California’s economy, at $2.7 trillion, represents the largest economy in the United States. In fact, it ranks fifth in the world and is larger than that of England and India (each $2.6 trillion). With industries ranging from agriculture to artificial intelligence, the Golden State’s economy is among the most diverse in the United States and the world.
Some consider California’s economy to be a bellwether for the rest of the United States. Given the depth and size of its economy, what better place to get a read of the current state of the asset-based lending market than in California?
Recently I had a chance to speak with two California-based asset lending specialists: Rey Abundo, managing director of Great Rock Capital, and Orrin Belden, senior vice president of Celtic Capital. The discussion dove deeper into the non-bank ABL lending landscape in California.
Abundo focuses on ABL financing between $10 million and $50 million for growth capital, acquisition financing, restructurings and rescue capital, refinancing, and recapitalizations through the financing of accounts receivable, inventory, machinery and equipment, real estate, foreign assets and subsidiaries, and divisional value. Belden specializes in ABL financing up to $5 million by providing financing against accounts receivable, inventory and machinery, and equipment for companies with complex financing needs, including rapid growth, leverage, turnaround and/or undercapitalization.
How has COVID-19 impacted new deal activity in your respective markets?
Abundo: The Paycheck Protection Program (PPP) has had a definite impact on deal activity in-market. This appears to have caused a 60- to 90-day lag and delay in deal flow, where existing lenders are still holding onto deals that they may have transitioned otherwise. Incumbent lenders have been more defensive of their credits. This lag in activity applies not only to the asset-based lending space but also to adjacent professionals in the turnaround and restructuring industries.
COVID has also impacted new deal activity that has traditionally come from in-person networking events. These events, some monthly and some quarterly, bring together deal professionals and result in new deal flow. The cancellation of these in-person networking events due to COVID has impacted deal activity.
Belden: New deal activity has declined because lenders and other deal professionals have been busy servicing their customers with PPP and CARES Act funding as well as services related to this funding. Borrowers alike have been concentrating on securing PPP and other government funding. This has caused pressure from lenders on borrowers to be temporarily put off.
What are the most significant changes to deal appetite in your market pre- and post-COVID-19 pandemic onset?
Abundo: Whereas ABL lenders and traditional commercial bank lenders were competing more frequently for the same transactions in the recent past, there appears to be more of a clear division developing between the credit appetite of traditional and non-traditional lenders. Additionally, COVID has reinforced lending discipline among both traditional and non-traditional lenders.
Belden: The most significant changes to deal appetite relate to focusing on prospects that work in or service the essential industries. There has also been more focus on the borrower’s customers to ensure that these account debtors are in essential industries as well.
A few industries that have seen an uptick in business are companies in the food processing and food manufacturing industries. Additionally, companies that produce packaging represent another bright spot among businesses. Another essential business that has remained steady are companies that supply construction companies.
Overall, companies in food processing and manufacturing, packaging and construction supply represent a few of the industries that have been insulated from the initial effects of COVID. Conversely, the companies that have been most negatively impacted by COVID appear to be those businesses that provide products and services to the broader retail and restaurant industries.
What type of business collateral (accounts receivable, inventory, equipment, commercial real estate) has been most impacted in your marketplace recently?
Abundo: As COVID has limited overall activity, including the number of inventory valuations and liquidations being conducted, some inventory valuations have been coming out softer.
Belden: The analysis of accounts receivable and account debtors has become increasingly important. Separate from COVID, equipment valuations, and aerospace equipment valuations in particular, have seen some downward pressure.
What is your outlook for your marketplace in the next six months?
Abundo: With PPP funds dissipating, there is an expectation that deal activity will pick up in the third and fourth quarters of 2020. As borrowers report Q2 financial information to their lenders, these results will begin to show the full impact of COVID on their businesses. With Q2 financial information in-hand, portfolios may need to be right-sized at this point.
Belden: One of the focuses will be to see if accounts receivable turnover and collections slow down as PPP and government funding dissipate. Without further government funding, new business in the ABL space may pick up in Q3 or Q4 of 2020.
More broadly, COVID seems to have further accelerated certain business trends, including the move away from traditional brick-and-mortar retail and into e-commerce and mobile platforms. This transition started taking shape before COVID and will continue to play out after COVID.
Overall, both Abundo and Belden expect that ABL deal activity will pick up in the second half of 2020. Orrin shared some encouraging anecdotal stories about bright spots in the economy and in certain industries that are — or service — essential businesses. Abundo noted that COVID has reinforced lending and credit fundamentals and disciplines.
Regardless of the changes that COVID continues to present to the economy, asset-based lenders’ consistent focus on underwriting collateral on par with — and at times with precedence over — cash flow will allow them to remain nimble and to deliver middle-market businesses with the financing they need.