Perer: Who is poised to take more share between bank and non-bank ABL and why?

Barredo: We believe those who are best-positioned have big balance sheets to refinance and hold the SNCs, as well as those who aren’t afraid of taking a chance on a riskier credit with less than 12 months of runway. I remember how during the Great Recession GE Capital took down large holds AND leaned in hard to the retail restructurings with no real fear of liquidating some of the largest retailers at the time. That strategy served them well. I think we will see this again; the question is a matter of who takes those risks.

Seigel: In the market Crown tracks, which is $20 to $200 million ABL transactions, we believe the bank share of the market is 80 percent. Then, there are 40 non-bank ABL platforms that are battling for 20 percent of the pie. Banks will always dominate the market based on inherent pricing advantages, with non-banks continuing to grow their share modestly. Banks are not going to lean into turnarounds, low opening availability, or situations where speed is paramount, and in aggregate I’d expect that share of the market to grow.

Winget: I believe the answer will depend on the depth of a potential future downturn/recession. Bank ABL portfolios are generally of good quality. Pricing will dictate whether non-bank ABLs can compete and/or participate in Bank ABL financings.

Fagnani: Most bank-owned ABL shops appear, with a few exceptions, to be more risk averse. There was a time when the industry sought to finance turnaround situations and even bankruptcies.  I do not see the banks actively participating in these activities at this time and believe they have ceded this part of the market to non-bank ABL shops and alternative lenders. So, if the economy actually does falter, I think we will see non-bank ABL shops take market share as banks seek to exit deals and companies seek refinancing. Non-bank ABL shops, in general, are also nimbler and faster to make decisions with fewer layers to navigate. Again, this helps borrowers that need speed and closer access to decision makers. That said, banks will always be able to offer the lowest rates and all the ancillary bank services which are so vital to every business. In addition, only the larger banks can underwrite and syndicate a very large transaction. In that sense the market is bifurcated. The large deal market will always rely primarily on banks to get the deals done while the non-bank ABL shops can effectively compete in the middle market and lower middle market. We should note that there is a newer breed of alternative lenders, the private credit funds, that have entered the ABL space and I believe they are poised to take market share from the banks on very large syndicated deals. They are far more costly, particularly now, but appear to be much more risk tolerant and generally faster to get to a closing.

Perer: What are the primary market drivers your team focuses on the most?

Seigel: We extensively track the lenders within the ABL market. For bank ABL, we track and have now released publicly our summary of the 50 most active bank ABL lenders. Within nonbank, we track 40 finance companies that have announced $20-plus million ABL transactions, also publicly released. We track these companies by deal announcements, deal size, and for those who fund public companies, we track the asset eligibility definitions and financial covenants contained in credit agreements pulled from SEC filings. In our quest to bring transparency to the ABL market, we are in the process of finding compelling ways to share this research publicly.

Winget: HBC remains focused on growth as we have hired talented and experienced ABL people in new offices and markets in 2023 in the Southeast, Midwest and West. We have also focused on growth within our ABL retail and metals verticals.

Fagnani: Many of our referrals come from lenders, lawyers or sponsors. We work with both healthy companies and companies in distress. We tend to focus on industries showing specific weaknesses (as it impacts overall performance) as well as macro events such as interest rates (inability to service debt or margin erosion), supply chain issues (as it relates specifically to inventory and delivery issues), shifting consumer buying habits (bricks and mortar versus e-commerce) and technology (those companies that harness data and how to effectively use it to win most of the time). We try to shift our focus as industry and macro events evolve.

Perer: Have you changed your strategy in reaction to where the market is today and where you think it is heading?

Winget: At HBC we have not changed our growth strategy. The challenges of the current banking market have actually provided us with better candidates to grow geographically and within the verticals.

Barredo: I am spending a lot more time looking at in-court and out-of-court restructurings. Businesses are over levered right now, but we are seeing attractive opportunities to work with companies in the early stages of turnaround efforts to optimize their balance sheets with fresh liquidity. We’ve been leaning in on these opportunities by putting them on ABL-lite or asset coverage covenant structure instead of traditional borrowing bases and charging a higher yield for that accommodation. This allows them to feel more like cash flow revolvers that these companies are used to but still allow some of the structure and appraisal discipline of an ABL.

Fagnani: We have always tried to go where the deals are and that means getting to know all the lenders in the marketplace including new entrants. We have also sought to bolster our talent in those areas where we see weakness so that we are prepared to take on any assignment regardless of industry. We merged with a very large accounting firm, PKF O’Connor Davies, about a year and a half ago. They provide us with additional industry expertise and bench strength. We think this will provide a long-term advantage.

Seigel: We honed our focus heading into 2023 exclusively on the market for $20 to 200 million asset-based loans. We did so because we believe we have a strong value proposition in this niche, and decided we would be most successful and happiest focusing on what we know best when trying to compete with the many well regarded investment banking firms that are much larger than us.

Perer: Do you face more competition from banks or non-banks?

