Bill Kosis,  EVP PNC Business Credit
Bill Kosis,
PNC Business Credit
Kurt Marsden,Head of Business Finance, Wells Fargo Capital Finance
Kurt Marsden,Head of Business Finance,
Wells Fargo Capital Finance
Joseph F. Nemia, EVP, Head of Asset Based Lending, TD Bank
Joseph F. Nemia,
EVP, Head of ABL,
TD Bank
Sam Philbrick, President, U.S. Bank Asset Based Finance
Sam Philbrick, President,
U.S. Bank Asset Based Finance
Michael Sharkey, President, Cole Taylor Business Capital
Michael Sharkey,
Cole Taylor Business Capital

Economists have mixed views of what is ahead in 2014. Will the slow growth of the past few years stagger and stall, or will the country continue its turtle-paced climb back to prosperity? There is no doubt about the environment in which asset-based lenders must work. The realities of today’s marketplace include intense competition, growing regulation, excess liquidity and pressure on structure and pricing.

To learn more, we talked to five asset-based financing leaders: Bill Kosis, executive vice president, PNC Business Credit; Kurt Marsden, head of Business Finance, Wells Fargo Capital Finance; Joseph F. Nemia, executive vice president, head of Asset Based Lending, TD Bank; Sam Philbrick, president, U.S. Bank Asset Based Finance; and Michael Sharkey, president, Cole Taylor Business Capital.

Most of our panelists agree that interest rates will stay low or increase slightly. “Given the Federal Reserve’s stated intention of keeping rates low until unemployment is reduced to a more acceptable level, I expect interest rates to remain in their current range throughout 2014,” comments Kurt Marsden.

Joe Nemia suggests rates won’t rise until there is measurable economic growth across many sectors of the domestic economy. “There are recent signs of improvement in new home sales, automobiles and other durable goods, most likely because of the lack of activity in these sectors in the 2009-2011 timeframe. The economy still needs to catch up, and I think we are looking at the second half of 2014 until any real adjustments are made.”

Increased bank liquidity has brought new players, higher hold limits and increasingly fierce competition to the ABL space. “The banks have capital and are looking for viable places to deploy it within the risk paradigm of their organization,” says Marsden. “For many institutions, asset-based finance fits nicely into that paradigm.”

“ABL portfolios are reflective of the improving economy, and peer group data suggests that weighted average risk ratings appear as healthy as they have ever been,” notes Nemia. “That’s the good news. On the flip side, new deal activity has not kept pace with the supply of funding available to invest in new opportunities.”
“We have corporate banks taking some of the borderline asset-based deals, but there are still plenty of great deals in this economy,” proclaims Kosis. “PNC Business Credit is a middle- market lender, and we see at least 100 deals every two weeks. In fact I rarely see the same names twice, and I’ve been in this business for more than 35 years. The U.S. middle market is extremely deep.”

When Cole Taylor entered the ABL market in 2008, there wasn’t much liquidity and the environment was good for ABL. “Gradually, over the last five years, that competition has intensified,” describes Sharkey. “It is as competitive right now as I have ever seen it. It’s not that there are more ABL lenders than ever before; it’s the commercial banks and the alternative lenders that are pressuring the market. The banks come in with bargain-basement commercial deals with no field exams and no appraisals. Then you add the explosion of alternative lenders taking on riskier cash-flow deals, and a big bite has been taken out of the market.”

“I have to believe that the deterioration of pricing will start to slow,” predicts Philbrick. “Where this intense, competitive environment leads us is that we need to compete on the basis of trying to be the first provider with the right answer for our clients.”

“We have done a lot of business with intermediaries and equity funds over the years,” says Kosis. “They tend to be our trusted partners, and that has helped us in this competitive situation. But there is no question that there are a lot of new players. We are holding more, especially when our clients grow. There’s tough competition, but we have been through these stretches before. We just have to work harder.”

New Players, New Pressures

“If you are in an institution that is trying to meet corporate customers’ banking needs, your set of capabilities is not complete unless you have the ABL product,” says Philbrick. “Our competitors have put more resources into the ABL business over the last five years, and I don’t see that changing. In terms of the market we are in, with intense competition and declining spreads, we all have to have a keen eye toward managing our credit and non-credit expenses appropriately.”

“Within our portfolio, we know other lenders are calling our clients, because our clients share that information with us,” states Marsden. “Hopefully as a lender, you are anticipating this activity and working to stay ahead of it by understanding your clients’ needs and developing creative solutions.”

Without growth in the portfolio and a quiet M&A market, Sharkey admits that the only way to grow is to steal somebody else’s customer. “That creates a ton of pressure across the market on structure, pricing and every aspect of what we do.”

“The advent of Business Development Corporations and B lending funds have been a major positive for us,” emphasizes Kosis. “Some of these funds have billions of dollars. They control part of the market and end up putting the leverage on equity-driven deals, such as M&A transactions. They need a player to do the asset-based monitoring and administrative work, and we cross-sell our bank products to the client. We end up getting a healthy return on those deals while enjoying a good support cushion from the funds.”

