Perer: Is there enough supply to meet the pent-up finco demand, especially given there are more new entrants?

Beriau: No, and I am seeing lighter covenant packages and looser structure to gain share. It could be argued that since pricing is not the sole factor, some entrants might be filling a previously underbanked portion of the market with higher yielding structures.

Lesch: Yes, there should be, but these groups must quickly realize that clubbing up a deal might be the way to win. Some newer entrants have smaller hold sizes; therefore, holding $30 million+ might be difficult, but if they begin to work together on a $50 million bank workout credit, two groups could easily take it down together. The trick here is finding a group with a similar capital structure and risk culture so that both groups are in lockstep with how to underwrite and manage the credit. The last thing they need is to work with a group that doesn’t share their same vision; nobody wins in that type of arranged marriage.  

Panichi: From what I see from our capital markets team, not at this point for quality of opportunities. For certain profiles, larger structures, you are seeing some price tightening given the competitive landscape and limited supply. In the middle market arena, you see a re-evaluation of risk and reward, with some attempt to differentiate through more aggressive structures, while others would rather deploy capital on tighter margins with less perceived risk.  

Mar: In years past, we have been able to refinance banks very easily. Now, there must be a plan in place and the company does not have the ability to be in bad shape. The pricing is higher for private credit who are looking at more of the credits, although in some cases the private credit firms end up underpricing their risk in an attempt to compete with traditional lenders with lower borrowing costs.

Perer: What are the lasting effects from the regional banking crises?

Panichi: Risk management will continue to focus on liquidity and duration risk as well as face increased regulatory oversight. Further, the proposed capital requirements will undoubtedly impact the cost of borrowing. The regionals are focused on building capital and so will be mindful of the pace of growth, dictated by liquidity and targeted return on equity as they seek to build capital.

Lesch: Again, we certainly hope lenders now understand how precious capital is and that ignoring a problem credit isn’t a winning solution. Taking a loss on a credit due to inaction is a surefire way to sink a bank. Banks have made this shift, and we anticipate their more proactive management style will be here to stay.  

Beriau: In the medium-term regional banks will have an increased focus on deposits and watch list credits in order to manage capital ratios. This may create an opening for fincos to refinance bank customers with heavy utilization, tight liquidity and limited deposits that would have previously remained banked.

Mar: The regional banks will have a challenging time with office real estate in addition to the significant issue of commercial real estate.

Perer: Where are we in this market cycle?  

Panichi: Likely late in the cycle, although we all keep pushing out the chance of a recession each year.  There are certainly mixed performance results and it’s plausible that we may see more of an asymmetrical cycle where some segments continue to soften while others do not. You have monetary tightening at the same time as fiscal stimulus. Infrastructure spending has not really been deployed yet and consumers continue to show some signs of resilience, likely given real wage growth that has occurred recently. We are seeing pockets of consumer discretionary goods struggling, but travel and leisure continues to perform. Volumes are off highs in commodities but stable. Even if we do get a technical recession, I don’t think anyone is seeing a 2008 situation. The banks are healthy, and many businesses do have muscle memory with management teams more adept at reacting more quickly to the environment, though higher rates for longer will eventually take its toll on the economy.

Beriau: Because the U.S. consumer has been resilient it feels like middle innings and if all else remains equal for import expenses and wages, I expect we will see 3 more years of expansion. This timeline would change quickly if increased container rates or tariff uncertainty occurred for the second time in an 8-year period.

Mar: Every time my partners and I attend a panel at a conference on the state of the market, all the panelists have different views. Many banks are doing fine and are trying to get rid of credits that are not performing well. Commercial real estate will be an issue, as discussed earlier. I do believe there will not be a severe recession with no extreme issues with the markets, but one of the features of being a middle-market focused firm is that management teams are weaker and less nimble than at larger companies and therefore less able to handle distress, irrespective of where the market goes. This market cycle will be like what we have already seen: poorly managed companies will have issues and the well managed companies will be fine.

Lesch: In a tight labor market coupled with higher interest rates, we continue to see pockets where businesses struggle. So, while we expect the M&A markets will continue the momentum from Q4, we still see a fair amount of activity in the distressed market. Overall, 2024 will be a very active year across M&A, Special Situations, and Debt Advisory.  

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

Mar: The market drivers for distressed companies are a plethora of deals done in the last five years that were initially leveraged with a TEV multiple of more than 10x or 12x. These deals are coming into workouts now because there is no more money left in the private equity firms’ funds that invested in the deal and the company has not grown into the capital structure, thus becoming distressed. We have seen many of these deals in 2023 and expect to continue seeing more of them in 2024.

Beriau: Given that the finco market is mainly driven by the transfer of credits from banks, EBC focuses on how our product can differentiate itself from the regulated market so that we can improve the customers experience in the initial refinancing and keep successful clients for years after.

Panichi: Portfolio management definitely is a focus with consideration as to the cycle of a particular segment and our existing exposure. However, not much trumps good management teams and a company with strong reporting capabilities, which assists in visibility and decisioning. We are a relationship bank focused on businesses that have a reason to exist and a vision for continuity.

Lesch: Our Debt Advisory and Special Situations practices are industry agnostic, so we don’t track market drivers like oil rig counts or auto builds as indicators. However, the higher interest rate environment coupled with the tight labor supply certainly has increased activity for both of our practice groups.  