Barredo: It is still a mix of both depending on the type of deal. One major difference I’m noticing this year is that a lot of deals just aren’t transacting. Seller price expectations remaining high have put lots of processes on hold. Incumbent commercial banks aren’t getting refinanced out and are not interested in liquidating right now so we are seeing them kick the can until Q4 with maturity dates getting extended. The stasis across the market right now doesn’t seem sustainable.

Seigel: One of the best decisions my partner Evan Nadler and I ever made was to launch a capital markets business that serves both banks and non-banks rather than competing with them. Our capital markets business has been 60 percent non-bank execution, and 40 percent bank. We try to appeal to both groups by being a source of market knowledge, presenting them with all of the information they will need in order to make an informed credit decision, and not wasting their time on deals they aren’t going to win.

Winget: HBC competes primarily with bank ABL groups. Non-bank competition remains primarily cash flow and structured finance credit facilities for the purpose of acquisition financing. Bank ABL continues to have a pricing advantage over non-bank.

Fagnani: Not relevant to PKF Clear Thinking.

Perer: How is the turnaround consulting industry evolving?

Fagnani: Fundamentally, what we do has not changed. Business and situation assessment, development of strategic options (which may include a debt restructure in or out of bankruptcy), development of budgets and supporting data, implementation, review and re-calibration, A/P and inventory management, etc., remain the backbones. However, we have seen some consolidation (much like our aforementioned merger) and we have seen the larger firms get very large and branch out into a whole host of specialized areas. I will say that turnaround firms are built to help fix companies, to improve performance, but all too often we are brought into situations very late – the borrower is in crisis, liquidity is completely gone, the lender is out of patience and that leaves very few options. In these cases, there is less “turning around” and more liquidation of assets.  I am not sure I would say this is how the industry is evolving, but it’s a current phenomenon that is not necessarily for the best.

Seigel: My perspective, based on my friends in the industry, is that turnaround firms have been staffing up in anticipation of being increasingly busy on restructurings and cash flow improvement mandates. We work closely with several of these firms where there is a mutual appreciation of each other’s value-add.

Winget: HBC is a proponent and utilizes turnaround consultants with our portfolio customers. Our valued turnaround consultants remain a critical partnership to HBC’s success.

Perer: How does the prospect of a multi-year, higher interest rate environment affect your business?

Winget: A higher interest rate environment increases risk within leveraged borrowers, especially with thinner margins. A multi-year higher interest rate environment should benefit ABL as companies seek a more flexible financing structure and look for alternatives to a traditional cash flow, or MM, financing structure.

Barredo: I think this is generally viewed as a good thing for non-bank lenders. The main issue is that debt service may be unsustainable for some of these businesses if interest rates remain higher for longer. Middle market companies are dealing with the adverse impacts of wage inflation, rising input costs, and discounting/margin pressures all on top of elevated interest rates. This is part of the reason low amortization and PIK toggle options are becoming popular as they are giving companies flexibility to manage through the interest rate environment.

Seigel: The increased costs are obviously challenging for our clients as debt service coverage, and total leverage multiples have been the primary constraints in transactions we have arranged.

Fagnani: In theory that bodes really well for our business as high interest rates materially impact a marginal company’s ability to service debt or survive. However, I do not believe we will remain in a high interest rate environment for a sustained period. As/when the Fed objectives are met I think we will see rates decline.

Perer: What is a perception you have about today’s ABL market that is not widely shared?

Barredo: I think there are a lot of unrealized losses in both bank and non-bank ABL portfolios right now. It will be interesting to see how that will unwind but as a non-bank, we have more tools in our arsenal to manage through those situations.

Seigel: The ABL credit approval process in general is overly sequential and compares poorly to corporate cash flow-based financings. The reality is that in virtually all middle market ABL closings, there is a credit committee that contains one or more decision makers whose backgrounds are not in ABL, and this creates friction to the process at a time of uncertainty. I am not sure this is the hill that I should try to die on, but my number one advice to asset managers and bank executive teams that back ABL platforms is to stay off credit committee and let the ABL credit professionals approve the ABL transactions!

Winget: The current Banking market and focus on capital should have a positive impact on overall ABL market demand. ABL enjoys a favorable LGD history that benefits pricing and ROE models. This may create opportunities and a market that is more like decades past.

Fagnani: I’m not sure whether this is widely shared or not, but Dan Fiorillo and I co-authored an article highlighting the fact that many of today’s younger professionals entered and grew up in the industry during a long period of excellent portfolio performance and few challenges and as a result may lack the requisite experience if/when their portfolios take a real turn for the worse. Training is important and can help, but there is nothing like hands-on experience and there just have not been many opportunities for people to hone their workout skills. Another perception I have is that for many organizations, what they call ABL today is a watered-down version of the original. Taking a lien, getting a once-a-month BBC and doing one field exam a year may be fine for near-investment grade borrowers with lots of liquidity and a low fraud profile, but may not be appropriate for more mainstream borrowers. It is called “asset based” for a reason and detailed attention to the specific assets involved will serve lenders much better if we do experience a sustained downturn.

The author appreciates feedback and he can be reached at charlie@sgcreditpartners.com.