“Where large ABL lenders will see an impact is on the talent side, as the new entrants look to expand their platforms with experienced lenders who provide immediate credibility to their growth efforts,” warns Nemia.

We asked our panelists to tell us how the Dodd-Frank Act has impacted ABL activity. “We are watching the volume of compliance increase, and that requires investment in systems and manpower,” reports Marsden. “This in turn increases the costs of managing the asset-based product. We look to increased automation of processes in order to become more efficient as we deal with current and future compliance requirements.”

“We should expect the regulators to continue down the path of increased oversight across the various risk and compliance areas of regulated institutions,” remarks Nemia. “There is a cost to improving systems, increased reporting and compliance, but it’s a non-negotiable.”

“Regulation is one of many factors that are part of our operating environment,” affirms Philbrick. “We work diligently to make sure all regulations are appropriately accounted for in how we do business.”

“We operate in the U.S., Canada and United Kingdom, and we have regulators on every front,” says Kosis. “We consider them part of the operation. We operate with them in a mode of total transparency; if I know about a problem, they know about it. Generally we find that if we support them and give them straightforward, transparent reporting, they come up with some ideas that are beneficial.”

Building Business

Increased M&A activity would be a welcome shot in the arm to the ABL industry, but would it also lessen the focus on each other’s customers? Marsden says his company will continue to focus heavily on refinance activity within its portfolio while pursuing new opportunities with prospective clients. “Merger and acquisition activity definitely decreased during the summer months, but we are looking for a pick-up as we move into the fourth quarter. Many of our private equity partners have raised additional capital and are ready to deploy it when opportunities arise.”

“It’s hard for me to understand why the M&A market isn’t more active,” ponders Sharkey. “There is so much money and liquidity chasing deals, that if you have something to sell right now, the multiples are outstanding. Perhaps sellers are waiting for their EBIDTAs to come back to where they were or for sales to return to prior levels. It could be that the private equity groups aren’t selling, because they can do a re-cap and take money off the table, but I don’t know how they are going to redeploy that capital if they get it back.”

“There are plenty of buyers out there, but there are not a lot of sellers who believe selling in this market at these prices is in their best interest,” responds Philbrick. “At some point, the sellers will realize that this is where we are, from a value standpoint, and will move forward if the sale makes sense for their future. The problem is certainly not a lack of capital!”

“Many ABL borrowers could ultimately be the target or the acquirer in an M&A transaction,” suggests Nemia. “Lenders will need to continue a high service level to remain in a business combination that impacts their borrowers. From a credit risk perspective, underwriting assumptions will need to be re-tested as the competitive landscape changes and higher interest rates could impact the combined entity.”

“The equity funds have a lot of money, and there are a lot of groups going out to raise additional money,” continues Kosis. “We value our partnerships with the big institutional BDCs and the deals we can participate in with them. We are able to do the front end, lead the revolver and the asset-based piece of the financing, and blend the pricing down with a one-stop outlook for the acquirers. This activity is picking up, and we should have a strong fourth quarter and 2014 on that front.”

“The fact that we have any increase in M&A activity is extremely encouraging,” mentions Philbrick. “I hope it lessens the focus on the refinancing that we’ve lived off for the last two years. True growth through M&A and improved economic activity is the thing that can carry us forward.”

“We hope that the banks doing non-ABL deals, or the lenders buckling to pressure to be more aggressive on structure, are going to have problems, lose money and stop being so aggressive,” expresses Sharkey. “It probably won’t happen until there is a bump in the road in the market. It is hard for me to see how the environment can get a lot more competitive — unless we start giving money away!”

Pipeline Report

Going into 2013 many lenders experienced diminished pipelines because of tax law changes that prompted clients to close business by the end of 2012. It appears that pipelines are in good shape for 2014. “We are seeing a robust pipeline back to normal levels,” relates Kosis. “I expect that to continue through year-end, and we should be at a much more normalized level going into 2014.”

“Absent any broad indication of increased activity in 2014, the impact of higher interest rates may spur companies to reassess their long-term value as it relates to a potential acquirer that will utilize ABL to affect the purchase,” comments Nemia. “There is still a significant amount of liquidity on the sidelines, so I’m hopeful that 2014 will be a more robust year for the industry.”

“Unless there is some significant catalyst of change, such as an economic event that takes capital out of the marketplace, I believe that 2014 will be very similar to 2013,” laments Marsden.

“We review as many packages and propose as many deals as ever,” claims Sharkey. “The problem is our winning percentage due to the nature of the market, the number of competitors and the alternative lenders. All these different aspects make it so intensely competitive, and our winning percentage is falling. It isn’t the pipeline that’s the problem. Between pricing, structure and covenant pressures, it is more difficult to win.”

“It’s still early to predict what 2014 will look like, but it’s safe to assume that it is going to be more of the same,” finishes Philbrick. “We are going to work very hard next year to grow our business.”

