May/June 2013

Villanova 2013 — Today’s Lending Environment: Industry-Specific Observations

At the sixth annual Education and Networking Conference sponsored by the New York Institute of Credit, the Philadelphia chapters of the Turnaround Management Association and Commercial Finance Association and the ABF Journal, four leaders in the commercial lending space offered their perspectives on today’s lending environment and provided observations from their respective areas of specialization.

Participating on the panel were Vincent Belcastro, managing director and group head, CIT Capital Equipment Finance; John D. Erwin, senior vice president, loan portfolio manager, Wells Fargo Capital Finance; Mike Gervais, chief executive officer, Gemino Healthcare Finance; and Russell C. Murawski, first senior vice president and manager of commercial real estate, Valley National Bank.

Moderator Paul H. Shur, a partner with Windels, Marx, Lane & Mittendorf, asked the panelists to first describe their respective industry niche. Next, Shur asked the participants to address trends and issues that affect all types of commercial lenders in today’s marketplace. To conclude the session, the participants shared details of interesting commercial lending case studies in which they participated. What follows is an edited report on the session:

Industry Niches

Erwin described himself as a full service asset-based lender, providing primarily working capital lending but also equipment and real estate financing for our working capital borrowers.” Wells Fargo Capital Finance, with $31 billion in assets, is part of Wells Fargo Bank, a $1.4 trillion bank. “We do every kind of asset-based lending you can imagine. In 2012, we acquired Burdale Financial, which is headquartered in the UK and provides cross-border financing, so we have a footprint in Europe now,” Erwin explained. Burdale Financial provides ABL financing from $10 million to $250 million. He added that Wells Fargo Capital Finance also recently established a junior capital group that provides junior secured loans from $7.5 million to $100 million. “So now we’re doing the B pieces. We’re trying to provide a full range of financing options for our clients,” Erwin explained.

Belcastro said that the mandate of his group at CIT is to provide term and asset finance solutions to middle-market companies that have mission critical and revenue generating assets that they need to leverage. Lending products are either structured across tranches, or occasionally multi-tranches, or they are structured against pools of assets within the company’s asset base and balance sheet.

“CIT has been around since 1908. We are a $45 billion company that looks to provide primarily corporate finance solutions to a whole host of middle-market companies, whether that is in industries like general commercial and industrial, energy, communications, media and entertainment, technology, healthcare,” he explained. He added that the other portion of CIT’s book is a large equipment leasing platform predominantly in the aerospace, rail and maritime sectors.

Gemino’s Gervais explained that his company is a private-equity backed firm that has raised approximately $300 million since its formation in 2007. Gemino’s focus is entirely in the healthcare sector, where it provides asset-based lending and some term financing in connection with a revolving line of credit. Transaction sizes are from $1.5 million up to $12 million, with an average transaction size of $5 million. The company has closed 67 deals since it was first funded. “If you looked at our portfolio today, it’s pretty diverse across the healthcare services — about 25% is behavioral health, 20% hospital, about 18% nursing and a host of others, such as staffing,” Gervais said.

Murawski said he is responsible for managing the commercial real estate department for Valley National Bank, which has more than $16 billion in assets and 207 branches throughout New York and New Jersey. Murawski’s portfolio is about $3 billion, equally split with $1.5 billion east of the Hudson River and $1.5 billion west of the Hudson. “What we’re looking to do is continue to do and find small relationships and ways to put some capital on the street. We provide financing for various types of projects including residential construction, land acquisition and site improvement. A very hot arena now is multi-family apartment buildings and co-ops,” he noted.

Business Development & Market Trends

Sources of New Talent

One of the challenges that the panelists discussed was where new talent will come from to populate the commercial lending space. Erwin noted that historically college graduates have often pursued other options in finance and would look at asset-based lending and ask “what in the world is that?” He explained that with the currently tight economy his group is finding a strong pool of candidates who are hungry for opportunity and interested in asset-based lending. He also noted that Wells is employee-focused and always searches first internally for talent, adding that positions that lead to roles in asset-based lending are often credit analysts or field examiners. However, he noted, “With the currently sluggish economy, banks are looking to do more with less. It’s not a robust hiring environment.”

In the healthcare finance space, Gervais noted that one of the biggest challenges is on the business development side of originations. “We’re very fortunate to have a good origination group at Gemino, but as we look to grow the business, we see a lot of people have been recycled in our industry and many don’t get involved on the origination side I guess they don’t understand healthcare or maybe there’s a hesitancy,” he explained. Gervais added hiring is an investment, noting that bringing on board an asset-based originator that doesn’t know healthcare usually will require a 12- to 18-month training cycle.

Specialized Lending Versus Banks

In addressing the choices a customer faces in today’s marketplace regarding selecting a specialized lender versus a bank that may have more options, Belcastro said the reliance on short-term commercial paper to provide flexible and affordable financing solutions for your client is a thing of the past. Thus, CIT has migrated from an independent finance company into a bank holding company. As a result, he noted, CIT is able to tap deposits and offer much more reasonable rates, making it much more competitive.

“Having an online bank to raise deposits offers us additional financing flexibility, and allows us to competitively price transactions,” Belcastro noted.

Erwin added that clients typically have multiple needs, and Wells Fargo can provide many solutions, which is helpful in producing an overall yield that in turn allows his group to offer competitive loan pricing. “If you’ve got a strong borrower, you can expect your competition knows it, and they’re going to try and win your client. Today we’re seeing loans go at rates that make you hold your nose . However, we are achieving satisfactory relationship returns by providing ancillary products and services that can bring a total financial solution package to the borrower. Loan return yields are sometimes minimal, but overall the relationships are satisfactory through cross selling multiple products, and you aggressively work to protect client relationships,” he explained.

