November|December 2011

Refinancings Drive ABL Pipeline Toward Record 2011 Issuance; 2012 Deal Flow Unclear

So far this year, asset-based lending (ABL) has been one for the record books — although the accompanying enthusiasm has been fairly muted. Looking forward to Q4/11 and into 2012, prospects for deal flow are in a bit of a fogbank in terms of where new deals will come from. And while it’s been a good year for ABL in terms of issuance, the rest of the year is unclear.

At over $82 billion, Q1/11-Q3/11 asset-based loan volume not only set a historical record for the first nine months of the year, it also set a new market benchmark by exceeding total annual volumes recorded by Thomson Reuters LPC over the last eight years. By way of comparison, at the end of 2007 during the market peak, asset-based lenders pushed over $74 billion through market (See Figure 1).

Equally notable, Q1/11-Q3/11 ABL represented 20% of total leveraged so far this year, the largest proportion of total leveraged lending on record. Although Q3/11 capital markets volatility rattled the broader loan market, contributing to dramatic swings in retail fund flows and a meaningful outflow of funds, liquidity among asset-based lenders remained robust. “The funding source for ABL is banks,” said one arranger. “There are an awful lot of U.S. banks that still have a lot of liquidity.”

At just over $22 billion, Q3/11 issuance was up 50% over the year-ago period but down 28% compared to Q2/11 as buyout activity dropped precipitously amid the dramatic surge in market volatility. In turn, refinancings re-emerged as the backbone of ABL. At less than $14.2 billion, Q1/11-Q3/11 new money ABL represented roughly 17% of total issuance — the lowest proportion of new ABL activity on record (See Figure 2).

LBO lending, which got off to a good start in 2011, stumbled in Q3/11 as market rumbles stymied new issuance, investors became increasingly risk averse, price exploration deepened and flex language widened. Underwritings became more selective and with them, the opportunity to combine asset-based structures with high-yield instruments grew increasingly difficult as the bond market roiled and private equity investors — despite having money to put to work — pulled back.

Nonetheless, if lenders were able to couple asset-based structures with either an institutional component, high-yield bond or a mezzanine tranche, asset-based lenders were supportive. In July, Academy Sports tapped the market for a $1.49 billion debt package — including a $650 million ABL facility — backing the company’s buyout by KKR. The deal blew out.

Similarly, in September, BJ’s Wholesale Club came to market with an $850 million, five-year ABL revolver that was supplemented by a $50 million FILO (first-in last-out) tranche. Both were part of a larger $2.225 billion bank loan package backing the company’s buyout by CVC Capital Partners and Leonard Green Partners. The deal was extremely successful and went on to secure a 100% hit rate among 20 asset-based lenders, each of which took a pro rata piece of both the first lien and the FILO piece. Of course, in the case of BJ’s the deal has almost 50% usage, and this is key to any successful ABL playbook.

“There are a lot of people who are trying to do more of a BJ’s type deal by increasing the ABL to minimize the term loan,” noted one arranger. “To the extent that you can fund under the revolver and throw in mezzanine and second lien, a deal can be appealing.”

The spreads on the BJ deal also worked to its advantage, especially in the context of the deal’s size. At LIBOR+200, the first lien tranche did not have the highest pricing, but it was certainly not the lowest. Indeed, given the traditional underpinnings of asset-based loans — namely, collateral and usage — a large, unfunded credit could struggle during syndication.

Apart from leveraged buyouts, spin-offs — including deals for Marathon Oil, John Bean and Fortune Brand — provided some additional opportunities for lenders, but they were arguably not enough to satiate lender appetite. A number of them, including recent deals for Kodak and Ericsson, represented smaller credits, often less than $100 million, which were therefore less likely to be syndicated. “If we want to win the deal,” said one lender, “we have to hold it.”

Still, by most accounts, both within the broader leveraged loan market and ABL, lenders are pricing more than will realistically unfold. Among non-event-driven transactions — namely the 83% of refinanced deal flow — lenders sought to push out maturities and trim spreads. Many of these were vintage 2008 and 2009 credits of at least $500 million, which filled the larger end of the deal size buckets in the ABL pipeline.