Room to Grow

“We continue to see an active syndication market,” declares Marsden. “There is an appetite for assets, and people are embracing creative solutions. In some cases they are embracing asset classes that asset-based lenders might not have lent on in the past. Particularly, international receivables and inventory are becoming more common in our loan structures, and more institutions are getting comfortable with these international components.”

“There is a lot of capacity, so reasonable deals will sell readily,” proposes Kosis. “That means that more sophisticated sponsors are cutting down the number of participants, forcing people to take larger positions. Many of the people, who are putting these deals together and buying companies, want to rely on a few banks they know and trust rather than bringing in ten banks. This has worked in our favor.”

“We have recently seen two large acquisitions in the retail sector: HBC’s announced purchase of Saks and the announced acquisition of Neiman Marcus,” stresses Nemia. “If these deals are consummated, the ABL product will play a significant role in the deal structure. Also coming to market is the Dell transaction that represents a $2 billion ABL facility. It will be a real test of the appetite relative to higher hold limits and more players in the market. Whether the market can digest that deal will be a key indication of market depth and the willingness to provide an enormous amount of money in the ABL product.”

We asked our panel whether average earning assets will be higher or lower in 2014 and what drives that outcome. “We have seen growth in average earning assets over the year,” says Marsden. “Because we provide revolving lines of credit, there is expansion and contraction in our portfolio throughout the year due to the cyclical nature of our clients’ businesses. For example, a large percentage of my client base comprises companies in the building-product space, and their business tends to ramp up in the spring and slow in the winter months. Consequently their capital needs shift dramatically throughout the year. Assuming the confidence level in business continues to improve — and we are seeing signs of this in our client base — I believe we will continue to see growth in our average earning assets as we move into 2014.”

Nemia predicts, “The key drivers to earning assets will be a pick-up in new deal activity in addition to organic economic growth that will motivate the typical ABL borrower to make investments in working capital assets and PP&E.”

“The economy is reasonably good, but there will be spread pressure because you have a lot more people in the market,” adds Kosis. “The credits will be good, based on the solid performance we saw this year. We have strong relationships, and we’ll continue to work with those folks while also developing new relationships. Hopefully that will carry us, and we’ll show some growth.”

“In 2012 we saw an uptick in the percentage of our lines being used by our customers, and that is a measure of organic growth in the portfolio,” states Sharkey. “This year it has been virtually nil, and I expect next year to be about the same. The government has become a huge part of the economy, and if it doesn’t fire on all cylinders, it hurts business growth. We have customers suffering from the sequester; they’ve lost volume and had to shrink their balance sheets because of a lack of volume from the government. The recent government shutdown is just going to exacerbate that problem. I don’t see much recovery in 2014.”

“We expect modest loan growth,” remarks Philbrick. “The question is whether your loan growth exceeds the deterioration in your spreads so you can realize significant revenue growth. We are optimistic that we’ll grow our business from a revenue standpoint, but it will be a challenge.”

Areas of Concern

“The unpredictable nature of where 2014 growth will come from has to be on the mind of everyone on this panel,” speculates Nemia. “Just listening to the Fed Chairman’s latest comments and continued asset purchases by the Fed certainly sends a message of uncertainty as to the timing of sustained U.S. economic growth.
“My concerns are two-fold,” admits Marsden. “The interest rates on asset-based loans are near record lows, and without a foreseeable shift in the competitive dynamics, I am concerned about continued price compression. My second concern is the aggressive nature of many recent loan structures. It’s important to be creative but avoid getting caught up in the fervor of this competitive environment.”

Kosis is concerned about quality personnel and keeping the company culture together. “We have a highly engaged workforce, and we want to keep it that way. PNC Bank is solid — and that gives us a lot of leeway — but it is hard work, with the normal credit and business headaches and the challenges of working with the regulators. We’ve grown over the years and have to develop good, fundamentally sound people as well as a few stars to drive the business along.”

“There’s a need for our products in good times and bad,” encourages Sharkey. “You have to be a little quicker and smarter while using all the ABL skills you’ve learned over the years and bring them to bear on a particular transaction. There is no lack of opportunities, but you have to decide which ones you want to do and what it takes to win. We are all being pressured to stretch our parameters, but you have to have the discipline not to do something that isn’t prudent. We walk the fine line of sanity all the time. We want to be around for a long, long time and that means we don’t try to push the limits too far just to grow today.”

“We are going to be in this environment of low interest rates, modest activity and intense competition for some time to come,” concludes Philbrick. “If that’s the backdrop for the foreseeable future, you have to manage your business very carefully. It is critical that you stay really close to your existing customers. You must manage your business from an expense standpoint, so you can continue to operate successfully with this pressure on margins. It’s an environment where you can really see who the good bankers are; those who can drive growth without sacrificing long term credit quality.”

Lisa A. Miller is a regular ABF Journal contributor who has worked in the commercial finance industry for more than 15 years.