President,
The Brownstein Corporation
Lenders must be well-prepared before entering a syndicated asset-based lending agreement. Howard Brod Brownstein provides a history of syndicated ABL and outlines common processes and best practices for lenders.
Lenders regularly join together to provide asset-based loans (ABLs), typically when a borrower’s needs are too large for a single lender’s loan limit or comfort level. The lender that has the primary relationship with the borrower recruits other lenders to help make up the total loan amount. When several lenders are involved, the lender group may be referred to as a “syndicate,” but even when only two lenders are involved, the structure is fundamentally the same, with one lender taking the lead and an intercreditor agreement among them. Such “syndicated ABL” transactions typically involve an “agent” or “lead” lender which originates the deal and may provide the largest loan amount, and “participants,” which provide other, often smaller, loan amounts.
While syndicated ABL financing provides opportunities for borrowers to obtain higher amounts of financing — and for lenders to participate in more loans — syndicated ABL also presents additional needs and challenges. While the borrower may only have contact with the agent, the satisfaction of all involved lenders is still of importance. And the agent may be faced with differing views among the lender group, especially if one or more participant lenders have sold their loan interests. For these reasons, syndicated ABL is a worthwhile topic of study and conversation and is often the subject of educational programs at SFNet and elsewhere.1
FROM CLUB DEALS TO A VIBRANT MARKETPLACE
The history of syndicated ABL provides an interesting background on its development. Regulated banks began as the main source of debt capital and, starting in the 1970s or earlier, formed “club deals” by involving other banks when the loan size got too big. By the 1980s, leveraged buyouts (LBOs) had become more common, with banks involved in acquisition financing. The Glass-Steagall Act of the 1930s was still in effect, which separated commercial and investment banking and limited the expansion of banks into more “creative” lending. Its repeal in the 1990s enabled banks to move into areas previously unavailable to them, with loans becoming an asset class for purposes of purchase or investment. The trend continued in the 2000s as LBOs grew until the 2008 financial crisis created global turmoil and forced a temporary “reality check” on ABL. But by the early to mid-2010s, expansive ABL lending had resumed, leading to the vibrant marketplace we still have today.
Other historical factors which have contributed to the development of syndicated ABL include the establishment of the Uniform Commercial Code (UCC) in 1952, which helped enable secured lenders to establish their security interests in collateral, the creation of the Bankruptcy Code in 1978, and subsequent refinements to both. The consolidation of banks, the creation and growth of ABL groups within those banks and the development of nonbank asset-based lenders for borrowers who couldn’t qualify for bank borrowing have furthered the practice of syndication over the years.
ABL SYNDICATION TODAY
Today, syndicated ABL facilities are nearly always senior secured loans, with a floating rate, callability and terms which may be heavily negotiated and variable from one loan to the next. The structuring, like all ABL loans, is based on advance rates for qualified accounts receivable and inventory, which make up a “borrowing base formula.” The rules regarding which assets are “qualified” may also be negotiated, e.g., with allowance for seasonal changes, customer concentration and permissibility of non-ABL facilities to exist alongside, such as lending on equipment and real estate. Additional covenants may or may not be included, depending on the risk factors for each loan.
If the formula doesn’t result in sufficient financing, but the borrower is otherwise creditworthy, lenders may provide a temporary or permanent “airball” — a portion of the loan not justified by the lending formula. ABLs often include some form of mechanism for cash dominion, such as rules regarding to where the borrowers account debtors should send payment of invoices and the lenders’ control of those deposit accounts.
FORMING A DEMOCRATIC SYNDICATE
It is important to note that the lead bank’s decision whether to form a syndicate, and if so, the number of participants to include, may not be driven solely by its own lending limit and whether the borrower’s needs exceed that amount. The lead bank’s appetite for risk, including the borrower’s perceived risk and the risk of its greater industry, are also factors. When selecting potential participants for the syndicate, the agent may consider banks with whom it has worked well in the past, as well as any preferences the borrower (or its equity sponsors) may have.
A key element of syndicated ABL is the syndication agreement between the lead bank and participants. It includes the degree of “lender group democracy” that may exist, whereby participants may have a voice in the administration of the loan, as well as whatever rights and remedies loan participants may have if they disagree with the actions (or inactions) of the agent lender. This “democracy” element is an important factor in syndication agreements and may be heavily negotiated when the agreement is created.
Another important element of syndication agreements is the degree of freedom that participants may have to sell all or part of their loan participation, which they may be induced to do if the borrower is underperforming, and total repayment is in doubt. Regulated banks typically take reserves early when a borrower is underperforming, and in an amount that may exceed the degree of loss they may face. This is due to the dynamic between such lenders and the regulators that review their actions. Unlike an IRS audit, bank examinations cannot be challenged on a line-item basis, so challenging a bank exam almost never happens. This “erring on the long side” by regulated lenders when taking write-downs and reserves is a practice I refer to as “regulatory arbitrage.”
This can sometimes lead to a sale of the regulated lender’s participation in the loan syndicate to a nonregulated lender, such as a finance company or hedge fund. Such nonregulated lenders see the world fundamentally differently, and their appearance in the loan syndicate can present new challenges for the lead lender. When the faces around the table have changed, the probability that participant lenders disagree with the agent lender increases. New participants may have purchased their participation below par, i.e., at a price below the amount that the selling participant had contributed to the original loan. For the foregoing reasons, it is not unusual for loan syndication agreements to include a right of first offer and/or right of refusal, limiting a loan participant’s rights to sell their participation.
BEST PRACTICES FOR AGENTS
For these reasons and more, agent lenders will be wise to follow best syndication practices. Foremost among these is early and effective communication by the agent to the participants. If the participants learn of issues with the borrower from some other source, they will understandably wonder what else the agent lender has not told them, or perhaps, has not been sufficiently vigilant to discover. If the loan syndicate has a large number of participants, e.g., seven lenders or more, it may be helpful to form a steering committee to strengthen the degree of oversight.
Although the syndicate will engage legal counsel when the loan is created and the syndication agreement is put in place, the syndicate might require different counsel should the syndicated loan get into trouble. Instead, “workout” counsel will be required, which involves a different set of skills and experience, as well as a different set of ethical conflicts of which to be clear. It might be worthwhile to select counsel to begin with that can provide workout services, or at least to identify at the outset potential future counsel for such purposes.
At the first sign of any possible difficulties with the borrower another useful tool for loan syndicates is for the agent lender to engage a financial advisor on behalf of the syndicate. This may be a turnaround management firm that the lenders might recommend for the borrower to engage, although a firm that is working for the lenders will not make any recommendations to the borrower, since that could expose the lenders to lender liability and/or equitable subordination. Rather, the financial advisor for the loan syndicate will gather useful information early and help to preserve the working relationship of the syndicate participants. The financial advisor can help improve communications with the borrower, interact with the borrower’s financial advisor if they have one since they “speak the same language” and help to make the loan syndicate’s subsequent decisions the right ones under the circumstances.
Syndicated ABL is an important feature for lenders to offer if they want to be part of larger deals. But it’s important for lenders to thoroughly understand what is involved and to be well-prepared for the needs that loan syndication presents. •
1The author led the creation and presentation of the first Syndicated ABL program offered by the Secured Finance Network’s predecessor organization, the Commercial Finance Association (CFA), in 2012.
Howard Brod Brownstein is president of The Brownstein Corporation, which provides turnaround and crisis management for borrowers, and also obtains sellers and refinancing, including for healthy companies. He serves as chair of ABF Journal’s Editorial Board.
