Downturn Plus Four Years — State of the Capital Markets
Contributing editor Howard Brod Brownstein talks to five leading ABL capital markets players about market conditions now that the official end of the downturn is four years behind us. All agree that market conditions are extremely competitive — comparable to before the financial downturn — and that this trend will continue for the foreseeable future.
Barry L. Bobrow, managing director, head of Loan Sales & Syndications, Wells Fargo Capital Finance
Britt Canady, managing director, Bank of America Merrill Lynch Anthony Foti, managing director, PNC Capital Markets
Neil Wessan, group head and managing director, CIT Capital Markets
Thomas Halsch, Debt Capital Markets, Citi
Salvatore C. Settineri, managing director, GE Capital Markets
Asset-based lenders are increasingly taking part in syndicated ABL facilities, whether as agents or participants, and the importance of syndicated ABL has been growing in terms of overall portfolios. As the economic recovery has continued, many lenders have been increasing their “hold” limits, and — for those that act as syndicate agent — have raised their sights in terms of the overall size of deal that they are pursuing. This trend has increased ABL’s importance in sync with improving economic conditions, as a variety of ABL structures make it possible to accommodate the changing needs of a recovering business.
In the meanwhile, overall ABL market conditions have continued to soften in terms of both pricing and structure, as more lenders enter ABL markets (or return to it, if they had withdrawn during the downturn), and everyone is looking for deal flow. For their part, foreign lenders often see syndicate participation as a readily available method of initiating or increasing their lending in the U.S.
These important trends led ABF Journal to survey leading capital markets executives about market conditions, now that the official end of the downturn is four years behind us. What are the current market conditions for agents and participants, and how have things changed? Have things returned to the pre-downturn environment?
I posed the following questions to interviewees:
• Four years past the official end of the Great Recession, what’s happening in the capital markets? Have we returned to pre-recession market conditions?
• How might your firm’s experience vary from that of others’?
• What is the outlook for syndicated ABL for 2014?
Current Conditions in Capital Markets
Wells Fargo’s Barry Bobrow, a longtime ABL veteran, notes that the economy has improved steadily over the past four years, although the political environment in Washington as well as events outside the U.S. have created uncertainty that has dampened the levels of corporate investment and M&A activity. As a result, even though there is plenty of liquidity and banks are eager to lend, there is a relatively low level of demand from new transactions. The excess of liquidity supply over demand has led to a “borrower’s market,” with softened pricing and structure terms beginning to resemble pre-recession conditions, but without the pre-recession deal volume.
Citi’s Tom Halsch also sees current capital markets as very issuer-friendly due to the excess in supply of liquidity. Interest rates remain very low, and debt capital markets very active. Pricing terms have essentially returned to pre-recession levels, but there is more underwriting discipline. Similarly, structural terms such as trigger levels and restricted payments are back at or around pre-recession levels. Lead banks in larger transactions are willing to take significantly larger hold positions than what they did historically.
Bank of America Merrill Lynch’s Britt Canady points out that the floating rate bank market, such as in ABL lending, has compressed its pricing dramatically from over three years ago. He pointed out, however, that these very low rates have largely remained flat over the past year. With regard to the institutional loan market, Canady notes that it is strong and fluctuates more than traditional bank lending.
From a liquidity standpoint, Canady feels that bank liquidity is at pre-crisis levels. According to Canady, the institutional loan market also has significant liquidity. He notes that both the bank and institutional market benefited from the bond market’s record issuance years, which provided liquidity to the senior floating rate market, as well as other sources and debt repayments. Despite the improved market liquidity and strength, Canady indicated that the market discriminates more and remains much more credit-focused.
PNC’s Anthony Foti agrees that the demand for ABL paper definitely exceeds deal flow. Having previously focused on deals up to $150 million, today PNC’s typical syndicated deal size range is $75 million to $300 million. While PNC may be a significantly smaller institution in regard to its primary competitors, it is among the top participants in the ABL market. Foti notes that there is still a dearth of M&A activity as this year has been dominated by refinancing at PNC.
In originating transactions, PNC’s Capital Markets group is active with PNC Business Credit in agenting or co-leading ABL transactions, but participates in deals led by other banks when they meet certain criteria. When deals are nonconforming, i.e., not limited to A/R and inventory, there is a limited number of potential interested participants. PNC looks for participants who “get it” and understand ABL. It is especially important when times become more difficult and participant support is critical in managing thorough a downturn.
