Hugh Larratt-Smith
Managing Director
Trimingham Inc.

Against the backdrop of higher interest rates, increased bank regulation and a brush with recession, Hugh Larratt-Smith of Trimingham Inc. spoke with asset-based lending industry thought leaders about what lies ahead this year.

The Second Bank of the United States on Walnut Street in Philadelphia was an elegant Greek revival building, with its design inspired by the Parthenon in Athens. When it was completed in 1824, the building’s resemblance to a Greek temple was deliberate, assuring the public of its stability. However, through its short history as the exclusive fiscal agent for the federal government, the serene exterior made up of Pennsylvania marble masked a life and death struggle between President Andrew Jackson and Nicholas Biddle, the Second Bank’s president. Jackson viewed Biddle, who was the 15-year-old valedictorian at Princeton in 1801, as the archetypal “eastern establishment banker.”

Biddle was holidaying in Paris as part of his grand tour of the continent when Napoleon Bonaparte was crowned as emperor of France. Upon his return, Biddle participated in an audit of the Louisiana Purchase, thus acquiring his first experience in financial affairs.

From there, as a Republican in the Pennsylvania State Senate, Biddle lobbied for the rechartering of the First Bank of the United States in 1811. In 1791, the First Bank of the United States was part of a three-part expansion of federal fiscal and monetary power, along with a federal mint and excise taxes. The First Bank was championed by Alexander Hamilton, who believed that a national bank was necessary to stabilize and improve the nation’s credit and to improve the handling of the finances of the U.S. government under the newly enacted Constitution.

However, in 1811, Congress opted not to renew the First Bank’s 20-year charter. This triggered monetary pressures and problems financing the U.S.  government during the War of 1812.

In 1816, Congress and President James Monroe granted a new 20-year charter to the Second Bank to handle all fiscal transactions for the U.S. government. Twenty percent of the bank’s capital was owned by the federal government, its single largest shareholder. The bank was charged with establishing a stable national currency as well as restraining a vast range of paper currencies and coins that threatened to create a credit bubble.

By the time of Jackson’s inauguration in 1829, the bank appeared to be on solid footing. The U.S. Supreme Court had affirmed its constitutionality in McCulloch v. Maryland, the 1819 case which Daniel Webster had argued successfully on its behalf a decade earlier. In addition, the U.S. Treasury recognized the Second Bank’s useful services, and public perceptions of the national bank were generally positive. However, the Second Bank came under attack by President Jackson in 1829 as a corrupt institution beholden to eastern business interests and dangerous to American liberties.

Opportunity in a Still Uncertain Environment

Fast forward 180 years. In the wake of the 2008-2009 financial crisis, the Federal Reserve Bank played a decisive role in successfully maintaining the U.S. dollar’s position as the world’s preeminent currency. A decade later, its tactical action plan “foamed the runway” for a soft landing during the global pandemic and the intense post-pandemic inflationary spiral.

Reflecting on this, Jim Clifton, chief commercial officer at Great Rock Capital provides color on current market conditions: “2024 is shaping up to be an interesting year. With macro-economic conditions generally improving and business optimism returning to the market, we expect financing activity to continue growing throughout 2024. In addition, while some banks are back in growth mode, most regional and mid-size banks we have talked to remain highly selective in using their balance sheets as they continue to face internal and regulatory pressures to bolster their deposit base and shore up their balance sheets. So we think non-bank financing opportunities will continue to increase. Great Rock Capital continues to see opportunities centered around one-stop solutions and term loan financings for companies executing on a repositioning or rebound from the supply-chain and economic pressures faced in 2022 to 2023.”

Indeed, as reported by CNN, by 2027, more than $2.2 trillion in commercial real estate loans will come due, which is causing intense pressure on the balance sheets of many regional banks. At the large banks, regulators have mandated tougher risk ratings and responses to downgrades.

“Sponsors and commercial banks seemed to sit on the sidelines in 2023, making it a good year for non-bank ABL lenders — and we can expect this trend will continue in 2024,” Jennifer Palmer, CEO of JPalmer Collective, says. “That said, there are certain realities that must be a part of our underwriting process. A market like the one we are now in is long overdue, and 2024 will likely be a year of great opportunity. However, lenders must operate prudently and not get too excited by their own hockey stick projections and dreams of unicorns.”

“Our borrowers tend to be lower middle-market companies with characteristics that put them just outside of a bank’s traditional lending appetite,” Meredith Carter, president and CEO of Edge Capital Lending, says. “These types of borrowers are typically the first to be shut out in a tightening credit environment.  Especially where non-bank lenders can demonstrate a history of creativity, flexibility and certainty of close, the specialty finance world is uniquely situated to help these companies continue to grow and thrive when bank capital is temporarily not available to them.”

Across the pond, Jeremy Harrison, managing director of ABN AMRO, provided a European perspective: “We have seen good demand despite M&A being virtually nil, so we have had more refinancings. A trend specifically for ABN AMRO is that our clients — being more global — are seeking cross-border financing solutions. Demand has also increased off-balance receivable purchase facilities, which typically are allowable under most complex leveraged financings.”

