Partner
Carl Marks Advisors
More middle-market borrowers are seeking alternative forms of financing as traditional lenders apply greater scrutiny to their portfolios amidst increasing regulation, opening up opportunities for non-bank asset-based lenders. Robert Lau of Carl Marks Advisors provides important context around this trend and how it will influence the market in the short and long term.
Earlier this year, investment bank Carl Marks Advisors released a survey that gauged the perspective of business executives and lenders about the financing landscape for middle-market borrowers in 2023.
Among the many findings from the survey, the most critical was that a large percentage of companies are seeking out alternative forms of financing as traditional bank lenders apply more pressure in the face of continually increasing regulatory scrutiny, leading to a swelling in the ranks of alternative lenders to address a growing opportunity set. To examine this trend and what it means for the asset-based lending industry, Robert Lau, a partner at Carl Marks Advisors, spoke with ABF Journal in an exclusive Q&A.
What were some of the major findings of this survey and how do they differ from the survey from 2021?
Robert Lau: The major finding was that middle-market companies continue to struggle from a variety of perspectives performance- wise and their lenders have shown less patience. In 2021, everybody was still in ‘kick the can’ mode, and the expectation was that that would continue for a while. What we’ve seen from an execution standpoint is lenders scrutinized the portfolio of companies a lot harder towards the end of 2021 and early 2022, and that has continued for the most part.
Are more businesses seeking out alternative financing options this year?
Lau: The alternative or unregulated lender space has continued to grow. If you look back in the old days when things were tough, it was the commercial finance companies like CIT [now First Citizens Bank] and Heller Financial and GE Capital that grew their books. But now, especially with tighter regulation of regulated institutions, there has been growth in the alternative financing space.
When you carve up the ABL financing space, it’s mixed. A lot of borrowers still have margin compression issues and other challenges. Inventory has ballooned and they’re looking for financing that’s outside of what traditional asset-based lenders would provide them in the past. Alternative lenders are willing to stretch on collateral or advance rates. They have an appetite to take on credits that would be rated out of the box in a regulated institution. I think it’s much easier to find these types of financings within that space, so the non-regulated, alternative lenders are staying pretty busy. The regulated ABL firms are staying busy as well, but it’s a different metric as far as the borrowers go.
What types of environments favor alternative lenders compared with more traditional lenders?
Lau: The appetite for regulated asset-based lenders to take on credits that are rated out of the boxes has shrunk over the years. In the old days, there were buckets where these lenders could have a dollar amount or a level of exposure that they would accept outside of the box. I think that’s been reigned in a little bit as the regulators have clamped down on the banks. When it’s down-the-pipe ABL, clearly the banks are the cheaper alternative, although there seems to be some compression going on.
There are a lot of borrower relationships that go back decades with many of these institutions as well, so if you’re a well-performing company, and have been over years, and you have a great relationship with your bank, why change? I think the challenge for some businesses from a performance perspective, a leverage perspective or even an industry perspective is that the appetite for more challenged credits in certain industries has declined, leaving more opportunities for the unregulated lenders.
Why are more businesses seeking out alternative financing options this year?
Lau: What you see in the unregulated space is more flexibility. I think the perception is that there is an easier path to close and less bureaucracy within an unregulated lender. There’s also an appetite to do things outside the box to some extent regarding advanced rates or certain collateral pools.
Earlier this year, we ran a process to refinance a company in the marine transportation space. The company was moderately levered, but we received almost zero interest from regulated institutions. We ended up refinancing it with a large private credit fund and that financing had an ABL component to it. But it was a good example of a financing where an alternative lender was the only solution for a company in this particular industry.
Do you expect this trend to continue? If so, for how long?
Lau: I think it will continue, both in the short term and long term. From a restructuring advisory perspective, we continue to see a fairly healthy flow of inbound calls from lenders. We will continue on that path at least through the end of this year and probably into sometime next year. Maybe it will settle down then. However, from a longer-term perspective, it seems to me anecdotally that the regulators have, over the years, tried to force a lot of the levered deals out of the banks, and that will force more financings to the unregulated side. I think that’s going to continue longer term.
What strengths do alternative lenders provide that might help them win business away from traditional lenders today?
Lau: I think the perception over the years has always been that banks were more relationship focused and some unregulated asset-based lenders were more transaction focused. But the key differences are that unregulated, alterative lenders offer more flexibility, an appetite for leverage and the ability to book rated credits that would probably be tougher for regulated lenders to stomach these days.
What types of alternative financing options are getting the most attention right now?
Lau: It’s mostly non-bank ABL. Larger credit funds that are able to put together a consolidated solution that includes ABL and term based on equipment, IP values or something like that are doing particularly well. Also, we do see a lot of other funds that have a bigger appetite for term debt or have become active in providing solutions to the challenges that are out there today. There are a lot of companies with liquidity challenges for one reason or the other, whether it’s performance or ramped up inventory needs that they haven’t been able to shrink yet and just need capital.
How can alternative lenders best take advantage of these developments?
Lau: It might seem obvious, but if you’re a non-bank ABL lender, you should be doing more reachout and marketing. Having been a marketing guy on that side of the business years ago, that would be my first answer. The rest is a bit trickier. All lenders strive to provide ease of execution and sell themselves as more relationship focused. I think that may be the biggest challenge. I don’t know for sure, but my perception is that these types of lenders have always been perceived as more transaction focused vs. relationship focused. They’ve improved on that, but overcoming that perception is a challenge these lenders have done a good job addressing over the last few years.
The survey said that a majority of respondents believe traditional lenders are applying more pressure to middle- market borrowers. Do you agree, and why might this be happening?
Lau: I agree with that. If you look back at 2021, the expectation was that everybody was going to continue to kick the can. There was still a lot of government support and COVID-related challenges out there, and everybody understood that. Because of these factors, lenders were extremely patient in dealing with their borrowers. That patience has eased a little bit and the money is no longer flowing from any sort of government assistance. Banks are dealing with an increased number of issues within their portfolios and need to deal with them efficiently, given staffing levels in special asset groups. Therefore, they are starting to turn the screws.
Against this backdrop, the only solution is to pressure some borrowers to refinance. The first option for many bank borrowers would be to seek an asset-based solution. The challenge is that many of these borrowers have been levered outside what an ABL can support. These credits often have to be restructured or sold, often alongside an operational as well.
How has bank consolidation impacted the availability of lending options?
Lau: If you look at recent bank consolidations, it’s been a relatively small portion of the market, so when you see failures at Silicon Valley Bank and others, I can’t imagine that had a giant impact. However, over the last 30 years, bank consolidation has been fairly robust, shrinking the number of banks left standing.
There was a bit of a knee-jerk reaction within lenders and regional banks regarding their appetite to do new deals after the bank failures earlier this year. But it was for a very brief period of time. If there’s anything I have learned, having been a lender and dealt with many lenders on the advisory side, it’s that bankers have short memories.
