Many ABL industry players think only 25% of transaction opportunities they see are direct competition
with alternative lenders. The balance of the deals
represents complementary opportunities. In those
“Red Ocean” cases where the lenders are all going
at each other, often the alternative lenders don’t feel
that the collateral or cash flow supports a second lien
position. The alternative lenders feel that it’s better to
take all of the collateral and do a bigger stretch piece.
“We don’t often compete with alternative lenders
directly because their risk/return profile is different
than my sweet spot in a supervised institution,”
Karas notes. “I’m happy to have a symbiotic rela-
tionship where their borrowers with demonstrated
improvement graduate to the lower cost structure we
can provide, while my borrowers with low effective
loan-to-value assets but weak financial performance
can migrate to those organizations.”
Jeremy Harrison, regional group head of Bank of
America Merrill Lynch, London and president of CFA
Europe, says, “One of the goals of CFA Europe is to
provide a platform for dialogue bet ween alternative,
direct lenders and the bank-owned ABL players. It’s
crucial that both groups understand how to offer the
best of both worlds to the borrower and how to work
constructively together if things go wobbly. We think
the two groups can support the needs of the PE and
middle market borrower community by providing
long-term flexible financing facilities that maximize
liquidity and support the anticipated growth of
their companies. In many cases, the combination
of alternative lenders and ABL lenders can provide
PE sponsors with a bespoke solution, which maxi-
mizes the debt capacity of the portfolio company.
In the minds of some sponsors, asset-based lending
is too constricting. The right combination of bank
ABL and alternative lenders can demonstrate to PE
firms how to wring the most out of their companies’
Another reason why alternative lenders and ABL
players are important to one another is that alterna-
tive lenders do not have the operational “back office”
capabilities to provide revolving credit facilities to
borrowers. This is the knife and fork of ABL players.
In Europe, Pan European asset-based loans are the
Holy Grail. Seamless back office functions across
European borders are crucial to realizing this goal.
Opportunities are emerging for good working
relationships between ABL players and alternative
lenders. What are the challenges?
Credit funds and bank ABL groups have different
heritages and, therefore, different credit cultures.
When a borrower is flashing warning signs of early
decline, the goals, pressure points and timelines
of the two types of lenders may diverge quickly
and widely. The first lien lender may stop funding
because the risk rating of the borrower has deteriorated, whereas the second lien lender may want to
meter cash in to protect enterprise value.
Chait offers a different perspective: “Although the deal count
is falling, average transaction sizes have increased (H1/16 = €112
million/$133 million, H1/17 = €176 million/$209 million), which suggests
that the disconnect on valuation is more at the smaller end, and that the
larger end is actually quite robust.”
Is the ABL Market Softening?
A pressing question for both ABL and alternative lenders in the UK
and Europe is whether demand for asset-based loans is softening or
not. According to the Wall Street Journal, a recent survey by Deloitte
in London covering Q2/17 showed that UK business leaders’ moods
have soured. A third of CFOs surveyed said they expected their capital
expenditures to decline over the next three years. With the heavy UK
focus of U.S. asset-based lenders, this may act as a damper on loan
demand by UK borrowers.
With some concerns that the credit cycle has peaked, many ABL
players welcome the involvement of alternative lenders who have a
strong credit culture honed over many credit cycles. They can benefit
from another set of eyes and ears looking at a proposed transaction, spotting any weaknesses in structure or in the credit quality of the borrower.
This wasn’t always the case. In the early 2000s, two catastrophic
frauds shook the asset-based lending community: American Tissue and
Alou. Both companies had multiple lenders in extremely complicated
capital and corporate structures. While the first lien asset-based lenders
felt secure, the sheer number of alternative lenders in dizzying interlocking corporate entities allowed the two companies to confuse the
lenders, and ultimately perpetrate the frauds. For example, American
Tissue had pledged parts of a large paper machine to 16 different
lenders! Alou had a corporate structure that looked like the piping on a
nuclear power plant, leaving lenders with a loss of $130 million in 2002.
These disasters left bad tastes with ABL players about participating in
deals with alternative lenders.
Today, alternative lenders and ABLs are more appreciative of one
another. Many ABL players find that alternative lenders welcome their
“hard wire brush” approach to collateral. Also, in transactions that have
some hair on them, alternative lenders appreciate the fact that legacy
ABL players may have a well-documented history of how collateral
performs when a company goes sideways. In a good working relationship, seasoned ABL players can quickly communicate that critical information about collateral to the alternative lenders in a crisis.
“Compared to term loan lenders, banks tend to have greater resources
to monitor the triggers that may impact value,” Chait says. “Early adverse
warnings — such as products being faulty or not selling well — influence cash flows received due to the necessary discounts needed to entice
customers. With Wells Fargo’s expertise and resources, we regularly
leverage our platform to offer covenant light solutions that support corporates, and we also monitor their operations via sales and collections data.
Through our experience, customer relationships and data feeds, we are
able to quickly respond to our customers’ changing circumstances.”
“The reemergence of non-bank ABL and alternative lenders fills a much needed vacancy created through bank acquisitions. Fremont, Finova
and Congress Financial were just three of many lenders that filled a crucial
place in the market for challenged and broken wing companies.”
— Dan Karas, Chief Lending Officer, TBK Bank