As with other major ABL capital markets players, equity sponsors account for a large part of PNC’s activity. Foti reports that PNC’s ABL Capital Markets group is having a very solid year, due especially to pursuing larger deals. Foti believes that ABL pricing hasn’t quite returned to pre-recession levels yet, but are close. He observes that structural terms are as competitive, or even tougher, than before the downturn, e.g., with covenant-lite terms, springing covenants, etc. He says that the market is very aggressive, and he notes that syndicate participants are hungry for opportunities. Foti doesn’t expect ABL pricing to go much lower, and notes that participants are beginning to push back on low yields, especially on deals with nonstandard conformity regarding collateral, e.g., deals that include fixed assets, international collateral, air-balls, etc.
With a strong capital base and a growing deposit franchise, CIT seeks to put capital to work in companies that are integral to the economy and are in growing industries. CIT’s Neil Wessan characterizes the current state of capital markets as “open for business.” He echoes the observations of others that there is tremendous liquidity available in the market right now — “a very fluid market, available to almost anyone who wants to raise capital,” and believes that “investor confidence and market liquidity have returned to pre-recession levels. As a result, leverage parameters and structural elements are back to being issuer-friendly. In ABL, cash dominion and covenants are generally springing, and all tied to excess availability.”
Wessan notes that some banks without prior ABL exposure have started groups to invest in the “recession-resilient asset class.” From a supply and demand viewpoint, there are significantly fewer new-money transactions to offset the increased supply of liquidity, so expectations are for further pressure on interest rate spreads if M&A volume does not increase. Wessan says, “Across the leveraged loan market, clubbed transactions have gained popularity in lieu of traditional underwriting/syndications. In the ABL world, arrangers have been increasing hold size and soft circling asset-hungry participants without going to a wide investor base.”
GE Capital Markets’ Sal Settineri agrees that, four years after the downturn’s official ending, capital markets are very healthy. He confirms that there are a number of new bank players in the ABL space, and that existing lenders have increased their maximum hold amounts. Settineri says that today’s capital markets resemble pre-recession conditions in that there is now an ample supply of credit liquidity for deals coming to market. “It’s a very healthy market for borrowers with very competitive pricing,” Settineri says. The main difference he sees from pre-recession conditions is that “the demand for credit is more heavily weighted toward refinancing existing credits on better terms, with relatively fewer new transaction opportunities, in large part due to today’s lower growth economy.”
GE is typically leading the ABL loan syndicate, but there are some transactions where it is willing to participate with other lead arrangers as well. As an agent, it looks for participants with whom it has past relationships, and where their participation will benefit the borrower. GE’s leadership in leveraged middle-market, sponsor-backed transactions is very synergistic with its direct ABL business, both in terms of what it can offer sponsors and in expanding relationships with loan participants.
How Lenders’ Experience Varies
Wells Fargo’s Bobrow notes that, because of his bank’s size and scope, it likely experiences capital markets very differently than banks and other institutions that might have more limited scale. While Wells Fargo has differentiated strategies in all of its businesses, he notes that, because Wells Fargo operates so broadly, it has a unique perspective. With over 100 years’ experience in the banking industry, Wells Fargo began offering capital markets products ever since the regulatory environment permitted banks to offer them. While Wells Fargo acts as either a lead or a participant in different asset-based deals, it prefers to be in a leading role with its clients so it can bring the full value of its franchise to them, and is always seeking to move into leading positions where the opportunity is presented.
Just as it cultivates long-term relationships with its borrower clients, Wells Fargo seeks the same with the institutions that participate in the syndicated ABL facilities that it leads, to work together effectively with them in all market conditions and especially when borrowers experience credit issues. And whenever Wells Fargo is a participant, it is critical that the lead banks have the ability to manage both the bank group and the underlying credit through difficulties in a manner consistent with how Wells Fargo would do it themselves.
Bobrow says that Wells Fargo as a whole is a highly relationship-driven organization — driven by its clients’ needs and not just pursuing league-table rankings and the like. Due to its breadth, Wells Fargo’s capital markets capabilities are an excellent fit with financial sponsors of all sizes, providing the full array of products and services for sponsors’ acquisition activities and their portfolio investments, plus Wells Fargo Securities’ Investment Banking can also raise capital for sponsors and their investment vehicles.
GE’s Settineri notes that GE has been an important player in the ABL market for decades, and has seen many credit market cycles — some more dramatic than others, which it uses to its advantage by taking a long-term view on achieving the appropriate risk-return balances to serve its customers.
Competitively, PNC’s Foti often sees the same handful of players on every deal, with more players these days going after PNC’s former focus area of deals under $150 million, with many competitors willing to hold the entire deal. Riding out the economic downturn with a strong balance sheet, PNC has been able to respond to increasing demand and to maximize its hold amount in order to compete effectively and grow its business. Foti has heard that some ABL competitors are not having as strong a year as in the past, but this is PNC’s strongest year yet in ABL syndications and it is looking to continue to make inroads into larger ABL syndication market.
