According to one lender, “We saw the capital markets improve. And we would have thought there would have been more [in ABL as a result].” Another added, “I was not surprised that the quarter was slow. But I was surprised that it was as slow as it was.”
Yet while asset-based lenders would have liked to have seen more retail volume in 2009, they were busy. On a simple level, it seemed there were fewer banks doing more deals. “Those of us doing deals are feeling busier,” said one lender.
Market capacity, while arguably less of a concern in December 2009 than was the case in January 2009, was still a relevant issue. With the exception of GE Capital, finance companies including UPS, Textron and GMAC either exited the market altogether or were less than predictable investors. In the large corporate space, in particular, “you essentially have two or three guys leading everything,” said one lender. “There was always a concentration of deals among the top syndicators, but now there is a huge drop off. We need to fill in the second-tier arranger group.”
In this setting, a number of regional banks including Regions and Union Bank were able to step up their commitments and up-tier their roles in large corporate ABL deals. “It was a good year for what we were trying to do,” said one regional player. “And that was play in more large corporate deals.”
Additionally, at year-end, lenders that had been largely absent from the ABL market over the last 12-18 months — such as Calpers and Burdale — began looking at deals once again. In many cases, they did so without having relationships with issuers in place.
Despite having to grapple with issues around market capacity and broader concerns around who was lending in the ABL space and who was not, ABL was the only game in town for the better part of the year. At $42.75 billion, 2009 ABL issuance was on par with 2008 volume figures ($42.34 billion)
During this period, total leveraged lending saw a year-over-year drop of almost 19%. At the outset, the underpinnings of asset-based lending as a traditionally counter-cyclical product fueled deal flow. It helped that lenders were talking about tightly structured borrowing base credits premised on regularly scheduled asset appraisals and field exams. Amid the rising default rate environment at the beginning of 2009 and declining credit quality in the leveraged market, it made sense that asset-based structures would take root as one of the few alternative sources to securing liquidity.
“There is only one place to go for covenant-lite revolvers and that is ABL,” said one lender.
In this context, a strong, wildly open high-yield bond market ushered in pre-2006 structuring trends that partnered asset-based loans with bond financings, providing issuers with the opportunity to term out debt. Appropriately sized ABLs with appropriate advance rates once again provided one of the viable financing options available to leveraged issuers in what was still a risk-averse and highly selective loan market. When all was said and done, asset-based lending made up over 18% of total lending for the year — the highest level in six years (See Figure 1).
Refinancings of existing portfolio names dominated deal flow as credits shifted from commercial bank groups to ABL groups. Event-driven transactions were scarce with the exception of a few DIP financings. New asset-based deals were largely concentrated among former cash-flow issuers, which overhauled their capital structures to incorporate ABL components (including names such as Liz Claiborne, Foot Locker, USG, Eastman Kodak and Barnes & Noble). At just under $14 billion, new issue loans represented just 33% of total ABL volume, down from 63% a year earlier. More significantly, in terms of dollars raised, the blend of self-help financings and DIP credits represented 91% of total ABL volume for the year.
Rather than starting from scratch, self-help financings were more likely to be pieced together from existing structures and existing bank groups via amend and extend credits. USG Corp, for example, amended its previously unsecured cash-flow revolver to provide up to $500 million in ABL financing. The structure was put in place by tapping lenders for 51% consent.
Although lenders came along for the ride, the amend and extend phenomenon was only grudgingly accepted by most. “We have looked the other way on those,” said one lender. “We are looking out for new, higher-priced deals coming into the market. [Fundamentally], we have figured out a way to get around the 100% vote. I don’t like it at all, and I don’t think that it has anything to do with the spirit of existing deals. No one contemplated that we would bifurcate a loan at the time of structuring.”
DIP and amend and extend activity made up one-third of total asset-based loan volume for the year among deals of at least $100 million (See Figure 2).
Ultimately, each credit had its own story. So did each lender. And timing mattered. In March, Sears Holdings tapped the market to extend its $4 billion ABL revolver. Based on the company’s BB+/Baa3 senior secured rating and price talk at a hefty LIBOR+400, it was generally deemed that “this was a good deal to do.” Nonetheless, lenders pointed out that there was heavy reliance on existing lenders (many of whom were not traditional ABL investors) to come into the deal, while the tier-one lenders were expected to take down a significant chunk of the financing.
Six months later, demand for new ABL loan assets outstripped supply. Both the Barnes & Noble and C&S Wholesale deals flexed down following their Q4/09 launch (C&S Wholesale was upsized by $50 million to $800 million). Of course, these were both good quality credits with strong lender relationships and good pricing.
