Attend any networking event frequented by asset-based lenders, and you’re bound to overhear complaints about softening ABL pricing and loosening structures. “Those other lenders must have amnesia!” say some lenders, while the Great Recession is still an all-too-fresh memory. Have some lenders returned to the irrational exuberance of pre-recession loan pricing and structure, or is the universally reported softening just a reflection of normal supply and demand, and where we are in the economic cycle? Do lenders really have “collective amnesia,” or are such accusations just expressions of “sour grapes” by the guy who lost a deal to a competitor?
Curious about what might really be going on, I canvassed experienced lenders from a wide spectrum of ABL organizations, ranging from ABL giants like Wells Fargo Capital Finance, with a large and diversified portfolio of more than 2,500 clients, over $31 billion in loans outstanding and over $70 billion in commitments, to smaller, non-regulated players, like North Mill Capital, relatively newer on the scene, with a loan portfolio in the $100 million range. With some exceptions, ABL executives were happy to share their candid observations.
- Marc Adelson, CEO of Capital Business Credit
- Anthony Aloi, senior vice president, Regional Credit Manager, Wells Fargo Capital Finance
- Gail Bernstein, executive vice president, PNC Business Credit
- Barry Bobrow, managing director, head of Loan Sales/Syndications, Wells Fargo Capital Finance
- John Brignola, managing partner, LBC Credit Partners Inc.
- John DePledge, senior vice president, Head of ABL Business Development, TD Bank
- Jeffrey Goldrich, president & CEO, North Mill Capital
- Deirdre McGuinness, managing director, Wells Fargo Capital Finance
- Tom Otte, senior advisor & regional manager, Presidential Financial
- Samuel Philbrick, president, U.S. Bank Asset Based Finance
- Michael Sharkey, president, Cole Taylor Business Capital
- Oleh Szczupak, chief credit officer & executive vice president, Keltic Financial Services
- Cyntra Trani, senior vice president & director of ABL Credit Management, TD Bank
- Perry Vavoules, executive vice president, Commercial and Specialty Finance, Capital One Bank
I posed the following questions to the interviewees:
1.) What’s happening in the marketplace in terms of pricing and structure? What have been the trends since the economic downturn? Are you surprised by how soon after the downturn the competitive pressures on pricing and structure have returned?
2.) How can such competitive pressures be met effectively, while maintaining credit quality? How can regulated lenders meet the challenge of non-regulated competitors that may not have to maintain the same credit standards (although their cost of capital may be higher)? How can non-regulated lenders level the playing field?
3.) What do you think will happen with ABL pricing and structure for the balance of 2012 and for 2013?
Trends in Pricing & Structure Since the Recession
All observers agreed that there had been a marked softening, especially in pricing, since the Great Recession officially ended in the second half of 2009 when the economy resumed growing, albeit slowly. When the financial crisis hit, of course, the capital markets had seized up like a motor crankcase full of sand, with many lenders leaving the field altogether. Those that remained, like DePledge’s TD Bank and others, enjoyed temporarily wider interest rate spreads as the Fed drove down the cost of capital, although perceived risk had risen significantly. Wells Fargo’s Aloi notes that, following the downturn, it took some banks time to get back to normal lending. His colleague McGuinness recalls, “ABL never shut down, and may have been the only capital market that didn’t shut down,” although she agreed that pricing and structures definitely got tighter.
As the recovery has slowly progressed, former ABL players returned and new ones entered. In fact, observers agree — from Cole Taylor’s Sharkey to Keltic’s Szczupak, that the return of banks to more normal asset-based lending by the end of 2010 accounted for the subsequent perceived softening in the market.
TD’s Trani notes the preponderance of “redo’s” in the past year — loans getting re-priced. Vavoules, of Capital One Bank, concurs, pointing out that the ABL market generally follows the lead of larger capital market transactions on pricing. U.S. Bank’s Philbrick observes, “It’s part of a cycle, and loan pricing and structure definitely move with the demand for loans that is driven primarily by the level of economic activity.”
In fact, our interviewees are unanimous in identifying simple “supply and demand” — an increasing number of banks and growing lender liquidity, chasing a reduced amount of deal flow — as the most important reason why ABL pricing and structure have softened. While DePledge says there are some outliers in terms of inexplicably low offers of pricing or structure, for the most part lenders are consistent among size and risk classes of ABL. PNC’s Bernstein observes that, “Borrowers with good credit are receiving more proposals, so it’s understandable that supply and demand have driven down pricing and even stretched structure in some cases.”
