Hugh Larratt-Smith
Managing Director

In 1897, Bernard Baruch, a Wall Street operator known as “The Lone Wolf of Wall Street,” said, “To belong to the Waldorf Crowd means a man has arrived.” Baruch punched his own ticket to the Waldorf Crowd when he orchestrated the takeover of the tobacco company Liggett & Myers.

In 1898, the Waldorf-Astoria Hotel was the afternoon watering hole of the rich and the famous. Located on Fifth Avenue at West 34th Street (today the site of the Empire State Building), the hotel’s main attraction was the chance to brush elbows with the likes of Charles Schwab, Gentleman Jim Corbett, Mark Twain, James Keene and Jim “Bet a Million” Gates, who earned his nickname by placing a $1 million bet on a game of baccarat one night at the hotel. (This may remind some readers of the $1 million “Liars Poker” bet made between Lewis Ranieri and John Gutfreund at Salomon Brothers in the late 1980s).

Keene was the stock market genius who worked his magic on behalf of J.P. Morgan. With his immaculate clothing and beard, he was known as the “Silver Fox.” He was never seen on the floor of the New York Stock Exchange but instead preferred to work at the Waldorf-Astoria. The New York Sun reported that brokers gathered there every evening “with the hope of getting an inkling of what Mr. Keene is to do next.”

During the time of the Waldorf Crowd at the end of the 1890s, the defining characteristic of the U.S. economy was that it was awash with liquidity. The economy had shaken off the Panic of 1893. The bull market starting in 1898 led to unprecedented trading volumes on Wall Street. As America’s leading technology, the railroad drove speculation that swept across the U.S. economy and spread to other sectors like sugar, steel, elevators, glue and coal.

As a sign of the liquidity frenzy, Henry Villard, a nascent railroad promoter, successfully floated Wall Street’s first blind pool (the equivalent of a special purpose acquisition company today). The purpose was to launch the takeover of The Northern Pacific Railroad (known on Wall Street as “The Nipper”), but Villard needed to acquire the stock of the The Nipper secretly without alerting competitors. His $8 million blind pool — a staggering sum in those days — was oversubscribed by railroad insiders such as George Pullman. It was labeled a “unique financial feat, without precedent or parallel.” Villard’s sumptuous mansion on Madison Avenue across from St. Patrick’s Cathedral at East 50th Street was a testimony to his success. The massive home was subsequently owned as The Palace Hotel by Leona Helmsley — “The Queen of Mean” — and later by the Sultan of Brunei.

The American public viewed the wealth, showiness and seemingly instant fortunes of the Gilded Age with fascination and jealousy. Hetty Green, the whaling heiress, turned her $6 million inheritance into $100 million and was a legend. Roswell Pettigrew Flower, the governor of New York from 1892 to 1894, gained a reputation as a canny investor, and as a result of his strong reputation, possessed an extraordinary capability to influence market sentiment. In 1898, his aggressive moves on Brooklyn Rapid Transit drove the share price of the company from $6 to more than $135 by late 1899. His sudden death while fishing in May 1899 threatened the entire stock market until Morgan and other leading bankers stepped in with millions of dollars of capital to stabilize the market.

For some bankers, storm clouds were on the horizon of this vast ocean of liquidity. Jacob Schiff was one such skeptic. Schiff was a hardened Wall Street veteran, a partner in Kuhn, Loeb & Co. and the lead banker to railroad magnate Edward Harriman. His unquestioned stature and authority on Wall Street was second only to Morgan. Writing in March 1901, Schiff commented, “It is almost terrifying to contemplate the way in which the market has risen, by leaps and bounds. The reaction will come; it is only a question of time.” Baruch would later remember the night of May 8, 1901, as “panic struck The Waldorf … and transformed it from the preening ground of all that was fashionable to a lair of frightened animals.”

Present Day Developments

Let’s fast forward to more recent events. In March 2020, the stock market sent a signal that the economy was facing meltdown. Credit committees were steeling themselves for waves of defaults. The Fed immediately flooded the market with liquidity to foam the runway. It became apparent as the year progressed that there were losers, particularly brick and mortar retail stores, but there were also winners.

Now, as the stock markets have rebounded to dizzying heights with unprecedented levels of liquidity, many lenders are scratching their heads at the delta between Wall Street and Main Street. Amidst these seemingly vast pools of liquidity, what is the direction of travel for asset-based lending players?

