Peter Ulmer
Managing Director
Wells Fargo Capital Finance
The narrative of any company — history, present circumstances and potential for continued success — is largely determined by its stakeholders’ decisions. In a constantly changing global economy, difficult decisions and occasional missteps are inevitable. For businesses that rely heavily on financial leverage to fund their operating needs and to enhance returns, the consequences can be amplified and can lead to financial distress.

If a company’s existing revenue base or its future sales prospects decline, restructuring often becomes necessary to stabilize its financial obligations. In many of these instances, the assumption that the company’s brand and value proposition possess enough long-term viability will allow for a negotiated solution rather than an immediate liquidation. As a result, the capital structure will reflect the consensus view on the company’s ability to service debt in the future.

Best of Both Worlds

As management teams deliberate the various alternatives for financing their operations post-restructuring, a basic set of priorities should include minimum cost and maximum flexibility. For companies rated below investment grade which are also asset-intensive businesses, an asset-based loan represents a logical “best of both worlds” solution for a range of reasons. While it remains one of the most cost-effective and reliable sources of capital available to middle market companies, the primary appeal of an ABL is the latitude for using proceeds for organic growth or M&A-related growth expenditures

In 2018, for example, American Tire Distributors (ATD), the largest wholesaler in the replacement tire industry, raised a $1 billion ABL to support a recapitalization and to fund investments in its talent and technology-propelled transformation.

Bill Williams, chief financial officer of ATD, recalls the role ABL played in the company’s December 2018 emergence: “Last year was a year of disruption and accelerated pace of change in the replacement tire industry. Our imperative was to restructure our balance sheet through a unique, complex financial deleveraging transition and emerge a stronger company through an accelerated, court supervised process. This required a new financial lender with the leadership to assemble an appropriate first-class bank group and flexible credit facility. This financing was critical to enabling ATD to become the leading intelligent digital tire distributor.”

An ABL structure is appealing because its primary financial covenant is a fixed charge coverage ratio, which is only measured during periods of low liquidity. Since this amount of unused credit is driven by a borrowing base calculation, which limits the total available loan advances to a percentage of the collateral pledged, borrowers can exert a great degree of control over whether they will be held accountable for complying with their financial covenant. The ABL is also designed to permit virtually any type of capital outflow or divestiture so long as the residual liquidity is sufficient to meet recurring funding requirements.

As most national and super regional banks have de-risked over the last decade, the appeal of ABLs has increased. As a result, the bank market is driving a reduced pricing structure and a tolerance for higher risk, which has benefited prospective issuers in several ways. For example, as companies globalize their presence and as commercial codes in certain jurisdictions are modernized, most of the domestic lending banks have kept pace with their clients’ expansions abroad by adding to the list of countries where they are active lenders.. Additionally, if the financing needs expand and the establishment of a syndicate is under consideration, the competition for ABL commitments among banks should boost the likelihood that ample dry powder will be available within a narrow rate spectrum to back expansion ambitions when they materialize.

Most ABL lenders have built a foundation of practical knowledge in the industry sectors that they see most commonly, including retail, consumer, industrials and energy, ensuring a streamlined execution on the front-end and a rational and timely reaction to any amendment requests. Many also possess extensive experience with insolvency proceedings and understand the likelihood of a sprint towards an exit once the interested parties have coalesced around a vision. This responsiveness is enhanced in banks that have a high degree of continuity within their personnel ranks. The combination of these factors injects a degree of certainty into an otherwise complex process.

While it is clear that an ABL’s cost, flexibility, scalability and versatility render it as the ideal financing option available to companies during every phase of their life cycle, it still maintains its strongest appeal in the context of balance sheet restructuring. •