Banks can afford to use lending as a loss leader since they require the cash from
customer deposits to perform. This sea change can be viewed through building blocks
of technology, market saturation and efficiency and non-sponsored companies starved
for credit. Banks again will have to adapt and transform as many now have sponsor
coverage groups. According to Brandon Ferrera, middle market senior vice president
at Comerica, “We have seen an increase in the aggressiveness of institutional capital
flowing to the non-sponsor market. The capital shift flowing to traditional bank-type
clients has already started as private credit funds are realizing they can obtain yield in
this asset class. Banks are coming under market pressure to provide more flexible amor-
tization and take more lenient positions on owner distributions, among other things.
Banks will continue to have a cost of funds advantage, but will be challenged by the
flexibility of non-bank lenders.”
Banks will begin to offer more structured products to non-sponsored companies
when market share erodes to a certain point. Again, banks lost market share to BDCs
and other funds that would have been bank-type deals 10 to 15 years ago, but now,
with many options for more leverage, the game has changed. This trend will inevitably
happen in the non-sponsored market, but it will come in different shapes and sizes. The
world is still round, and most folks are fairly rational. Non-sponsored companies will
never get the same leverage and structures as sponsored, but their options are going to
increase. Today’s market is inefficient because of the risk and lack of equity support.
Banks Will Respond
To combat the impending changes, the national banks will de-centralize and shift
power to regional levels, offering more flexibility and services. Presumably banks will
use M&A to attract strategic acquisitions of new lending entrants as a way to add
new products and services. As reported in past issues of ABF Journal, many banks
now own factoring, ABL and SBIC funds, so they are transforming as well. The capital
drag caused by too many debt providers focused on private equity-backed companies is going to cause competitive pressures for banks. Banks will take a wait-and-see
approach and then commence M&A activity to consolidate as they have in cycles past.
Banks will not sit idly while their core constituency is taken away. Once they understand how the new lending strategies to non-PE companies play out, they will want
a say in this market through acquisitions. For these reasons, it is clear we are at the
beginning of a sea change that will transform and consolidate lending options for non-private equity backed companies. abfj
CHARLIE PERER is head of Originations at Super G Capital and a member of its credit committee.
finance are entrepreneur owned and seeking a flexible debt structure to spur the
growth necessary to graduate to the middle market, where a multitude of financing
solutions are more readily available. By combining ABL with a proprietary collateral
system, we are able to better monitor the health of those businesses and be in a
position to make real-time decisions, benefiting both the borrower and TCJ alike.”
The ABL business has proven to be highly adaptable given the relatively small
amount of non-private equity backed clients that qualify for true cash flow lending.
According to Matt Grimes, managing director in Ares Commercial Finance’s ABL
group, “The shift towards non-bank lenders in the family-owned/entrepreneurial
lower middle market already has traction. Although banks will always have a pricing
advantage due to their lower cost of funds, non-bank lenders are not constrained
by federal regulations that restrict a bank’s ability to provide the same amount of
liquidity as non-bank lenders.
“The end result is that entrepreneur-owned businesses are able to obtain more
availability and flexibility even without a sponsor. The sophistication of non-bank ABLs and need to deploy capital has alleviated the need to pursue private
equity as a path towards growth capital, turnaround liquidity or partner buy-outs.
Management teams at many of these lower middle market companies realize that a
financial solution providing increased liquidity and covenant flexibility can be more
valuable than a less expensive, but restrictive, bank solution.”
Financing the “Air Ball”
Super G Capital’s cash flow lending group was formed to finance the “senior stretch”
or “air ball” risk that ABLs and banks usually decline to finance. A shortage of
capital exists for companies that need more than their bank or ABL are willing to
provide and are too small for traditional mezzanine or unitranche capital. Most of
these companies are family owned and do not have the equity backstop that typically comes with private equity. Super G’s goal is to fill this void. These companies
also need flexibility from their lender and the ability to amend loans when necessity
dictates. Lending to such companies is often not for the faint of heart, but these
companies can provide solid credits. While the level of risk is higher, the market
opportunity presented by non-private equity owned companies is larger.
Creating a bank-like offering with more flexibility is the goal. This clearly comes
at a price. Each borrower needs to decide what is best for it, but the availability
of this option is only going to grow as more firms build a proven static pool of
performing credits. Speed and service are also superior as spread lenders have only
one source of income: lending. Lending is not a loss leader at non-bank spread
lenders the way it is at banks.
Banks will not sit idly while their core
constituency is taken away. Once
they understand how the new lending
strategies to non-PE companies play
out, they will want a say in this market
through acquisitions. For these reasons,
it is clear we are at the beginning of
a sea change that will transform and
consolidate lending options for non-private equity backed companies.
Source: PitchBook Data
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Deal value ($B) of deals closed
Lower Middle Market PE Activity