“Supply chain disruptions will continue to impact business across the spectrum and will be compounded as companies move to rebuild inventories to pre-pandemic levels to meet pent-up demand. This will require lenders to provide the liquidity to finance higher inventory levels to assure adequate flow of products,” Robert Grbic, president of White Oak Commercial Finance, says. “We also see borrowers finding acquisition opportunities for competing or complementary businesses, as well as companies accelerating a shift from bricks and mortar to online business models. ABL products are ideally suited to provide the liquidity to meet today’s challenges and opportunities.”

The sudden downward shift in demand — indeed, an air pocket for many companies — forced many CFOs to focus on working capital efficiencies and the shortening of cash cycles. For some, that meant increased stratification of inventories based on velocity. For others, it meant re-engineering their invoicing procedures to speed up cash flow.

“Similar to what we saw in 2020, speed of execution and certainty will be incredibly important criteria for prospective borrowers when they evaluate their lender options. Based on expectations that an economic recovery will not occur until the latter part of 2021, ABL lending should continue to see a surge in demand, with companies in need of working capital and time to turn things around,” Rob McMahon, chief commercial officer of Encina Business Credit, says. “We are carefully monitoring the regulatory environment to see how that may impact the commercial banking sector’s decision-making process around new and existing C&I loans. While regulators were very patient and relaxed standards in 2020, it is unclear how long that dynamic will last. We are expecting 2021 to be a solid year for M&A activity as sponsors and large direct lenders re-evaluate existing investments and acquiring sponsors look for areas of post-pandemic growth through bolt-on acquisitions or opportunistic restructurings.”

George Psomas at BHC Funds in New York concurs: “A lot of M&A ‘cans’ got kicked down the road. Now we are at the end of that road where deals need to happen and, I believe, will happen. We expect to see a marked pickup in activity this spring heading into summer.”

Last year, financial advisors and turnaround consultants expected a tsunami of cases, ranging from monitoring roles to hard bankruptcies. Bankruptcy attorneys expected to be working 22 hours a day. One year ago, nobody anticipated the “safe harbor” that the government has dredged for risk ratings. In some cases, this has allowed some borrowers to go dark during COVID-19, which is unprecedented.

Kathleen Lepak, asset-based lending director at Peoples United Bank provides some market color: “We’ve seen COVID-driven portfolio contraction level off at the end of [Q4/20]. As we move into 2021, with liquidity stabilized through government programs (PPP) and focused cash flow management, companies appear ready to re-engage in growth. We have a growing pipeline of opportunities to finance companies prepared to move forward. Particularly as vaccinations increase and states lift business restrictions, we see businesses eager to put 2020 behind them. We expect the second half of 2021 to deliver increasing loan usage. As always, competition remains fierce in the ABL market.”

It seems that a new credit fund appears on the horizon every week. Some are plain vanilla asset-based lending. Other funds are bespoke, focusing on sharply defined segments of the economy. One thing is for certain: The amount of money raised by some of these players is astounding — and they are ready to pull the trigger on transactions.

Nate Land at BHC Funds in New York supports this view: “We see clients and prospects across C&I and real estate sectors seeking capital to prepare for the expected recovery in 2021. Companies have postponed growth investments and/or extended vendor terms for obvious reasons. They are eager now to compete on the front foot and/or to reward patient vendors, but this requires capital. ABL bank and non-bank lenders have sufficient liquidity on the sidelines waiting to deploy, but lenders can be selective. Deals are getting done.”

Government Aid

For many portfolio managers, government rescue capital programs like the Paycheck Protection Program and the Main Street Lending Program have provided vital sources of liquidity. The bad news for credit committees is it can be challenging to prudently determine how some companies will reboot as the impact of the programs fade.

According to Dan O’Rourke, president of Burnley Capital, “One of the underwriting challenges we are facing is our ability to determine if companies who benefited from the COVID crisis are going to sustain those trends (for example, additional sales in their e-commerce channel) once the vaccine roll-out is completed. Another challenge is adjusting for PPP/EIDL loans and determining whether they have qualified for loan forgiveness, or would we need to factor that additional debt service in the future if they did not qualify. On the loan originations front, we are seeing a definite increase in loan opportunities in the past few weeks as confidence in an end to the crisis appears near.”

