Are We Entering a Lenders’ Market? Identifying Themes in Non-Bank ABL

A new environment with higher interest rates, fewer stimulus packages and a refocus on deposits may mean that we are entering a lenders’ market. Derrick Wong of Eagle Pointe Capital spoke with representatives from FGI Finance to get the perspective from the non-bank lender side.

In August 2020, I spoke with several nonbank asset-based lenders for an article examining COVID-19 pandemic trends in asset-based lending. At the time, many were anticipating increased deal activity in the ABL industry, with the pandemic expected to reinforce lending and credit fundamentals and disciplines.

Developing a clear line of sight was incredibly difficult at that time given the state of the world in the midst of the pandemic, which slowed production, crushed supply chains and drastically altered how most industries conducted business. In hindsight, as these challenges mounted, the ABL environment wrangled with record low interest rates, approximately $5 trillion in government stimulus through the Paycheck Protection Program and other government lending initiatives, and an overabundance of low-cost deposits for traditional lenders. These forces tilted the ABL market in favor of borrowers, allowing them to borrow cheaply with lenders who were looking to deploy excess liquidity and deposits through new loans.

Three years later, those same themes and factors have largely reversed. Interest rates have risen precipitously, pandemic-era government stimulus packages have largely ended and traditional lenders are focused on gathering low-cost deposits in the wake of bank collapses earlier this year.

Although these new forces may be helping to restore equilibrium in the ABL market, there are still many questions to answer: What do these new themes mean for bank and non-bank asset-based lenders? Are we now entering a lenders’ market?

To seek out some answers, I spoke with Robina Peanh, business development director of FGI Finance, and Ronnie Bloom, managing director of FGI Finance. Peanh and Bloom focus on asset-based loans, receivables financing and invoice discounting globally, with transactions ranging from $4 million to $40 million.

How has the new environment — including higher rates, potential increased regulation of traditional lenders and a possible recession — impacted new deal activity in your market?

Robina Peanh and Ronnie Bloom: It appears from the recent increase in the level of deal activity we’re seeing, particularly on the refinancing and restructuring side, that borrowers are beginning to feel the effects of the higher interest rate environment we find ourselves in. We’re seeing more and more companies struggling to meet their debt service coverage/fixed charged ratios, especially those that are highly levered, with many in breach of financial covenants with their lenders. Whether due in part to the over-aggressive deal structures we’ve seen recently or simply lender fatigue with certain borrowers (some of whom have yet to fully recover from the effects of the pandemic and supply chain disruptions), there has been a noticeable uptick in refinancing opportunities, which we expect to continue in the near term.

Additionally, the recent highly publicized struggles with several regional banks further contributed to the increased deal flow we have seen of late. Numerous regional banks have curtailed any and all lending to new borrowers regardless of credit quality. The only exception appears to be in those rare instances where borrowers are willing to bring sizable deposits to those banks, given the regional banks’ need to increase deposits to previously held levels.

The workout/special asset management groups within banks appear busy dealing with busted cash flow deals or troubled conventional loans where borrowers have tripped covenants. This, in turn, has led to an increase in deal activity amongst turnaround groups and consultants. With interest rates forecast to remain at current levels, if not to increase further, we expect deal activity to remain robust for alternative lenders.

What are the most significant changes to deal activity in your market in the current environment?

Peanh and Bloom: In this type of environment, deal activity for alternative lenders is far more robust than it has been in the last few years. The challenge, or change, if you will, becomes less about finding the deals but rather more about finding the right opportunities to pursue. We’re seeing quite a few deals where companies are nearly insolvent and hanging on by a thread, lacking the working capital needed to see them through any turnaround. Those are the tough deals for lenders, even alternative lenders, to get behind. At FGI, we’re looking for opportunities where not only is there sufficient working capital but, equally as importantly, where there is a strong management team in place who understands what is needed to turn the business around and can effectuate and execute such a plan.

That said, there is still quite a bit of liquidity in the market and we’re still seeing some fairly aggressive structures, even from alternative lenders, on some of the better-quality deals, which remain highly competitive.

What is the outlook for your marketplace in the next six months?

Peanh and Bloom: With interest rates on the rise, banks tightening up and being more conservative and an increase in activity among bank special loans groups, we expect deal activity to increase even further into the third and fourth quarters for non-traditional lenders. On the M&A side, while deal activity has trailed off the last few months, there has been an increase in the distressed M&A market, which we expect will continue to get even busier going forward. From what we’ve been seeing and hearing from the turnaround consultants, advisors and special asset management groups within the banks, the consensus is that this is only the beginning.

This is what we all anticipated would happen when COVID-19 hit, but it never materialized; in fact, it was just the opposite. The aggressive deal structures that we saw during the past few years (many cash flow structures), coupled with the significantly higher interest costs as a result of current rates, will lead to more and more covenant breaches and bank exits of credits from traditional lenders, leaving alternative lenders to provide flexible financing solutions that give companies the opportunity to execute on their turnaround plans.