TMA Northeast Annual Asset-Based Lending Panel Recap
Reflections from Panelist, Lawrence Klaff
Date march 2014
On Friday, March 21st, members of the TMA Northeast Chapter gathered for the Annual Asset-Based Lending Panel in Boston. The panel included leaders within the asset-based lending community and focused on such major questions as how the competitive landscape has affected structuring, how major regulatory shifts will impact the industry and how lenders will attain their performance goals in 2014. Below we’ll recap key takeaways of the discussion from Lawrence Klaff, Managing Director of GB Credit Partners, the investment management affiliate of Gordon Brothers Group.
With excess liquidity fueling ABL activity, the industry recorded its second best year in 2013 in terms of dollar volume at $82.6 billion. However, there has been comparatively little excitement despite this strong performance. This lack of enthusiasm can be attributed to the fact that the majority of these transactions represented refinancings. With the cost of capital so low and a frothy competitive environment, lenders have had to make concessions to win deals and seek opportunities in new areas.
These environmental factors, including abundant capital and limited demand have pushed lenders to pursue opportunities outside of their typical hunting grounds, with many larger lenders chasing comparatively smaller deals within the middle market. While these lenders strive for responsible growth, there are inevitably growing pains for even some of the most sophisticated banks in adapting their services to a new market and accommodating the peculiarities of that niche. This has also led to a convergence of pricing and terms. Even the lower markets, which have historically been insulated from some of the broader trends affecting the marketplace, have not been immune to the pressure points being felt throughout other areas of the ABL industry. In response to the entrance of new players in this area, lenders such as GB Credit Partners, which already has an established presence in the middle market, have looked towards crafting around the edges to find new opportunities and creative ways to get involved in larger transactions.
Despite the availability of capital, it is certainly a borrower’s market and lenders of all kinds have been forced to make some concessions to win and keep clients. This has been exacerbated by business development companies and private equity groups with lending capabilities entering new markets and bringing a cash flow mentality to the ABL marketplace, which has further resulted in a pushing of the envelope. In response, GB Credit Partners has sought ways to offer some perks to clients without sacrificing structuring and exploring alternate ways to maintain risk management practices while also staying competitive and meeting market needs.
In order to keep up, GB Credit Partners looks to fully leverage every aspect of the balance sheet, drawing on the valuation and disposition capabilities of Gordon Brothers Group within the real estate, brand, retail and commercial & industrial sectors. This expertise informs structuring and advance rates and factors into the calculation of whether the client has a significant downside risk, and ensures that the transaction is fully amortized by the time the client approaches that point. Regardless of these attempts to maintain discipline, clients and partners have continued to push, at times requesting advance rates exceeding 100% of the net orderly liquidation value.
Prompted by steep demands and the need to be aggressive to win deals, the underwriting process within GB Credit Partners has become even more intensive to offset potential risk. For example, GB Credit Partners has narrowed its focus on compelling growth stories, examining the fundamentals of each client carefully. While the team previously would look to ensure a minimum of one year of liquidity from prospective clients, that requirement has intensified due to the inability to compensate for risk through advance rates and other practices that are threatened by increasing competition. This has also triggered a move towards increasingly creative structuring and providing more flexibility in working with ABLs.
In the wake of the Dodd Frank Act and with other regulatory measures looming, banks have taken steps to prepare for the effects and the market shifts they may prompt within the ABL industry. While over recent years governmental agencies appear to have developed a comfortable tolerance for asset-based lending and a fairly comprehensive understanding of the business, there are still many aspects of these changes that have yet to play out. With larger banks making heavy investments into compliance programs and adjusting their appetite for various types of transactions, opportunities have emerged for non-traditional lenders. Where larger banks may begin to hold back, lenders such as GB Credit Partners can fill in. Because of its collaboration with Gordon Brothers Group in risk management, this allows GB Credit Partners to maneuver confidently where less specialized lenders would hesitate.
The Deals that Don’t Get Done
With such ferocious competition in the marketplace, many observers question whether there are still deals that are “off limits.” However, with the proper structuring and as long as lenders truly know their borrowers, few deals are truly impossible, especially for a non-traditional lender such as GB Credit Partners. Particularly in this environment, many deals that previously would not have gotten done are now commonplace, including many with coverage ratios of less than one. Additionally, deals that might not have gotten done before due to size, are now routine for mezzanine and second lien lenders. Previously $10 million of EDITDA was the floor for many cash flow lenders, however, $5 or $7 million of EDITDA has become the new floor for many prospective deals.
The final consideration, however, as to what deals can and cannot get done for a fund such as GB Credit Partners, is investors’ palate for certain deals due to moral considerations. Deals that are incompatible with investors’ values may still never get done, even in the current marketplace.
With news of all kinds breaking each day, lenders must expect the unexpected and adjust to changing events that may impact asset values. However, if properly assessed from the start and monitored throughout the life of a loan, such external shocks should be a fairly minor consideration and not pose a significant threat to a well-structured ABL deal. That’s not to say these factors should not be watched. For example, the GB Credit Partners team is currently monitoring for shifts in public policy affecting solar energy subsidies and regulations against fracking, noting that shifts in either direction could have an impact on outstanding deals in those sectors. While legislative issues should be noted, at the end of the day, collateral is collateral and the coverage it offers should be sufficient if properly managed and monitored. Monitoring should also be performed in considering a potential liquidation strategy. For example, a contraction in the market for M&E assets overseas would have an impact on disposition strategies and asset values domestically.
How to Make Budget
Despite the many factors affecting the ABL marketplace today, lenders are still expected to deliver growth and achieve their budget goals over the coming year. This may involve being less discriminating, accepting less yield and being flexible with borrowers and partners. In order to deliver on expectations in 2014, the GB Credit Partners team will target other industries, expanding the energy and aerospace portfolio, in addition to traditional retail and consumer deals. GB Credit Partners will also continue to explore areas where other lenders are exiting, which has historically offered much growth. For example during the auto crisis, the team provided financing to multiple Tier 1 and 2 original equipment manufacturers (OEMs). A similar scenario unfolded in the wake of the housing crisis where GB Credit Partners provided financing to companies that were supplying to the housing market and lending on depressed real estate assets at the time.
In the search for greener pastures, GB Credit Partners has also set its sights on European opportunities over the coming year. Gordon Brothers Group’s international operations in Germany and the UK positions GB Credit Partners to maximize opportunities overseas, however, varying regulations by country may limit maneuverability in certain areas.
Competitive factors, as well as cheap capital and the advent of new regulations are having a major impact on the ABL market. But compelling opportunities exist for creative, flexible lenders. While senior lenders face confinement with the introduction of new regulations, it is incumbent upon second lien lenders to fill in the gaps beyond where many senior lenders may venture. Creative lenders of this kind will thrive as they pursue growth for themselves, while also filling a great need on the part of borrowers and other lenders.