Now, some credit committees are increasingly focused on the threat of rising interest rates in response to inflationary signs. Inflation is evident in many materials used in manufacturing, including chemicals, metals and cardboard. Some risk managers are becoming increasingly concerned about the market’s ability to absorb the enormous amount of government debt set to flood the market in 2021, particularly if inflation expectations are rising. Interest and fixed charge coverage covenants are much more manageable when Fed funds are at the historic lows we are now experiencing. What happens if Fed funds climb back to 5.25%, as was the case in January 2007, or 6.5%, as was the case in May 2000? (Some readers will remember Fed funds spiking at 19.85% in June 1981 to crush inflation.)

Some people will scoff at the idea that interest rates will increase. After all, the Fed has the accelerator pushed flat against the floor. It wouldn’t dare take the punch bowl away now. But the sheer scale of government stimulus — $1.9 trillion plus the $3 trillion proposed by the Biden administration, which is equal to nearly 25% of GDP — vastly exceeds the inflationary impact of government spending in the Vietnam War. Some observers think there is substantial risk that the amount of water being poured into the bathtub will overflow and flood the room. This could manifest itself if the Fed reverses course and sharply increases interest rates, tipping the economy into a recession.

“Despite market disruptions due to the pandemic, 2020 proved to be a very active new business year,” Tony Vassallo, senior vice president of the Northeast region for Gibraltar Business Capital, says. “As we’ve moved into 2021, it appears that the Paycheck Protection Program is driving a decline in new business activity and funding requests. However, this program has also brought much needed stability to many of our borrowers in the form of permanent liquidity. The overall quality of our portfolio remains strong.”

Preparing for the ‘New Normal’

As noted, the pandemic has forced borrowers to manage their working capital and cost structures ruthlessly in order to survive. One challenge facing middle market borrowers is how to increase their working capital as business returns to pre-COVID-19 levels. One vein of ore to mine for additional liquidity could be fixed assets for some companies.

Moving down the capital structure, Lori Potter, managing director of Great Rock Capital, says, “The market remains frothy for traditional asset-based deals, especially with higher quality borrowers, but as a term-heavy lender, we provide a unique liquidity option to the middle market and have been able to capitalize on opportunities. We look to continue our recent momentum well into 2021. Towards the end of [Q3/20], banks slowly began to implement exit strategies for certain borrowers, and Great Rock was able to step in, plus provide companies with additional growth capital. As 2021 progresses and PPP money slows, we are expecting to see an uptick in these opportunities as banks re-evaluate their portfolios and look to fully exit or refinance the term loan exposure of their underperforming customers.”

In 2021, commercial real estate values are a tale of two cities. On the one hand, real estate values in supply chain crossroads like Easton, PA, and Reno, NV, are robust, as massive distribution centers spring up almost daily. On the other hand, real estate values in city centers like Portland, OR, are suffering.

J.W. Clements, president of Clements Capital, says, “One comment that could be made is that there seems to be a number of non-bank commercial real estate (CRE) lenders on the sidelines waiting for investor/developer recaps and restructuring to take place. Some of [the] activity is happening now, with some banks agreeing to some discounts and the new CRE lenders structuring the new loans for success (with a bridge across COVID). Something to note is some traditional non-bank CRE lenders are now willing to look at single tenant, owner-occupied deals in the business capital space if they can get comfortable with the credit and COVID impact. These terms could provide interest only or capitalized interest for part of the term (not a willing structure for traditional business capital lenders). Once traditional CRE investor/developer restructuring deals heat up, some of the interest in single tenant, owner-occupied will wane.”

The Paycheck Protection Program and Main Street Lending Program have been heaven-sent for many middle market borrowers. For those at the smaller end of the market, the second round of the PPP in 2021 has been a further boon. The question for some credit committees is whether these programs have been a bridge to nowhere for some borrowers. Will some borrowers stall mid-flight as they take off the runway?

Michael Haddad, president of capital finance at Sterling National Bank, says, “The ABL marketplace in 2021 looks the same as it did in the latter half of 2020: confused, conflicted and cluttered. It’s almost impossible to tell who the competition is, how many you are [competing] with and when you hear the name, you say ‘who?’ The lack of capital spending in 2020, PPP funds still hanging around and a tremendous excess of capital have stuttered demand.

