Finding the Right Fit… Bank-Owned or Independent Lender?
Associated Commercial Finance executive Mark Wierman goes head to head with First Capital executive vice president John Curtis in a lively debate about what some of the considerations are when a perspective ABL borrower contemplates dealing with a bank versus an independent.
As we know, the economic downturn resulted in more stringent lending parameters on traditional sources of credit, and many borrowers seeking alternative funding sources turned to asset-based lenders (ABLs). While asset-based lending has been an established financial tool since the 1970s, we have seen unprecedented utilization of it in the past several years. In 2011, syndicated asset-based lending volume reached a record $101 billion representing more than 390 financings.
Volume in 2012 was down 20% from the 2011 high, but that still represented $80 billion in loans, the second highest syndicated asset-based lending volume on record. Through the first half of 2013, we are continuing to see 2012-like volume levels, with total volume comparable to the first half of 2012.
As borrowers continue to utilize asset-based lending facilities, there is a wide array of potential lender types for them to consider that can easily be divided into two main groups —bank owned or non-bank independent. The largest ABLs in terms of overall volume are the large banks. All of the major banks, such as Wells Fargo, Bank of America and JPMorgan Chase, most medium-sized banks, including Associated Bank, and even many smaller regional banks have in-house asset-based lending units. This is a natural extension of their existing loan businesses, which allows them to serve a wider range of customers, many of whom would not qualify for more traditional forms of financing. The independent lender pool also consists of a broad range of players, from large firms such as GE Capital, CIT and First Capital to small- to mid-sized entities.
While the benefits of working with a larger or smaller lender may be readily apparent to most borrowers, it may be less clear why one would chose a bank-owned lender over an independent, or vice-versa. The process that either type will typically follow tends to be similar regardless of affiliation. Both will conduct field examinations and collateral assessments and each would employ an underwriting regimen. Most go to market in similar ways. However, there are many distinctly different characteristics between the two choices that could make a significant difference for the borrower depending on relative importance of each and/or circumstance.
Because we each have our own views from contrasting perspectives, we thought it beneficial to engage in a discussion about where there are similarities and, of course, differences that could be explored for the benefit of a perspective borrower.
Given the structure of a typical bank, ABLs have ready access to capital, so their cost of funds would tend to provide a pricing advantage assuming similar loan spread requirements on either side. With the exception of large non-bank players such as GE Capital, independent lenders typically source capital from their original investors and/or leverage up by borrowing. Historically, the lion’s share of this leveraged capital has come from large banks with dedicated “lender finance” units that lend to financing companies such as an independent ABLs. And although there are more specialty finance shops that are interested in supporting the independents, the need for capital to support growth will likely continue unabated causing the cost of capital to be higher for the independent versus a bank-owned competitor, which of course translates into higher pricing for the customer.
While bank-owned ABLs enjoy the benefit of readily accessible funding, they are subject to much of the same regulatory scrutiny and oversight as their parent. Their loan and underwriting process tends to be governed by the same general risk assessment standards. The net effect of this factor will often limit the lender’s flexibility. Independent ABLs report to stakeholders, not regulators, which often allows for more flexible deal structures for the borrower. Additionally, an independent will not be required to move through as many layers of control in their credit approval process, thus they are able to close transactions more quickly than their bank-owned ABL counterparts.
Despite the varying degree of regulation, both types of lenders are very selective when it comes to the type of transactions they pursue. However, the strategy behind those selections can differ significantly. Regulatory oversight demands that bank-owned ABLs select transactions that fit within a more conservative risk profile, somewhat limiting their flexibility. Independent ABLs, on the other hand, generally look further out on the risk spectrum. Transactions often include companies in transition, whether in turnaround situations or shifting into high-growth mode. Many times these companies do not have strong balance sheets or a full year of profitability to report. Independent ABLs’ ability to take on these transactions, priced to appropriately reflect the risk associated with them, can offset the challenges associated with their higher cost of capital.
Whether independent or bank-owned, asset-based lending is a referral-based business. How the two types of lenders may differ is where they look for their referrals. Bank-owned ABLs usually have a built-in referral network within the various other lines of business that a bank typically offers. Commercial customers throughout the institution are directed to the bank’s asset-based lending group as needed. Independent ABLs rely more heavily on external relationships. These include consultants, turnaround specialists, private equity groups, investment bankers, lawyers, accountants and banks that do not offer asset-based lending facilities, but who could retain the banking relationships with the borrower. It may also include counterparts at larger financial institutions that have asset-based lending capabilities but for whatever reason (e.g., risk profile, compressed timeframes, etc.) the larger institution would not be able to work with a particular customer. Independent ABLs also reach out to more non-traditional geographies for lending prospects outside of the major metropolitan cities that have businesses that are in need of a structure not provided by their local bank.
Deal Structure and Servicing
The actual structure and servicing of deals may also differ between the two types of lenders. While bank-owned lenders benefit from in-house referral sources and customers that fit the appropriate risk profile to seek funding from existing financial services partners, independent ABLs are usually able to offer a more accommodating structure to borrowers. They may be more flexible on factors such as the length of the credit facility, certain advance rates against the underlying collateral, financial covenants and other market-driven elements.
Deals structured by bank-owned ABLs typically do not have that level of flexibility. However, there are other value-added elements that they can offer borrowers, including a full array of treasury management services to assist with the transaction from start to finish. Independent lenders have an extra step in the process, where they may need to arrange for cash management servicing with another institution. This may actually be attractive to some borrowers, as the independent lender could provide a more objective recommendation for a servicer that fits the borrower’s needs, rather than simply offering the in-house solution that bank-owned ABLs typically provide.
While more of a niche business, factoring — situations in which a company sells its receivables to the lender — is more often engaged in by independent ABLs. In most cases, factors are smaller and focus on certain target markets. The factor is relying more on the underlying strength of the customers and accounts than the strength of the borrower. The factoring company is structured to monitor and track the underlying collateral much more frequently, which is time consuming and labor intensive. For this additional risk and monitoring, the factor is going to want a higher return for its effort, which makes this a more expensive form of borrowing. However, in the case of a business that is relatively new, may be launching new products and needs working capital to fund these opportunities, factoring can be a very beneficial way of financing its company to the next level. More expensive debt financing like factoring of the company’s accounts receivable will still always be less expensive than raising equity that dilutes the ownership of the company and may create other challenges for the business owner. While factoring is provided by some of the larger banks across the country, this segment of the industry is very fragmented with a number of regional and national independent factoring companies.
Asset-based lending continues to be an integral source of financing for companies with a wide range of needs and priorities. Both banks and independent finance companies provide unique services and benefits to companies searching for working capital to grow their enterprise. Companies should weigh the benefits to them offered by both banks and independent finance providers as outlined above to determine what is best for their individual financing needs.
Mark Wierman has been the president of Associated Commercial Finance since 2008 and has been in the asset-based lending industry for 27 years. Prior to joining Associated Bank, he spent 12 years at LaSalle Business Credit.
John Curtis is executive vice president and asset-based lending central regional manager with First Capital. Prior to helping to start First Capital in August 1988, Curtis worked for First Asset-Based Lending Group, a wholly owned subsidiary of First National Bank.