By Lisa Rafter
The once-distinct lines between asset-based lending and cash flow lending are continuing to fade, giving rise to hybrid structures that fuse the collateral rigor of ABL with the flexibility of cash flow financing. This convergence is not merely a trend — it’s a strategic response to a volatile economy, high interest rates and the relentless demand for liquidity in private equity (PE)-driven dealmaking. For the dealmaker ecosystem — PE sponsors, investment bankers, legal advisors, specialty lenders and turnaround experts — this evolution reshapes how capital is deployed and managed, balancing risk and opportunity in an increasingly competitive landscape.
The Convergence Unveiled: Data and Dynamics
The blurring of ABL and cash flow lending reflects a market adapting to new realities. Secured Research estimates ABL’s market size at $450 billion in 2024, while the Federal Reserve places private credit, heavily cash flow-driven, at $1.7 trillion.[1] PitchBook reports a 15% CAGR in hybrid facilities blending these approaches from 2020 to 2023, with projections for continued growth into 2025 as bank tightening persists.[2] S&P Global underscores the shift: 70% of private credit loans in 2024 were covenant-lite and increasingly paired with ABL’s asset-backed discipline.[3]
Economic pressures fuel this trend. With SOFR projected at 4.5% to 5% in 2025 by State Street, borrowers seek structures that optimize cost and flexibility.[4] Market analysis suggests this convergence reflects an environment where liquidity trumps rigidity — hybrids are the ecosystem’s answer to 2025’s uncertainty.
Case Studies: Hybrid Structures in Action
U.S. deals illuminate this convergence. Consider the financing of Christmas Tree Shops, a Massachusetts-based discount retailer. Pathlight Capital provided a $180 million senior secured credit facility, blending $120 million in cash flow-based private credit with a $60 million ABL tranche tied to inventory.[5] The cash flow portion — a covenant-lite revolver at an estimated SOFR + 500 bps — funded growth, while the ABL, with a 65% inventory advance rate, ensured working capital stability. Investment bankers structured the hybrid, legal advisors crafted intercreditor terms prioritizing ABL repayment, and turnaround experts monitored seasonal cash flows, showcasing ecosystem alignment.
Another example is the 2024 refinancing of SRS Distribution, a Texas-based roofing distributor acquired by The Home Depot for $18.25 billion with backing from Leonard Green & Partners. Apollo Global Management led a $6.5 billion private credit package, incorporating a $1.2 billion senior secured revolver blending cash flow flexibility (SOFR + 475 bps, estimated) with ABL-style collateralization of receivables at an 85% advance rate.[6]
Technical Mechanics: Blending ABL and Cash Flow
Hybrid structures integrate distinct features:
Pricing and Leverage
Cash flow tranches, often covenant-lite, range from SOFR + 400-600 bps with leverage up to 5-6x EBITDA, per PGIM’s 4.5x first-lien benchmark.[7] ABL, tied to receivables (80% to 90%) and inventory (50% to 70%), offers SOFR + 150-250 bps at 1-2x leverage. In the SRS deal, the revolver balanced high-yield cash flow debt with cost-efficient ABL.
Collateral Framework
ABL secures liquid assets with tight borrowing base controls, while cash flow lending leverages enterprise cash flows and broader liens. The Christmas Tree Shops facility prioritized inventory for ABL, with cash flow debt tapping unencumbered assets, governed by intercreditor agreements.
Flexibility Triggers
Hybrids often include delayed draw options or payment-in-kind (PIK) interest — Morgan Stanley predicts a 2025 rise in PIK usage to offset rate pressures — bridging ABL’s rigidity with cash flow’s adaptability.[8]
Ecosystem Implications: Roles and Responses
This convergence reverberates across the dealmaking ecosystem:
Private Equity Sponsors
PE firms leverage hybrids to stretch capital efficiency — McKinsey pegs 2024 middle market buyout leverage at 4.1x, up from 3.8x in 2022, enabled by these structures.[9] For Leonard Green in the SRS deal, the hybrid unlocked scale without over-reliance on equity.