Wells Fargo’s Bobrow notes that, despite the relatively loose lending structures in 2006-2008 and the worst recession since the Great Depression, no lenders lost money on larger syndicated transactions originated during that time. Others echoed that ABL recoveries coming out of the recession were superior to other classes of loans. What may have saved ABL is the inherent discipline in lending on assets, and varying such lending in real-time as assets change. Several lenders observed that current ABL interest rate spreads were already back at pre-recession levels.
Opinions differ about the degree of pressure that exists currently in the market on pricing and structure, with non-regulated lenders reportedly feeling those effects the least. LBC’s Brignola views the situation in his non-regulated segment as a rebalancing. “There’s been spread compression across all classes of fixed income assets, and pricing is just a reset on a macro level,” he says. Capital Business Credit’s Adelson, who heads a relatively new and growing lender in the under-$10 million space, sees little competition from regulated banks, and therefore less market pressure. Another relatively new non-regulated entrant, Goldrich’s North Mill Capital, has seen a few of his more credit-worthy customers whisked away by banks willing to do such deals, and he feels that bank standards have definitely loosened. This can force non-regulated lenders to go down-market in order to grow. “The trick is not to go too far!” Goldrich says. Szczupak mentions banks’ SBA and USDA loan programs as one source of recent bank-based competition in his smaller ABL market, not previously seen. Another prominent small ABL player, Otte’s Presidential Financial, has seen more bank activity in the $5 million to $10 million segment than for under $5 million loans.
It follows that few experienced asset-based lenders are very surprised by the market softening, although some with the speed of market change. Vavoules is not surprised at all, since he feels enough time has elapsed since the downturn for weaker players to regain their strength and return to the market. He believes the supply-demand equilibrium had shifted in favor of borrowers. In addition, M&A activity has been spotty, a factor mentioned by several of our interviewees.
McGuinness reports being slightly surprised by the market change, but echoes that there were no large scale losses in the asset-based lending market during the recession, just a few massive liquidations like Circuit City and Linens ‘n Things. “The ABL market was fine, since it was structured properly,” she says, “so it seems appropriate that we’re normalizing price and structure; it’s a good competitive process. If you stay within good ABL underwriting, all will be OK, but you get into trouble if it looks more like a cash-flow deal. The more stretch, that’s where potential trouble lies.”
Goldrich is surprised with the suddenness of the softening, with banks seemingly going down-market all at once. Szczupak concurs, and notes that it’s really competitive forces at work: “No one is doing air balls,” he says. Even major players like Bernstein and DePledge admit surprise at the rapidity of the softening, again attributed to there being fewer borrowers and more lenders. Philbrick attributes the market softness to the slowness of the recovery, recalling that recoveries from past recessions had been faster in spurring loan demand.
Maintaining Credit Quality
More than one regulated lender, like Aloi, mentions a built-in advantage that banks have in maintaining credit quality — the ability to offer a suite of products, and be relationship-driven rather than transactional. DePledge notes that they are selective and that close to 50% of the company’s borrowers are sponsor-owned, and being careful about relationships and management teams is a key to managing their credit quality. Philbrick echoes the importance of evaluating the borrower’s management team. “Stick to your knitting!” says Bernstein. “People get into trouble when they lend into unfamiliar industries or approve structures beyond their normal parameters.” Vavoules calls it a disciplined lending philosophy to continue making loans throughout different economic cycles. He explains, “The loans made today become the workouts so lenders don’t deviate on key structural issues to achieve loan growth.”
However, trying to grow in a soft market, while maintaining credit quality, can be a challenge, admits Trani, which requires discipline. Sharkey speaks of having to “use all your ABL skills to be creative and competitive.”
Nonetheless, as Brignola notes, the differences between regulated and non-regulated lenders can be overstated, as most non-regulated lender executives came from the regulated bank world. For him, “It’s business as usual in maintaining credit quality in the face of competitive forces.” Adelson and Goldrich agree, citing the experience of their lenders, many of whom trained at banks. Szczupak will meet market pricing, but won’t sacrifice structure, and doesn’t feel that they’re losing any business as a result. However, Goldrich reports that some smaller community banks have been trying to compete in the small ABL market, and he questions their preparedness to do so.
