With business development companies (BDCs) as a peer group continuing to trade at about 80% of book value, essentially prohibiting their ability to accretively raise equity capital, commercial finance company M&A activity has generally screeched to a halt. BDCs, however, are willing to opportunistically consider commercial finance M&A, and they continue to be an attractive option for growing specialty finance companies as a source of debt capital, particularly junior debt that can be treated as equity capital and levered with cheaper senior debt from traditional lender finance providers such as Wells Fargo and Capital One.

Private equity firms continue to show interest in commercial finance companies, although new investment activity has been slower in 2016 than in 2015. Two interesting transactions include Light Year Capital’s investment in Pathlight Capital, a consumer and retail oriented asset-based lender, and Palladium Equity’s investment in Fora Financial, a tech-enabled small business lender. Private equity buyers do not enjoy the same cost of funds synergy as a bank or even some non-bank finance companies, but they frequently bring other attributes to the table such as operating expertise or relationships with other portfolio companies that could be helpful in a combination. We expect further private equity transactions involving commercial finance in 2016, given the continued abundance of capital pursuing investment opportunities. Private equity buyers generally only get to high valuations in the event of a high growth and high return scenario, however. Otherwise, private equity firms will continue to be prudent in their pricing.

Another interesting trend to keep a keen eye on is that of international buyer interest in U.S. commercial finance firms. Negative interest rates in Japan, for example, could continue to have a positive impact on U.S. M&A deal activity, as evidenced by Hitachi Capital America Corp.’s recent acquisition of Creekridge Capital, a Minnesota-based vendor finance business focused on the healthcare and IT sectors. Both Japanese and European firms have been rumored to be interested in various bank and non-bank firms in recent months.

A final (and perhaps most attention grabbing) sector to keep an eye on in the near and intermediate term is the marketplace/internet lending industry, particularly given the highly publicized recent woes of Lending Club and continued earnings pressure at OnDeck Capital. While questions abound about credit quality and funding, the fact is that not all companies in this sector will survive. Credit quality will worsen and funding will dry up for more players, creating a need to seek strategic alternatives for some companies. Therefore, consolidation is likely coming to this sector, meaning those players with strong funding will be well positioned to pick off competitors and drive greater market share. It is in this sector that we expect increasing activity in the coming months.

Conclusion

The M&A market for commercial finance companies remains active, albeit with a fraction of the pace that you see in other sectors of financial services like banking and fintech. But that is the historical norm. As long as net interest margins remain stressed at banks and capital continues to abound in the non-bank finance company, international and private equity sectors, we expect continued steady M&A for the rest of 2016. Furthermore, a lot of capital flowed into the commercial finance sector via private equity during and after the recession. That was now several years ago and those investors that have been waiting for the right time to exit may get to a point that they want to exit before the market sours, which could also contribute to continued steadiness in commercial finance M&A.

The intervening variables to watch that could further impact deal flow, beyond macroeconomic factors such as growth and volatility, include overall credit quality for commercial finance companies, access to efficient senior financing, and the broader condition of the overall marketplace lending sector. However you look at it, the next year should be an interesting one to watch when it comes to commercial finance M&A.

Note: Statements and opinions expressed herein are solely those of the author and may not coincide with those of Houlihan Lokey.