Whatâ€™s in Store for 2014? Challenges and Opportunities of the Year Ahead
Longtime ABF Journal contributor Lisa Miller talks to five industry heavyweights about whatâ€™s ahead for asset-based lending in 2014. The lenders discuss interest rates; how increased bank liquidity has brought new players, higher hold limits and fiercer competition; Dodd-Frank and more.
Economists have mixed views of what is ahead in 2014. Will the slow growth of the past few years stagger and stall, or will the country continue its turtle-paced climb back to prosperity? There is no doubt about the environment in which asset-based lenders must work. The realities of todayâ€™s marketplace include intense competition, growing regulation, excess liquidity and pressure on structure and pricing.
To learn more, we talked to five asset-based financing leaders: Bill Kosis, executive vice president, PNC Business Credit; Kurt Marsden, head of Business Finance, Wells Fargo Capital Finance; Joseph F. Nemia, executive vice president, head of Asset Based Lending, TD Bank; Sam Philbrick, president, U.S. Bank Asset Based Finance; and Michael Sharkey, president, Cole Taylor Business Capital.
Most of our panelists agree that interest rates will stay low or increase slightly. â€œGiven the Federal Reserveâ€™s stated intention of keeping rates low until unemployment is reduced to a more acceptable level, I expect interest rates to remain in their current range throughout 2014,â€ comments Kurt Marsden.
Joe Nemia suggests rates wonâ€™t rise until there is measurable economic growth across many sectors of the domestic economy. â€œThere are recent signs of improvement in new home sales, automobiles and other durable goods, most likely because of the lack of activity in these sectors in the 2009-2011 timeframe. The economy still needs to catch up, and I think we are looking at the second half of 2014 until any real adjustments are made.â€
Increased bank liquidity has brought new players, higher hold limits and increasingly fierce competition to the ABL space. â€œThe banks have capital and are looking for viable places to deploy it within the risk paradigm of their organization,â€ says Marsden. â€œFor many institutions, asset-based finance fits nicely into that paradigm.â€
â€œABL portfolios are reflective of the improving economy, and peer group data suggests that weighted average risk ratings appear as healthy as they have ever been,â€ notes Nemia. â€œThatâ€™s the good news. On the flip side, new deal activity has not kept pace with the supply of funding available to invest in new opportunities.â€
â€œWe have corporate banks taking some of the borderline asset-based deals, but there are still plenty of great deals in this economy,â€ proclaims Kosis. â€œPNC Business Credit is a middle- market lender, and we see at least 100 deals every two weeks. In fact I rarely see the same names twice, and Iâ€™ve been in this business for more than 35 years. The U.S. middle market is extremely deep.â€
When Cole Taylor entered the ABL market in 2008, there wasnâ€™t much liquidity and the environment was good for ABL. â€œGradually, over the last five years, that competition has intensified,â€ describes Sharkey. â€œIt is as competitive right now as I have ever seen it. Itâ€™s not that there are more ABL lenders than ever before; itâ€™s the commercial banks and the alternative lenders that are pressuring the market. The banks come in with bargain-basement commercial deals with no field exams and no appraisals. Then you add the explosion of alternative lenders taking on riskier cash-flow deals, and a big bite has been taken out of the market.â€
â€œI have to believe that the deterioration of pricing will start to slow,â€ predicts Philbrick. â€œWhere this intense, competitive environment leads us is that we need to compete on the basis of trying to be the first provider with the right answer for our clients.â€
â€œWe have done a lot of business with intermediaries and equity funds over the years,â€ says Kosis. â€œThey tend to be our trusted partners, and that has helped us in this competitive situation. But there is no question that there are a lot of new players. We are holding more, especially when our clients grow. Thereâ€™s tough competition, but we have been through these stretches before. We just have to work harder.â€
New Players, New Pressures
â€œIf you are in an institution that is trying to meet corporate customersâ€™ banking needs, your set of capabilities is not complete unless you have the ABL product,â€ says Philbrick. â€œOur competitors have put more resources into the ABL business over the last five years, and I donâ€™t see that changing. In terms of the market we are in, with intense competition and declining spreads, we all have to have a keen eye toward managing our credit and non-credit expenses appropriately.â€