“There is certainly more demand out there,” noted one lender in December. “A couple of deals have been done recently that have been so oversubscribed that we have been cut back 40% on our commitment.”
In Bon-Ton’s case, the issuer tapped the market for a refinancing in December that included a $75 million FILO tranche (which would have been unthinkable six months earlier). Lender commitments on the primary $675 million, 3.5-year asset-based revolver were expected to be cut back during final allocations.
Despite the improving market profile, lenders sought to reconcile their increasing optimism with fears around deteriorating deal structures and spreads.
“Where some banks see high demand,” explained one lender, “is in better names which have the luxury of doing better deals” — names like Barnes & Noble, for example. But tougher credits and true middle-market credits are not easy. There is a risk that the market will become bifurcated. “There is a pro-business mentality,” said one arranger. “But it is not clear that lenders will continue to do what we want them to do.”
As such, although ABL lenders pushed almost ten deals of $1 billion or more through syndication in 2009 (including Sears, Toys R Us, Lyondell Basell and Barnes & Noble), smaller credits were often tougher and were more vulnerable unless they were heavily clubbed.
Of course, nothing came easily when the rules of engagement were still being defined. Structures that were tightened in the beginning of the year to include higher spreads and even the occasional LIBOR floor were briskly loosening by December — especially for better names and strong-relationship based credits. The days of LIBOR+400 and 100bp undrawn are largely gone, said one arranger, despite having been “middle of the fairway” for the better part of the year.
Over 58% of total issuance among deals of at least $75 million was priced at LIBOR+400 in Q1/09 (35% of total issuance was priced at LIBOR+450 or greater). For full-year 2009, however, 53% of total issuance was priced at LIBOR +400 and a much thinner 27% made up deal volume priced at LIBOR+450 or greater (See Figure 3). In turn, average spreads in Q4/09 were just over LIBOR+391 (LIBOR+382 exclusive of DIP financings), down 10% from Q1/09 levels, but still up a resounding 47% from Q4/08 levels.
Moreover, this was still a bargain — especially when compared against cash-flow-based BB pricing, which despite some compression during the course of the year, was still significantly richer than that of a comparable ABL credit when incorporating the incremental costs associated with OIDs and LIBOR floor that many of the deals required (See Figure 4).
Looking toward 2010, spread pressures are expected to continue. “Spreads will come in — a lot for smaller deals and better credits,” noted one lender. “But for tougher deals in tougher sectors it will still be hard.”
“The overriding issue for the market is that portfolios are down in size,” said another arranger. “[And this means we are] reducing the number of check boxes required to get the job done — the rules that [drove] capital allocations are being loosened.”
This means that lenders are now more willing to look outside of their core regional markets for investment opportunities or may reconsider the scope of ancillary business opportunities. Case in point: The market has observed lenders relax their demands for funded credits. According to one source, “Right now, we can sell unfunded credits or credits with 10% utilization (as was the case for Michaels Stores and Burlington Coat Factory),” but as he went on to explain, unused fees are still hovering at 75-100bp so there is still an interest level among lenders. In the case of Burlington Coat Factory, the deal was also not that big at $600 million. If it was $1.2 billion, it may not have gotten done that well, according to sources.
“There is no bubble yet,” said one lender. “It is not as aggressive as it was three years ago, and it is not a case of getting 10-20bp fees as we were, but more like 100bp.”
This give and take may work well for arrangers and lenders in the near term. The anticipated ABL financing for Smurfit-Stone that will follow the company’s TLB financing was being talked at LIBOR+350 — a bit thin perhaps, but there is little anticipated usage.
In addition to lower spreads, lenders are also anticipating the return of five-year credits. In fact, tenors that had been pulled in to three or fours years in early 2009 modestly made up 3% of issuance (via amend and extend maturity extensions) by Q4/09 (See Figure 5). Yet lenders emphasize that despite increasing competition, no one is doing anything crazy. Club deals — or at least top-heavy syndicates — are also expected to stay in place, according to several arrangers.
“You can never have enough market depth,” said one source. While market tone feels better, it is still difficult to measure how much better it really is. More significantly, as liquidity returns to the broader leveraged loan market, it will be interesting to see how asset-based structures will be incorporated into large corporate financings — especially as a number of institutional investors struggle with bifurcated collateral structures.
“We were much more relevant in 2009,” said one lender. “But we benefited from large complex structures” in 2006-2007. Ultimately, there is only one place to go for covenant-lite revolvers: “Volumes will be higher in , maybe revenues will not be as high, but there will be activity,” said another source.