick-up, and lined up with meaningful commitments. ABC Supply, another vintage ABL issuer, tapped the market in May with a $650 million asset-based revolver that refinanced existing debt and backed the company’s purchase of Bradco Supply, one of its key competitors. The retail syndication was to a modestly wide group of lenders and raised over $1 billion. Pricing on the deal was flexed down 50bps to LIBOR+250. The financing ultimately represented a meaningful upsizing for an existing ABL credit with positive cash flow, good current assets and 40% usage under the proposed credit.

At the end of H1/10, among deals of $100 million or greater, at 9% of total issuance, M&A activity remained markedly off historical levels of roughly 20-35% of total asset-based volume, but was nonetheless up from year-end 2009 levels that closed out the year at 5% of total issuance (See Figure 3). Moreover, lenders expect to gain ground in 2H10.

The expectation is that in Q3/10 and 4Q10, M&A activity will increase to roughly 30% or 40% of total issuance, according to lenders, across the deal size spectrum. Nonetheless, there is a word of caution: Lenders “who just want to buy into deals [may not] see enough dealflow. We have to limit invites [into syndicates] because there is so much demand that we would be too oversubscribed,” explains one source.

Lenders note that larger financings will continue to need help from other markets. Toys R Us increased capacity on its existing $1.63 billion ABL revolver to $1.8 billion in combination with an anticipated IPO filing, for example, and the bond market remains key to the success of event-driven financings. But for the right credit, it is not a matter of what can get done, but how much supply will come to market.

In this context, the market has seen a small but meaningful increase in the size of deals. Fifty-six percent of total H1/10 asset-based activity (on a deal count basis) represented deals of $100 million or greater, up from 47% at the close of 2009, and far more in line with levels observed during headier days between 2006 and 2008 (See Figure 4).

If the availability of capital and the ensuing appetite for assets represent a key theme in the current ABL lending environment, it follows that a second theme is structural loosening. Despite expectations that the market will see increased issuance in the second half of the year, few expect deal flow to pick up to a point where there will be enough deals or outstanding to satisfy lenders. Unsurprisingly, in the near term, this had led to more aggressive terms and conditions.
Spreads have already come down. At the end of Q2/10, average spreads hovered around LIBOR+340, although in practice, lenders were already structuring credits well south of that (See Figure 5).

Jones Apparel, and more recently, Toys R Us, each returned to market seeking to push out maturities on existing credits, and were able to reduce spreads in the process. In the case of Jones Apparel, pricing is based on a usage grid subject to a traditional borrowing base. Out of the box, drawn spreads are set at LIBOR+275, down from LIBOR+450 on the previous credit.

Similarly, the Toys R Us credit refinances a 2009 ABL revolver priced at LIBOR+400. The new credit is initially priced at LIBOR+275 until 2011. The margin will subsequently vary, based on usage, between LIBOR+250 and LIBOR+300.

“There is a mental block,” says one lender, and “LIBOR+250-275 seems right.”

Except among smaller deals, lenders agree that pricing has hit a plateau in the range of mid-200bps for drawn credits. Unless the rest of the loan market becomes significantly more aggressive, few expect pressure for incremental thinning of spreads.

Indeed, despite some spread deterioration and relaxed structures (lenders note, for example, they are seeing more fixed assets come into consideration when structuring deals), the market is focused on some measure of discipline. A number of banks have steered clear of deals with a heavy reliance on fixed assets and expect to continue to do so.

Additionally, although lenders highlight market capacity, not all deals are created equal. Capacity stops or, at best, is extremely limited for unfunded credits or non-cash flowing credits.