â€œWithin our portfolio, we know other lenders are calling our clients, because our clients share that information with us,â€ states Marsden. â€œHopefully as a lender, you are anticipating this activity and working to stay ahead of it by understanding your clientsâ€™ needs and developing creative solutions.â€
Without growth in the portfolio and a quiet M&A market, Sharkey admits that the only way to grow is to steal somebody elseâ€™s customer. â€œThat creates a ton of pressure across the market on structure, pricing and every aspect of what we do.â€
â€œThe advent of Business Development Corporations and B lending funds have been a major positive for us,â€ emphasizes Kosis. â€œSome of these funds have billions of dollars. They control part of the market and end up putting the leverage on equity-driven deals, such as M&A transactions. They need a player to do the asset-based monitoring and administrative work, and we cross-sell our bank products to the client. We end up getting a healthy return on those deals while enjoying a good support cushion from the funds.â€
â€œWhere large ABL lenders will see an impact is on the talent side, as the new entrants look to expand their platforms with experienced lenders who provide immediate credibility to their growth efforts,â€ warns Nemia.
We asked our panelists to tell us how the Dodd-Frank Act has impacted ABL activity. â€œWe are watching the volume of compliance increase, and that requires investment in systems and manpower,â€ reports Marsden. â€œThis in turn increases the costs of managing the asset-based product. We look to increased automation of processes in order to become more efficient as we deal with current and future compliance requirements.â€
â€œWe should expect the regulators to continue down the path of increased oversight across the various risk and compliance areas of regulated institutions,â€ remarks Nemia. â€œThere is a cost to improving systems, increased reporting and compliance, but itâ€™s a non-negotiable.â€
â€œRegulation is one of many factors that are part of our operating environment,â€ affirms Philbrick. â€œWe work diligently to make sure all regulations are appropriately accounted for in how we do business.â€
â€œWe operate in the U.S., Canada and United Kingdom, and we have regulators on every front,â€ says Kosis. â€œWe consider them part of the operation. We operate with them in a mode of total transparency; if I know about a problem, they know about it. Generally we find that if we support them and give them straightforward, transparent reporting, they come up with some ideas that are beneficial.â€
Increased M&A activity would be a welcome shot in the arm to the ABL industry, but would it also lessen the focus on each otherâ€™s customers? Marsden says his company will continue to focus heavily on refinance activity within its portfolio while pursuing new opportunities with prospective clients. â€œMerger and acquisition activity definitely decreased during the summer months, but we are looking for a pick-up as we move into the fourth quarter. Many of our private equity partners have raised additional capital and are ready to deploy it when opportunities arise.â€
â€œItâ€™s hard for me to understand why the M&A market isnâ€™t more active,â€ ponders Sharkey. â€œThere is so much money and liquidity chasing deals, that if you have something to sell right now, the multiples are outstanding. Perhaps sellers are waiting for their EBIDTAs to come back to where they were or for sales to return to prior levels. It could be that the private equity groups arenâ€™t selling, because they can do a re-cap and take money off the table, but I donâ€™t know how they are going to redeploy that capital if they get it back.â€
â€œThere are plenty of buyers out there, but there are not a lot of sellers who believe selling in this market at these prices is in their best interest,â€ responds Philbrick. â€œAt some point, the sellers will realize that this is where we are, from a value standpoint, and will move forward if the sale makes sense for their future. The problem is certainly not a lack of capital!â€
â€œMany ABL borrowers could ultimately be the target or the acquirer in an M&A transaction,â€ suggests Nemia. â€œLenders will need to continue a high service level to remain in a business combination that impacts their borrowers. From a credit risk perspective, underwriting assumptions will need to be re-tested as the competitive landscape changes and higher interest rates could impact the combined entity.â€