Regulatory Oversight

In addressing lenders’ concerns regarding regulatory oversight, Erwin noted that for commercial banks, the regulatory environment is more onerous today than it has ever been — and growing. He explained, “One of the things I find that’s disconcerting is the Dodd-Frank bill passed two and a half years ago, and they have yet to write half of the rules that will come out of that legislation. They’re trying to figure out how to measure it. We bankers have become sort of the guinea pigs with regard to how to implement these regulations and have them make sense. It seems the federal government is taking a one-size-fits-all approach. Some of the well-intentioned regulations to keep us from another financial crisis are targeted more toward investment banks, but commercial banks are caught in the web. Today, we’re seeing regulations that really just add cost, slow us down and don’t get to the intended target. In asset-based lending, because of the nature of what we do, our customers tend to show higher leverage and become defined as ‘high risk borrowers or potentially troubled debt restructure.'”

Murawski added, “We’re all afraid to do things for our customers because it then gets looked at as a TDR, and it has to be reported, then you have to take reserves and you have to classify the asset. It’s absolutely onerous. Many organizations, like mine, are regulated by the OCC. Recently our in-house OCC examiner looked at us and said, ‘You ain’t seen nothing yet,’ in regard to Dodd-Frank.”

Regarding smaller banks, Erwin wondered how those that aren’t very well capitalized will be able to comply with these expensive regulations and survive in the long run. He noted that we might see more consolidation among smaller banks. He continued, “Recently there has been much debate about whether we should tolerate ‘too big to fail.’ My sense is that it’s too late for that debate. We already have institutions that are too big to fail, and reversing this status will not happen. According to the Federal Reserve, there is roughly $13 trillion today in commercial banking assets spread among 6,600 institutions, i.e., federally insured banks. Twelve of those 6,600 banks hold 70%, or $9.1 trillion, of the $13 trillion in assets.”

Construction Financing & Real Estate Growth

Murawski explained that in regard to construction and real estate growth, there has been a shift over the past few years from tract single-home developments in the suburbs to condominium and townhouse construction along train lines in order to get closer to jobs and services. However, the commercial real estate industry is still very sluggish, he noted. “We’re seeing a lot of people picking up some properties at very good prices in a speculatory nature, knowing that at some point in time a dark mall is going to put the lights back on or a partially completed or partially full building will eventually get a tenant.”

Experience With Legal Counsel

Regardless of the type of commercial lender, all encounter legal counsel on both sides of the table. Gervais said that Gemino uses three or four law firms that know asset-based lending and have healthcare expertise. “Many of our providers are smaller and haven’t been through an asset-based loan before, so we must engage in an education process. A good law firm that knows that and can work with the other counsel is important,” he added.

At Valley National Bank, Murawski and his group rely on a staff of in-house lawyers and on a quarterly basis they review the list of outside counsel. “The names that appear have been proven over the years as being able to provide good counsel. Sometimes we are opposite them in certain situations, and that’s more often how they get on the list — they provided excellent counsel or excellent adversarial work against us.”

Erwin said his unit at Wells Fargo relies heavily on external counsel. “What I found is the best success comes with the lawyers that can really help deals happen. If you’re heavily negotiating documents and the lawyers are trying to prove to each other who’s the smartest person in the room, it can become very expensive and counterproductive,” he said.

For Belcastro at CIT, having specialized counsel is of primary importance because most of the transactions his group structures tend to have to fit within the confines of a senior loan agreement. Having the right counsel to document the inter-creditor issues and to document the lien priority issues for specific pools of assets is highly important. “In certain instances, we take a lot of stock in having a fantastic turnaround advisor in the room who can bless all of the cash-flows and the turnaround plan,” he added.

Erwin concurred, ” Turnaround consultants are very important partners who can help to advise debtors and their counsel. It’s never a good situation when you have counsel on the other side that may be in a little over their head. They become combative, they don’t quite know what should be happening, and your case can really run off the rails. In those situations, a skilled crisis manager who can guide the debtor and help set realistic expectations is very important.”

Case Study — Dana Transportation

Belcastro presented a case study featuring Dana Transportation, a chemical and fuel hauling trucking company with a 30-year history and nationally diverse transportation footprint, as an example of working through inter-creditor issues and structuring different advance rates out of a single credit based upon different types of collateral that were part of a single transaction.

Belcastro said he picked this case because “it’s an interesting example in which you had to bring three different lenders together at three different parts of the capital structure.”

Belcastro went on to describe Dana as having a solid core business with an excellent “blue chip” customer base that “violated its covenants during the downturn.” Their agent lender had gotten “fatigued” with the credit. The company was able to source a new revolving lender that was willing to finance the ‘A/R’ and some of the real estate, but Dana had this pool of tank trailers that few in the asset-based community could get comfortable with. You need to be specialized in this space and understand this collateral pool as it can be a challenge,” Belcastro said.

Due to the demand for a loan with a greater collateral cushion, a second lien solution provided by GB Credit Partners, the investment management affiliate of Gordon Brothers Group, was required. The challenge was to structure a second lien strip with a highly negotiated inter-creditor agreement between CIT as the term loan agent and the revolving lenders. Belcastro explained CIT was unable to get comfortable on a first lien structure alone as it felt a greater collateral cushion was required to successfully refinance the current senior lender.

“We brought in GB Credit Partners to execute the second lien There is a deeply subordinated inter-creditor between GB Credit Partners as second lien lender — who did a phenomenal job on understanding this credit and the cash-flows — and certainly the turnaround manager, who the previous lender had put in place, had done a good job giving us various operating scenarios and helping us to sensitize the cash-flows,” Belcastro explained.

“The whole thing start to finish was about six months of legal documentation, and I’m happy to say that the company ended up with about $9 to $11 million of opening availability and it is fully refinanced,” he concluded.