Large, relationship credits fared well — especially if there was usage under the credits. Substantially sized, investment grade-like, unfunded credits were more difficult. For example, the recent refinancing of Navistar’s existing, largely undrawn ABL via a $355 million (LIBOR+175) is said to have struggled.

In October, United Rentals entered into a $1.8 billion ABL revolver, upsizing its earlier $1.36 billion credit, and lowering spreads to LIBOR+200 (down from LIBOR+275). According to sources, the deal had limited sell down and closed with a somewhat top-heavy syndicate of 25 banks. Upon closing, the company promptly drew down $800 million under the revolver.

HCA also tapped the market with a refinancing this fall. The deal priced below what many lenders refer to as the market’s current spread floor of LIBOR+175-200 by coming in at LIBOR+150, but the capital markets business associated with the credit mitigated concerns around the thinner spread.

Average drawn spreads continued to compress into Q3/11, closing out the quarter at just over LIBOR+230 (See Figure 3) as lender competition intensified, but the pace of the spread decline slowed. “I do feel that certainly pricing declines have abated, and we have found the bottom of the market, particularly on larger, more broadly syndicated credits,” said one lender. “Among $250 million deals [and smaller] there will be competition to protect business.”

Undrawn fees have hovered in the range of three-eighths and 50bp closing out the quarter just south of 40bp. Sources agree it is unlikely to go much lower. “Price is holding steady,” said one lender. “We have had fewer people commenting on pricing over the last few months.” However, sources added that issuers are trying to maximize or tighten structure to focus on equity.

The biggest concern, added another lender, is that for sub-standard credits, “we don’t have anyone to sell to. The market has changed and we can’t partner up with the same people on multiple deals.”

Looking forward to Q4/11 and into 2012, prospects for deal flow are in a bit of a fogbank in terms of where new deals will come from, according to several lenders. “Will we get to $100 billion?” asked one arranger. “Is there enough left out there to do?”

Sources said that up until now, it’s been mostly refinancing. And while it’s been a good year for ABL in terms of issuance, the rest of the year is unclear. “There is probably some more refi activity out there, but will it get done by year end? We all have seen the refi cliff,” a source said. “Assuming that it is correct, we can see that there is nothing going out a few years.”

Indeed, the next meaningful uptick in maturing ABL debt is not until 2016 (See Figure 4). During the previous market dip, the 2009 credit crunch, the market saw fallen angels — including Motorola and U.S. Steel — tap the ABL market. And although a few may surface in the new year, lenders do not expect a lot of volume to be driven by DIP financings.

Fundamentally, credits are performing. M&A prospects appear to be limited as lenders wait for stabilization in the high-yield bond market.

“The only way macro issues have affected us is that there were a few M&A deals that would have been ABL plus high yield and are now ABL plus mezzanine,” said a source. “Other deals just don’t work.”

One area of possibility is cross border deals. “Sponsors have cash, but are increasingly focused on overseas opportunities because of lower purchase multiples,” said a source. “But larger equity checks are required.”

In the meantime, a number of issuers including Office Depot, McJunkin and Levi Strauss have structured deals with collateral components located outside the U.S., providing new opportunities. With the exception of Office Depot, which had international collateral, the credits were at least partially premised on Canadian assets. Sources pointed out that if well structured, the collateral component of the deal is less of a concern — local currency funding may be more of a concern depending on the bank.

With maturing portfolios and a limited deal pipeline forecasted in the near term, the secondary market has provided some opportunities for lenders. HCA is a key example of a name that has been picked up. HD Supply was trading at a steep discount and Sears, by virtue of its size, have each provided lenders with opportunity to pick up assets when the primary market has offered less than adequate supply. (See Figure 5)

Maria C. Dikeos is a vice president and senior market analyst at Thomson Reuters LPC in New York and has been with the company since 2001.  Her focus is primary market analytics including the production of league tables and industry analysis, as well as the enhancement of data collection and expansion of product offerings.  Previously, she worked as an associate at a major investment bank.