â€œThe equity funds have a lot of money, and there are a lot of groups going out to raise additional money,â€ continues Kosis. â€œWe value our partnerships with the big institutional BDCs and the deals we can participate in with them. We are able to do the front end, lead the revolver and the asset-based piece of the financing, and blend the pricing down with a one-stop outlook for the acquirers. This activity is picking up, and we should have a strong fourth quarter and 2014 on that front.â€
â€œThe fact that we have any increase in M&A activity is extremely encouraging,â€ mentions Philbrick. â€œI hope it lessens the focus on the refinancing that weâ€™ve lived off for the last two years. True growth through M&A and improved economic activity is the thing that can carry us forward.â€
â€œWe hope that the banks doing non-ABL deals, or the lenders buckling to pressure to be more aggressive on structure, are going to have problems, lose money and stop being so aggressive,â€ expresses Sharkey. â€œIt probably wonâ€™t happen until there is a bump in the road in the market. It is hard for me to see how the environment can get a lot more competitive â€” unless we start giving money away!â€
Going into 2013 many lenders experienced diminished pipelines because of tax law changes that prompted clients to close business by the end of 2012. It appears that pipelines are in good shape for 2014. â€œWe are seeing a robust pipeline back to normal levels,â€ relates Kosis. â€œI expect that to continue through year-end, and we should be at a much more normalized level going into 2014.â€
â€œAbsent any broad indication of increased activity in 2014, the impact of higher interest rates may spur companies to reassess their long-term value as it relates to a potential acquirer that will utilize ABL to affect the purchase,â€ comments Nemia. â€œThere is still a significant amount of liquidity on the sidelines, so Iâ€™m hopeful that 2014 will be a more robust year for the industry.â€
â€œUnless there is some significant catalyst of change, such as an economic event that takes capital out of the marketplace, I believe that 2014 will be very similar to 2013,â€ laments Marsden.
â€œWe review as many packages and propose as many deals as ever,â€ claims Sharkey. â€œThe problem is our winning percentage due to the nature of the market, the number of competitors and the alternative lenders. All these different aspects make it so intensely competitive, and our winning percentage is falling. It isnâ€™t the pipeline thatâ€™s the problem. Between pricing, structure and covenant pressures, it is more difficult to win.â€
â€œItâ€™s still early to predict what 2014 will look like, but itâ€™s safe to assume that it is going to be more of the same,â€ finishes Philbrick. â€œWe are going to work very hard next year to grow our business.â€
Room to Grow
â€œWe continue to see an active syndication market,â€ declares Marsden. â€œThere is an appetite for assets, and people are embracing creative solutions. In some cases they are embracing asset classes that asset-based lenders might not have lent on in the past. Particularly, international receivables and inventory are becoming more common in our loan structures, and more institutions are getting comfortable with these international components.â€
â€œThere is a lot of capacity, so reasonable deals will sell readily,â€ proposes Kosis. â€œThat means that more sophisticated sponsors are cutting down the number of participants, forcing people to take larger positions. Many of the people, who are putting these deals together and buying companies, want to rely on a few banks they know and trust rather than bringing in ten banks. This has worked in our favor.â€
â€œWe have recently seen two large acquisitions in the retail sector: HBCâ€™s announced purchase of Saks and the announced acquisition of Neiman Marcus,â€ stresses Nemia. â€œIf these deals are consummated, the ABL product will play a significant role in the deal structure. Also coming to market is the Dell transaction that represents a $2 billion ABL facility. It will be a real test of the appetite relative to higher hold limits and more players in the market. Whether the market can digest that deal will be a key indication of market depth and the willingness to provide an enormous amount of money in the ABL product.â€
