Charlie Perer outlines an emerging trend of bank-owned asset-based lending divisions conducting business in a fashion similar to non-bank asset-based lenders while gaining an advantage due to the ability to price like a bank.
Small and regional bank asset-based lenders that operate like non-bank asset-based lenders are shaping the lower end of the ABL market. To be clear, these are banks with specialty finance divisions that operate just like non-banks but are still under a bank’s umbrella and therefore price like a bank. This group of ABLs includes UMB, First Business, Crestmark, TAB Bank, MidFirst Business Credit, Cadence Business Finance (formerly Alostar Capital Finance) and Sterling National Bank, among others. Frequently, these ABLs are priced 30% less than the traditional lower middle market non-bank ABLs. They can do this while providing the same structure as the non-bank ABLs given their cost of funds. Many of the aforementioned are either industrial banks or set up as a subsidiary of their parent bank to avoid regulatory hurdles. In any event, these bank ABLs truly think, act and execute like a non-bank ABL and are becoming a national market force.
Forming the Third Tier of ABL Pricing Options
These bank-owned specialty finance ABL groups are typically priced in between traditional, larger bank ABLs and non-bank ABLs, thus creating a three-tiered pricing menu in most markets: large bank ABLs, specialty finance bank ABLs and non-bank ABLs. Advisors and borrowers now have three clear and delineated options to pursue in each market, although the credit quality and minimum funds employed are much higher for larger bank ABL deals. The void that non-bank ABLs used to fill with no competition has now become competitive on a national basis. Historically speaking, the market was two-tiered, as many of the specialty finance bank ABLs did not have national reach, while many of the non-bank ABLs achieved national scale and efficiency through acquisition. National reach and scale are the two best friends of a finance company and this has clearly not been lost on the ABLs that were acquired by business development companies and banks with specialty finance divisions. This has led to reduced pricing across the board by both constituencies, especially given the lower cost of funds that result from the BDC structure, which utilizes access to public markets to achieve cheaper capital.
The lower end of the ABL market has never been more competitive as competition converges and many firms now have national reach. BDCs and the general consolidation of ABLs has enabled lower pricing, national reach and scale. This is a recent trend, as it took both BDCs entering the market and regional banks with specialty finance ABL groups expanding nationally. In addition, new lending market entrants with specialization, including new lenders focused exclusively on the consumer products industry or non-traditional ABL such as intellectual property, real estate, and machinery and equipment, have created more options and competition. New firms, new products and more options has been great for advisors and borrowers but is clearly causing some market friction for lenders. The end-result is clear: increased competition and compressed margins. However, the market changes are not always easy to spot upfront.
That said, the primary market changing trend here is the proliferation of regional banks with specialty finance ABL groups expanding nationally rather than just regionally. These firms are focused on the lower end of the market and are not looking to go head to head with the national bank ABL groups. Rather, they have very good business plans, which hinge on leveraging their national reach and lower cost of funds to take share from the non-bank ABLs. They also can happily fund the smaller deals that larger bank ABLs avoid or are unable to complete. In this way, these firms have filled the void in the market that the larger bank ABLs used to fill by doing smaller deals. These specialty finance bank ABL groups clearly recognized this void and have been aggressive in addressing it.
The Advantages of ‘Non-Bank, Bank ABLs’
Why wouldn’t they when their value proposition is the same product at a lower price? It’s just like the saying: “Everything you can do, we can do at a lower rate.” This is the message the bank specialty finance groups are sending nationally, as these groups are a clear bright spot for their bank owners in this low rate environment. Another reason regional banks have expanded their specialty lending groups is not just to build a broader footprint and gain higher yields, but to gain treasury management income from clients that they would not have seen otherwise. While the non-bank ABLs have achieved a level of scale, it still does not match these bank ABLs that can act like a non-bank while pricing like a bank. The key change in this market is the national reach of these banks with specialty finance ABL groups.
A few years ago, just a handful of ABLs had national reach and the ones that did were non-bank ABL groups that were purchased by banks. Many banks clearly have paid attention to this trend and taken the step of hiring executives and business development officers around the country to attain national reach. Many of these groups are run by former non-bank lenders themselves, which allows them to achieve success with minimal write-offs. Write-offs kill the channel immediately and can lead to a quick demise of a startup ABL group at a bank. When done right, however, the risks are minimal, but the returns are very high. There is a reason why this market has become very competitive while banks with specialty finance groups take national share from the non-banks. Previous to this constituency, the non-bank ABLs just competed with each other rather than a disruptive group of out-of-town specialty finance bank ABL groups.
This trend is here to stay — especially as banks start to exit clients — and should play a meaningful market role for years to come given we are just entering a new cycle. The evolution of the market and shift in credit appetite and deal structures should make for an interesting demarcation in terms of risk appetite for each constituency. However, it is unclear if the market leading non-banks and banks with specialty finance groups have the capital and fortitude to stick with the strategy through a tough cycle. The majority of new entrants obviously entered the market and expanded nationally well in advance of COVID-19. So it remains to be seen what the push-pull within banks will look like when liquidations and potential losses start to occur. The dynamic between many banks and their specialty finance groups is going to be tested as most banks work-out versus liquidate because they don’t have a choice. The specialty finance ABLs certainly have a choice and, make no mistake, there will be liquidations. The tide is going to go out soon enough and we will all find out which new entrants are here to stay.
Charlie Perer is the co-founder and head of originations of SG Credit Partners. In 2018, Perer and Marc Cole led the spin out of Super G Capital’s cash flow, technology and special situations division to form SG Credit Partners. Perer appreciates feedback and can be reached at firstname.lastname@example.org.