Citi acts in both lead and participant roles, but where it is a participant it was likely involved in other capital activity for the borrower. Depending on the transaction size, there could be two to four lead banks in the syndicate with large amounts committed, with the syndicate then filled out with smaller investor banks. Citi’s Halsch would like to see more “retail investors” involved, e.g., with a $15 million to $50 million participation. He notes that consolidation over the past several years has decreased the number of syndicate participants, and that some leading finance companies have consolidated and/or become banks themselves. Halsch also points out that Citi’s global importance means that it serves virtually every industry in every part of the world, and is usually involved in other types of debt for its capital markets borrowers. As with other large lenders, Citi’s relationships with equity sponsors are very important to its capital markets activities.
CIT’s Wessan says that its capital markets group is focused on providing value-added services to private equity sponsors and middle-market investor clients, as well as to other parts of CIT. Although CIT’s Capital Markets group was started in 2005, the CIT organization has decades of deep and broad lending and factoring experience spanning many industries. As the middle market becomes more competitive, CIT’s Capital Markets team has been an essential part of CIT’s strategy, and their activity is reflected at the top of the league tables. In addition to leading deals, the CIT Capital Markets group opines on almost all transactions throughout CIT, ensuring that the appropriate structures and pricing are in place.
With its expansive industry and capital markets knowledge, CIT looks to lead deals in both the ABL and cash-flow spaces. It looks for participants that have industry knowledge, can help CIT provide value to its clients, are relationship-driven and seek to partner with CIT on future transactions. CIT finances a broad range of debt issuers, both on a cash-flow and ABL basis, including involving traditional and non-traditional collateral. CIT has well-known expertise in traditional ABL industries such as retail, and it also lends against fixed assets as well as intangibles, and is a leader in transportation finance.
Capital Markets Outlook for 2014
Wells Fargo’s Bobrow says that the outlook for 2014 looks much like 2013, barring any major economic or political events. High levels of liquidity and a relatively low level of new transaction activity are likely to drive aggressive terms — a “borrower’s market.” Of course, exogenous shocks from political or global sources could cause temporary volatility, but overall Wells Fargo expects capital markets in 2014 to be very similar to 2013.
GE’s Settineri sees the syndicated ABL market as remaining very healthy in 2014, with increased new business coming from further improvement in the economy, and a pick-up in sponsor-led as well as strategic M&A activity.
Citi’s Halsch sees the outlook for 2014 as fairly good. Nearly all of the refinancing from older deals has now been done, and he is hopeful that the M&A pipeline will pick up, which would benefit ABL capital markets. He notes that many equity sponsors have raised new funds and the hope is that they will be more active. In addition, he sees 2014 as including possible refinancings of deals done in 2011 and 2012, as well as LBOs and the occasional restructuring or a “fallen angel” transitioning from cash-flow lending to the ABL market.
PNC’s Foti sees a limit to how many more refinancing deals are left to be done. Having one of the largest ABL portfolios in the ABL market will help ensure that PNC will remain active.
Sponsor groups are very important to PNC, and Foti estimates that about half of its ABL syndication comes from them. PNC’s relationships with equity sponsors are “long and deep,” since the capital markets and ABL teams at PNC have been together for such a long time. Their experience has enabled PNC to see which equity sponsors support their portfolio companies through both peaks and troughs, and which do not. And for those who do, PNC will go above and beyond typically conforming collateral deal structures. Foti notes that one factor that differentiates PNC’s ABL capabilities is that it can do quasi-cash flow deals since its Steel City Capital Funding affiliate provides second lien capability with sponsors whom they know well. It would not be unusual for PNC to support multiple sponsors pursuing the same deal.
Bank of America Merrill Lynch’s Canady acknowledges that the ABL market is very competitive. Given the current economic cycle, ABL lender profitability needs M&A activity to drive better volume and returns.
CIT’s Wessan expects continued pressure in capital markets to drive aggressive terms and force lenders to look outside the traditional ABL box. He believes that ABL will become a more broadly used loan product, e.g., to create covenant-lite situations on top of high-yield bonds, for nontraditional collateral and to minimize borrowers’ cost of capital.
Leading ABL capital markets players concur that market conditions are extremely competitive, comparable to before the financial downturn, and that this is expected to continue for quite some time. Maximum hold amounts are up, new market entrants are increasing, and interest rates have been held down both by an excess supply of liquidity and by the government’s fiscal stimulus policy. These factors are likely to intensify in 2014, barring an unforeseen event, leading to even further increases in competitiveness in ABL capital markets.
Howard Brod Brownstein is a Certified Turnaround Professional, president of The Brownstein Corporation and a contributing editor of ABF Journal.