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

Panichi: Seems like it’s everywhere in the current environment. Last year, anecdotally, a large portion of the banking sector backed away from aggressive pricing and structures to win a deal, likely given the aftermath of bank failures and focus on capital and liquidity. Given a need to re-deploy funds, this may not be the same in 2024. Non-banks are increasingly playing a larger role in secured financial transactions. However, as they continue to grow, we are also seeing increased attention from regulators and concerns over systemic risk.

Beriau: Non-banks. As more of our peers recapitalize there is more pressure to grow and credit structure follows. Almost all of the finco lenders have been started or purchased by hedge funds/private equity and they have expectations.

Lesch: We are seeing commercial banks pull back a bit in the ABL space.  This has allowed the non-bank ABL players to step in and fill the void. I think credit quality at non-bank ABL portfolios has improved in this environment, as they do not have to stretch as far now that banks are more disciplined.  

Mar: Although as financial advisors we do not compete with banks or non-banks, private lenders have made most of the loans to middle-market private equity. From a turnaround perspective, we are seeing a significant increase in deal flow from that sector as opposed to the regulated sector, although the regulated sector continues to dominate.

Perer: How busy is the turnaround consulting industry given it’s a leading indicator or future ABL deal flow?

Mar: Currently, our industry is very busy, and our firm is no exception. It is a leading indicator of more ABL deal flow or more deal flow to the private-credit firms. Our firm is currently at over 50 professionals, most of us are fully utilized, our engagements deal with more complex financial and operational issues as well as larger bank groups, and we continue to hire this year in anticipation of these trends continuing.

Beriau: It certainly seems like most consultants are quite busy. Telling signs include the 21 percent increase in commercial bankruptcy filings year over year during January and Fitch Ratings’ notification in February that Large Middle Market issuers within Fitch’s leveraged loan universe reached 5.5 percent for 2023, the highest rate within Fitch’s data going back to 2007.

Panichi: The industry saw an uptick in criticized loans in 2023, but portfolios are coming from a position of strong credit quality in general. Consultants have gotten busier as well, but in pockets. For example, the healthcare segment and inventory issues were two themes from the aftermath of Covid. Overall, though, the speed of doing business seems to be separating good management teams from those who are less prepared. Consultants are out pitching operational improvement, not just crisis management. An ABL structure can offer flexibility in turnaround situations, but we would look to the root cause and if that has been rectified and ability to develop a long-term relationship.

Lesch: We currently have the same turnaround group on two deals we are working on, if that is any indication. This goes back to banks more actively managing distressed credits and mandating a turnaround consultant to be on the ground to help protect the bank’s position.  

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

Panichi: We have seen some impact from higher for longer on those businesses that have both high financial and operational leverage as debt service consumes more free cash flow. This has been more impactful on businesses that are still finding a new equilibrium of sales to inventory levels. Rates have also impacted deal flow. M&A and dividend recapitalizations have been good drivers of business, both of which were dramatically down in 2023.

Mar: It is significant because most companies are accustomed to interest rates in the 2 to3 percent range. Now, it is in the 8to 9 percent range, which means a higher percentage of their free cash flow goes toward paying interest as opposed to investing in improvements to the company. Given the higher interest rate, if a company maintains the same level of EBITDA, that will be problematic.

Beriau: Higher interest rates will likely lead to further opportunities across the middle market as bank covenants will be harder to maintain during periods of business transformation. On the other side of that coin is increased competition as private credit groups search for yield while needing to put funds to work.

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

Beriau: This may not be a narrow belief, but I believe that we will not see another CIT/GE sized finco until a group can solve the capital and waterfall issues caused by offering a true one stop unitranche solution, while using bank leverage. Maybe loss pools can fill a gap, but there aren’t enough bank lender finance groups out there to support a $5+ billion portfolio.

Lesch: The banks have finally pulled back. Due to competition, commercial banks had historically been very aggressive in winning new mandates. This led to various accommodations, lending on foreign collateral, stretch pieces, and over advances, to name a few. Banks have pulled back from that type of lending and are instead using more of ABL 101 approach to structuring deals. The bank consolidation certainly played a role in changing the lending environment. Still, the other driver of the bank’s conservatism was the banking crisis. But while structures are tighter, it’s still a competitive environment; therefore, on stronger credits that fit nicely within an ABL box, commercial banks compete with price, and strong borrowers get deals done below a S+ 1.75 adder..  

Mar: The role that ABL working capital lenders is to be the canary in the coal mine for highly leveraged deals with large term debt. I believe lenders have a role in managing the key indicators in a loan for the entire capital structure. ABL lenders tend to understand the business and collateral better than other banks in the capital structure.

Panichi: I can’t say that I have a perception that may be outside of the consensus today.  However, I believe the field will change over the next decade with the advent of technology and expansion of non-bank business models that focus on secured debt market. Think of some of the non-bank platforms that exist today and have expanded vertical and horizontal services provided – appraisals, investing, liquidating. Software will be a catalyzer for transactional tying, and by that I am referring to the life of an asset. Understanding asset values in real-time has vastly improved as buyers and sellers globally are better matched today than a decade ago and the use of blockchain will only increase the speed and accuracy of certain transactions and reduce costs in the process. As markets become more efficient, it reduces the element of arbitrage. This will be interesting as to how it plays out and with whom.