Other lenders agree — the purported advantages of non-regulated lenders may be a canard. The larger ABL players, like Bobrow and Trani, report not competing very often against non-regulated lenders in the larger deals that they pursue. The larger non-regulated lenders of yesteryear, like CIT and GE, have become banks or are effectively being regulated the same way. “We’re fishing in different pools from the non-regulated lenders,” says Aloi.
As Sharkey, a past president of the Commercial Finance Association, points out, the higher cost of capital of non-regulated lenders leads them to having to take greater risks, in order to justify higher pricing to earn a return on capital that a “bankable” borrower simply won’t pay. As a result, the non-regulated lenders typically focus on smaller ABL deals where banks have a harder time being competitive, perhaps for operational reasons: smaller loans can’t bear the costs of the compliance organizations and other higher costs of regulated banks. Otte says he rarely sees banks in his segment.
Junior capital is typically provided by non-regulated funds, although at least one regulated bank, PNC, has its own Steel City unit that functions like a non-regulated lender, providing junior capital, and other regulated lenders may be considering following suit. “We’re in the business of lending money and pricing risk, says McGuinness. “When we look at nontraditional lenders coming into our market — either a big refinancing or restructuring, we really don’t compete with them, we are complementary to them. We are always senior secured, first lien, and those nontraditional lenders come in behind us. It’s additional leverage for the borrower, so we do look at its overall ability to service total debt.”
When some non-regulated funds began offering “unitranche” deals — one-stop-shop financing including senior and junior tranches, some wondered whether this would threaten banks’ preeminent position in the senior-most position. However, as several commentators observed, many of these unitranche deals involve a regulated bank as a “partner,” providing the senior ABL financing at competitive pricing, as only they can. So the advent of unitranche financing hasn’t lived up to its predictions yet, although Philbrick reports that such deals are increasing.
Most of our interview panel predicts continued softness in the ABL market for the remainder of 2012 and into 2013. Goldrich says, “There will continue to be pressure on yields, since banks have lots of liquidity and are under pressure to lend. It all begins with the banks, our [small ABL] market derives from what they do or don’t do.” Adelson concurs, seeing continuing yield compression in most ABL segments.
Philbrick thinks about the economic forces that have affected loan demand, and notes the continued uncertainties: “We’re in an election period, there’s slowness in the economy, there are European debt issues, and we’re facing a fiscal cliff.” He feels that slow economic growth will continue for a while, holding down ABL demand. Aloi adds, “I don’t see a return to the crazy structures of the 1990s for regulated banks, given the regulatory framework.”
Sharkey says, “We can’t get much more competitive on structure, but we’ll continue to maintain good credit discipline. We’ll always meet the market on price, but without economic growth, there’s no opportunity for ABL to play its classic role of financing such growth. I expect we’ll keep muddling along.” Trani agrees: “It will get harder to meet growth goals as market pressure continues.” But Bobrow points out that the interest rate spreads that a bank-based ABL unit may accept is a corporate decision by the bank, not by the ABL unit alone.
Szczupak is watching the regulators, and believes that banks’ attitudes toward any newly-acquired ABL customers may be affected by year-end results early in 2013. He also doesn’t see the economy recovering much next year, regardless of the election outcome. Fellow small ABL loan player Otte expects a continuation of current market conditions.
McGuinness would like to see an uptick in the M&A market, and notes that equity sponsors are sitting on a lot of cash. “We are still stuck in a refinancing cycle, but it should be ending soon. Nonetheless, it will be tough for lenders if there are no new deals, so pricing could continue to be under pressure.” Bernstein doesn’t expect much change in market conditions until M&A activity picks up. She says that some prospective business sellers may be waiting for the outcome of the election in order to see whether their sale valuations rise. DePledge expects general stability in prices and structure, but wouldn’t be surprised to see lenders offer two-to-three-year term stretch loans alongside revolvers, as well as seasonal increases in advance rates, to meet any increase in unitranche competition.
Brignola thinks the institutional markets will cool off, which could alleviate competitive pressure in the ABL market. And Vavoules notes, “Every five years or so, something disrupts the dynamics of the lending markets. In the past, we’ve seen the Asian debt crisis, the implosion of long-term capital, the tech bubble, and the Great Recession. The next event may not be on our radar yet — only time will tell!”
Howard Brod Brownstein is a Certified Turnaround Professional, the president of The Brownstein Corp. and a contributing editor of ABF Journal. He can be reached at Howard@BrownsteinCorp.com.