A ‘Level-Setting’ in the M&A Market?

In January, the Wall Street Journal reported that “corporate M&A last year plunged to the lowest level in a decade,” fueling an increase in earnouts and a hesitancy by some acquiring companies to fully integrate acquired businesses in an effort “to measure progress against an earnout.”

“For private equity, 2023 turned out to be a tough year,” Jeff Manning, founder of Silver Birch Group, says. “The projected rate of distributions to investors was the second-smallest in a quarter century as firms grappled with higher borrowing costs, economic uncertainty and sluggish fundraising.”

“Historically, there was a sense of reassurance in sponsor-supported deals, but we have seen sponsors’ appetite for portfolio company under-performance diminish,” Palmer says. “For example, we have seen holding companies walk away from beloved portfolio companies in favor of efficiency. This puts more pressure on lenders to help borrowers who have lost the support of their sponsors — and to assume little to no sponsor support when looking at prospects.”

Rick Hyman, a restructuring partner at Crowell & Moring has seen this phenomenon in practice.

“2023 saw an increase in sponsors’ willingness to ‘hand the keys’ to underperforming credits to their lenders, whether they asked for them or not,” Hyman says. “Explicitly through a consensual transaction ceding control, or implicitly through a failure to provide additional support, this trend is likely picking up steam in 2024.”

Some sponsors are still acting as though its 2019, which is causing stresses between the credit side of the house and business development folks. Call it “Rip Van Winkle” syndrome. In many cases, the senior debt is the fulcrum security, creating situations that sponsors are loath to accept. This year may be the year that the power balance between lenders and sponsors “level-sets.”

Bankruptcies Continue to Rise

There were 36,607 total bankruptcy filings in the U.S. in January, a 17% increase, according to Epiq. Total bankruptcy filings have increased on a year-over-year basis every month for 18 consecutive months. Adding to challenges of higher borrowing costs already faced by small businesses, the debt eligibility limit of $7.5 million for businesses looking to elect Subchapter V reorganization under Chapter 11 is due to sunset back to $2,725,625 in June.

“There are concerns about the companies who received millions of dollars in pandemic related grants that simply papered over pre-existing financial problems,” Steve Donato, who heads Bond, Schoeneck & King’s business restructuring, creditors’ rights and bankruptcy practice, says. “It would seem that once that money runs out, many of these companies will be forced to seek restructuring in or out of the bankruptcy court. As many of these companies would not qualify for traditional refinancing, presumably, some of these companies could refinance on some basis with non-bank lenders.”

Noting some clouds on the deal-making horizon in 2024, George Psomas at Brooks Houghton in New York cautions: “The disparity in credit appetite from one lender to the next can be dramatic. At times, one wonders if they are looking at the same deal. And any hint of progress payments is like touching the third rail on the tracks of the E train to Manhattan. And lenders are becoming wary of deals with so-called ‘fundless sponsors’ and ESOPs where fresh equity can be challenging.”

Additional Risk Factors

Macro-economic risks also remain. The Congressional Budget Office recently predicted the U.S. deficit will increase by almost two-thirds in the next decade to $2.6 trillion, with government interest payments accounting for three-quarters of the rise. In addition, the Financial Times reported that at least one member of the Federal Open Market Committee is advocating for a patient approach to interest rate cuts despite assertions from the Federal Reserve in late 2023 that there would be at least three such cuts this year.

“2024 should pick up where 2023 left off for non-bank ABL lenders,” Scott Winicour, CEO of Gibraltar Business Capital, says. “With increased regulation and compliance continuing to be a factor in the regulated bank market, non-bank ABL lenders should continue to see more opportunities for growth. The war on talent should deepen during the year as well. However, there should be opportunities for quality bank professionals to move to entrepreneurial non-bank lenders. Finally, with a sigh of relief, I expect an increase in spreads as many of the non-bank lenders’ costs of capital begin to increase as they renew and expand their senior debt facilities.”

The Fate of the Second Bank

In 1832, at Biddle’s direction, the Second Bank poured tens of thousands of dollars into a campaign to defeat Jackson in the presidential election. During the election, Jackson’s Republican opponent, Henry Clay, ran a re-charter campaign for the Second Bank with Biddle’s financial and political support. This sparked the “Bank War” and placed the fate of the Second Bank at the center of the 1832 presidential election.

In 1833, President Jackson proceeded to gut the bank as a financial and political force by removing its federal deposits. Federal revenue was diverted into selected private banks by Executive Order, ending the role of the Second Bank. In 1836, the Second Bank became a private corporation under Pennsylvania law. In the absence of any regulatory oversight provided by a central bank, state-chartered banks in the West and South relaxed their lending standards, took greater risks, maintained unsafe reserve ratios and contributed to a credit bubble that eventually burst with the Panic of 1837 lasting seven years.

The Second Bank building was designated a National Historic Landmark in 1987 for its architectural and historic significance. Today, it is part of Philadelphia’s Independence National Historic Park.

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