Investment Bankers
IB firms like JPMorgan and Goldman Sachs refine hybrid tranching, aligning cash flow flexibility with ABL discipline to maximize proceeds and mitigate risk.
Legal Advisors
The complexity of intercreditor dynamics — ensuring ABL priority in distress — elevates legal expertise. Dechert LLP, active in the PetVet refinancing, sees this as a 2025 priority.[10]
Specialty Lenders
ABL providers like Pathlight collaborate with cash flow lenders, de-risking overleveraged deals with asset-backed buffers, as seen in Christmas Tree Shops.
Turnaround Advisors
With cash flow’s looser covenants, advisors stress-test borrowing bases and cash flows preemptively, guarding against distress in volatile conditions.
Risks and Resilience: Navigating the Trade-Offs
The hybrid model carries inherent tensions. The IMF highlights that covenant-lite cash flow loans — 70% of 2024 private credit — amplify default risk if economic growth stalls, especially with one-third of borrowers cash-flow negative.[11] ABL’s collateral focus mitigates exposure, but market analysts warn that a 2025 recession shrinking inventory values could compress borrowing bases, testing hybrid stability. Floating-rate debt, while lender-friendly, burdens borrowers if SOFR climbs — a scenario State Street flags as plausible.
Stress-Testing Framework:
- Base Case: SOFR at 4.5%, 3% EBITDA growth — leverage sustainable at 5x[12] (PGIM).
- Adverse Case: SOFR at 5%, -10% EBITDA — 20% of firms below 1x coverage[13] (S&P inference).
- Severe Case: SOFR at 5.5%, -20% inventory value—distress spikes to 35% (Market analysis estimate)
Looking Ahead: A New Standard for 2025
The convergence of ABL and cash flow lending is poised to redefine middle market dealmaking in 2025. PGIM Private Capital notes that with $1.6 trillion in PE dry powder, hybrids will drive M&A as rates stabilize.[14] For the ecosystem, this demands agility — investment banks streamlining tranching, legal teams securing collateral priority, specialty lenders adjusting advance rates and turnaround advisors fortifying resilience.
This is not merely a financing tweak — it’s a structural shift blending ABL’s precision with cash flow’s ambition, setting the stage for a dynamic 2025 in middle market finance. Those who master this convergence will be well-positioned to capitalize on the significant opportunities it presents while navigating the inherent complexities of these sophisticated hybrid structures.
Lisa Rafter is publisher of ABF Journal.
Footnotes:
[1] Fang, Cai and Haque, Sharjil, “Private Credit: Characteristics and Risks,” Board of Governors of the Federal Reserve System, Feb 23, 2024.
[2] “PitchBook | LCD Releases Institutional-Grade Research on the Syndicated Loan and Private Credit Markets in Q3 2023,” Pitchbook. Press Release. Oct. 12, 2023.
[3] Rising Global Defaults Will Test Private Credit Funds In 2024,” S&P Global, May 1, 2024.
[4] “2025 Credit Research Outlook: Soft Landing or No Landing?” State Street Global Advisors, Jan. 9, 2025.
[5] “Pathlight Capital Agents $180MM Credit Facility for Christmas Tree Shops Acquisition,” ABF Journal. Nov. 9, 2020.
[6] Mutua, Caleb, “Home Depot Eyes $12.5 Billion Debt Package to Fund SRS Merger,” Bloomberg. March 28, 2024.
[7] Harvey, Matthew, “Middle Market Remains Private Credit Sweet Spot,” PGIM Investments, Dec. 12, 2024.
[8] Miller, David, “2025 Private Credit Outlook,” Morgan Stanley, Dec. 18, 2024.
[9] Edlich, Alexander, et. al., “Global Private Markets Report 2025: Private equity emerging from the fog,” McKinsey & Company, Feb. 13, 2025.
[10] “Private Credit Trends and 2025 Outlook,” Dechert LLP.
[11] Cohen, Charles, et. al., “Fast-Growing $2 Trillion Private Credit Market Warrants Closer Watch,” International Monetary Fund, April 8, 2024.
[12] Harvey
[13] “Rising Global Defaults…”
[14] Harvey