“COVID, COVID, COVID! More of the same remoteness, hampered loan origination opportunities and a lack of relationship[s] has become a real issue for all ABL lenders. Clients almost don’t care who they are with unless it’s the cheapest deal with most availability, and oh by the way, ‘leave me alone’ with no or minimal reporting. All of the above sounds like the ABL world sucks — it does, but how exciting it has finally become. True survival of the fittest!”

Across the pond, Jeremy Harrison, head of sales UK at ABN AMRO Commercial Finance UK, provides a UK and European perspective: “Like all asset-based lenders, we’ve seen very little distress amongst our clients. The government pandemic support schemes are doing exactly what was intended by covering business overheads in times of dislocation. This has meant that client advances are lower than normal and so we’re concentrating on building up new business. 2020 saw a massive shift in the way we work, and we adapted quickly to complete some 20 deals. M&A came back in [Q3/20] and I see that continuing in 2021. ABL has to be able to deliver in the timescales of private equity in processes, and guaranteed borrowing bases are an effective tool we have. 2021 has started well, albeit slower than we would have liked, owing to lockdown three, but most of our clients are operational, so once restrictions lift, we’re expecting a surge in activity. In the UK, we’re seeing deals shift from cash flow loans to asset-based lending, something we’ve been advocating for a number of years, but I truly believe this is our time!”

History on Repeat?

Until the Federal Reserve Bank was created in 1913, the big circus tent for liquidity in the U.S. economy was Wall Street — and Morgan was the ringmaster. The Waldorf Crowd was merely a side-ring act in the big circus. The Panic of 1901 shattered the conviction of many Main Street investors that Wall Street’s leaders were committed to economic stability and ample liquidity, instead amplifying the image of robber barons like Henry Clay Frick and Commodore Vanderbilt. Liquidity — and the nest eggs of many Main Street investors — vanished in the blink of an eye. By the time the dust settled, America’s leading industry — railroads — had been blamed for not one but two economic crashes and a severe contraction in liquidity.

During the time that the Panic of 1901 burnt fiercely, the belief still reigned on Wall Street that the situation could be put right by the steady hand of Morgan, the circus ringmaster. One Wall Street operator blamed the April 1901 market convulsions on Morgan’s vacation on the French Riviera. The Wall Street speculator Jefferson Monroe Levy opined, “If Mr. Morgan had been here, this never would have happened.” While Morgan was on his annual foray into the European art market in 1901, capping his trip with the acquisition of Raphael’s Collona Madonna and pieces by Ruebens and Titian, the Gilded Age had reached its zenith in a convulsion of intense flame on Wall Street.

In the clash of the railroad titans and their bankers over control of The Nipper in early 1901, Morgan saved many shorts who were betting big on a fall in The Nipper’s share price. As rumors swept the floor of the New York Stock Exchange on May 7, 1901, that the market for The Nipper’s shares had been cornered, traders physically mauled each other as they tried to buy shares to cover their short positions. After the New York Stock Exchange closed, the Waldorf Crowd was nervously dining in the Palm Room at The Waldorf-Astoria, anxiously buttonholing anyone at nearby tables who might have information on The Nipper. At 2 p.m. on May 9, 1901, Morgan & Co. and Kuhn, Loeb & Co. jointly announced that they would not demand delivery of shares of The Nipper from the shorts that day. At the same time, a consortium of banks led by Morgan & Co. formed a pool of $20 million to put the brake on the rise of the shares of The Nipper, saving the shorts from financial ruination.

During the Panic of 1907, Morgan organized a coalition of financiers that saved the American monetary system from collapse. Owing to his towering figure over banking, Morgan was able to “jawbone” bankers into injecting liquidity into markets, which was something that became the role of the Fed in later years. His legacy of “Morganization” brought order and stability to banking, the railroads and the steel industry and places him at the forefront of American financial history. Today, a person can visit the Morgan Museum on Madison Avenue in New York and imagine the art-lined, smoke-filled library where Morgan’s butler locked the door until railroaders, bankers and steel magnates bent to Morgan’s indomitable will.

Twain once said, ”It is the differences of opinion that makes horse races.” Few will disagree that the COVID-19 pandemic has brought enormous stress onto the economy. But most agree 2021 will translate into more opportunities as economies reboot. The unprecedented levels of liquidity have spawned conditions in the ABL marketplace that are more intensely competitive than ever. But most ABL players agree the market has now cleared the runway for takeoff as the calendar pages of 2021 turn.

Hugh Larratt-Smith is a managing director of Trimingham and is a regular contributor to ABF Journal.