We asked our panel whether average earning assets will be higher or lower in 2014 and what drives that outcome. â€œWe have seen growth in average earning assets over the year,â€ says Marsden. â€œBecause we provide revolving lines of credit, there is expansion and contraction in our portfolio throughout the year due to the cyclical nature of our clientsâ€™ businesses. For example, a large percentage of my client base comprises companies in the building-product space, and their business tends to ramp up in the spring and slow in the winter months. Consequently their capital needs shift dramatically throughout the year. Assuming the confidence level in business continues to improve â€” and we are seeing signs of this in our client base â€” I believe we will continue to see growth in our average earning assets as we move into 2014.â€
Nemia predicts, â€œThe key drivers to earning assets will be a pick-up in new deal activity in addition to organic economic growth that will motivate the typical ABL borrower to make investments in working capital assets and PP&E.â€
â€œThe economy is reasonably good, but there will be spread pressure because you have a lot more people in the market,â€ adds Kosis. â€œThe credits will be good, based on the solid performance we saw this year. We have strong relationships, and weâ€™ll continue to work with those folks while also developing new relationships. Hopefully that will carry us, and weâ€™ll show some growth.â€
â€œIn 2012 we saw an uptick in the percentage of our lines being used by our customers, and that is a measure of organic growth in the portfolio,â€ states Sharkey. â€œThis year it has been virtually nil, and I expect next year to be about the same. The government has become a huge part of the economy, and if it doesnâ€™t fire on all cylinders, it hurts business growth. We have customers suffering from the sequester; theyâ€™ve lost volume and had to shrink their balance sheets because of a lack of volume from the government. The recent government shutdown is just going to exacerbate that problem. I donâ€™t see much recovery in 2014.â€
â€œWe expect modest loan growth,â€ remarks Philbrick. â€œThe question is whether your loan growth exceeds the deterioration in your spreads so you can realize significant revenue growth. We are optimistic that weâ€™ll grow our business from a revenue standpoint, but it will be a challenge.â€
Areas of Concern
â€œThe unpredictable nature of where 2014 growth will come from has to be on the mind of everyone on this panel,â€ speculates Nemia. â€œJust listening to the Fed Chairmanâ€™s latest comments and continued asset purchases by the Fed certainly sends a message of uncertainty as to the timing of sustained U.S. economic growth.
â€œMy concerns are two-fold,â€ admits Marsden. â€œThe interest rates on asset-based loans are near record lows, and without a foreseeable shift in the competitive dynamics, I am concerned about continued price compression. My second concern is the aggressive nature of many recent loan structures. Itâ€™s important to be creative but avoid getting caught up in the fervor of this competitive environment.â€
Kosis is concerned about quality personnel and keeping the company culture together. â€œWe have a highly engaged workforce, and we want to keep it that way. PNC Bank is solid â€” and that gives us a lot of leeway â€” but it is hard work, with the normal credit and business headaches and the challenges of working with the regulators. Weâ€™ve grown over the years and have to develop good, fundamentally sound people as well as a few stars to drive the business along.â€
â€œThereâ€™s a need for our products in good times and bad,â€ encourages Sharkey. â€œYou have to be a little quicker and smarter while using all the ABL skills youâ€™ve learned over the years and bring them to bear on a particular transaction. There is no lack of opportunities, but you have to decide which ones you want to do and what it takes to win. We are all being pressured to stretch our parameters, but you have to have the discipline not to do something that isnâ€™t prudent. We walk the fine line of sanity all the time. We want to be around for a long, long time and that means we donâ€™t try to push the limits too far just to grow today.â€
â€œWe are going to be in this environment of low interest rates, modest activity and intense competition for some time to come,â€ concludes Philbrick. â€œIf thatâ€™s the backdrop for the foreseeable future, you have to manage your business very carefully. It is critical that you stay really close to your existing customers. You must manage your business from an expense standpoint, so you can continue to operate successfully with this pressure on margins. Itâ€™s an environment where you can really see who the good bankers are; those who can drive growth without sacrificing long term credit quality.â€
Lisa A. Miller is a regular ABF Journal contributor who has worked in the commercial finance industry for more than 15 years.