The commercial specialty finance market (broadly defined to include asset-based lending (ABL), receivables factoring and equipment finance companies) has never been defined by extensive M&A transaction volume. Even in the most active of years, such as 2021 and 2022, the commercial finance market witnessed an average of approximately 20 closed M&A transactions per year. That being said, 2023 qualified as downright slow, with less than 10 independent commercial finance companies having sold (data provided by S&P Global Market Intelligence).
The reasons for the slower activity have been discussed at length with rising and uncertain interest rates, economic queasiness, credit quality concerns, and lack of bank interest as the most notable. Thus far, 2024 doesn’t look to be much more active. So, what does the rest of the year portend? Before looking forward, it’s worth discussing a few notable bright spots from the last year or so that may help to identify trends for the future.
What deals did close in 2023?
While slower overall, especially in the equipment finance sector, 2023 did result in a handful of intriguing sale transactions involving well-known companies in the asset-based lending and receivables factoring sectors at top valuations that seemingly ran counter to the lack of closed deal activity. The year started with Renasant Bank of Mississippi acquiring New Orleans-based Republic Business Credit. Later in the year, Paychex, the payroll industry leader, announced the acquisition of Alterna Capital Solutions of Orlando. And at the end of the year, Power Funding of Houston was acquired by family office Fourshore Partners, based in Miami.
Each of these transactions involved a buyer-specific strategy for entering the receivables finance space that paid off, quite literally, for the respective sellers. For example, Renasant was interested in augmenting its previous acquisition of ABL company Southeastern Commercial Finance, with the deep, broad team and platform of Republic. Likewise, Paychex was eager to add a generalist factoring platform to complement its staffing company-focused payroll finance provider, Advance Partners. Lastly, the factoring products offered by Power Funding complement the asset-based loans offered by fellow Fourshore portfolio company, Celtic Capital.
In other words, if you know where to look in today’s buyer universe, a worthwhile exit can still be found for owners of commercial finance companies. Each buyer noted above was looking for a specific target for very specific strategic reasons and as a result, offered fair economics to get the transaction closed. But these transactions may prove to be the exception to the new normal.
Who are the sellers in 2024?
In addition to the factors previously mentioned, another reason for the recent drop off in M&A activity in commercial finance is the dichotomy of valuation expectations between buyers and sellers. Despite interest rate pressure and economic uncertainty, credit quality has only recently started to deteriorate across the commercial finance sector. For many ABL companies, factors and leasing companies, defaults are up, but actual credit losses have not yet spiked. Therefore, the M&A market has not seen an uptick in distressed sellers – yet.
Many finance companies have admirably weathered the robust rise in interest rates, passing through much of the higher cost of capital to borrowers. However, others have experienced significantly shrinking margins due to a mismatch of fixed rate loans being funded by variable rate liabilities. What if credit quality deteriorates and losses begin to eat through those skinny margins? It would stand to reason that the lender finance banks, who already are working within a tightening credit box, would start to feel uneasy. In cycles past, this dynamic has led to financially stressed companies becoming sellers to satisfy their creditors and other stakeholders, be it subordinated debt lenders or equity owners.
Transportation factoring is one such industry to monitor closely. With a down freight market and generally no ability to pass higher interest costs through to borrowers due to the industry standard flat fee structure, many trucking factors’ margins have compressed. And while trucking volumes grew in February, only the fourth month of volume growth since early 2022, spot rates remain low due to lingering fleet overcapacity (ACT Research). The good news is that the market will turn, and many freight factors had plenty of margin to begin with so they could afford some compression. But if credit quality worsens, financial stress could intensify, leading to prospective company or asset sales.
Additionally, healthy companies that have waited patiently for the M&A market to turn may run out of patience as investors’ capital grows long in the tooth or impending debt maturities foreshadow a change to cost of capital or even availability of capital. Even finance companies with adequate capital and no funding concerns may be tempted to test the market to see if a strategic buyer will pay an attractive price, just like in the Republic, Alterna and Power deals mentioned earlier. These strategies could contribute to more sellers coming out of the woodwork as the year progresses.
Lastly, commercial banks, that very recently were a leading buyer of finance companies as they focused on deploying pandemic-era excess deposits, are currently more likely to divest of commercial finance businesses than to acquire one. Liquidity remains of utmost importance after last year’s bank failures and continuing stress in commercial real estate. As a result, the vast majority of banks are much more focused on acquiring deposit-rich banking franchises versus supplementing origination capability. Banks that struggle to improve liquidity may opt to take a different approach by selling off assets as a way to generate funds. When this happens, specialty finance business lines are often the first to be jettisoned.
Who are the buyers in the current M&A market?
As challenging as it may be to operate in the banking sector today, the broader asset management sector – defined as private equity firms, credit funds, business development companies and family offices – is sitting on unprecedented levels of dry powder to invest. With banks continuing to tighten credit, expect these funds to work to fill the funding gap for commercial borrowers. The substantial capital raised by asset managers that specifically operate in direct lending is likely to continue to spill over to the collateralized lending world, resulting in M&A announcements such as Ares Management acquiring the business of BciCapital from City National Bank of Florida in March 2024. Furthermore, many asset managers have joined forces with insurance companies to create even greater funding capacity. These buyers are just as interested in funding loan assets as they are in buying platforms, as evidenced by KeyBank’s recently announced forward flow program with Blackstone Credit & Insurance.
Larger, well-capitalized finance companies also stand to take advantage of opportunities in the current market. Many institutional equity-backed lenders continue to enjoy support from their senior lenders and stand ready to entertain M&A as a way to build market share, expand product offerings or geographic reach, and add experienced talent. With banks a lesser player in today’s commercial finance M&A market, these non-bank buyers can aggressively pursue opportunities knowing that it’s unlikely that a bank will come in and outbid them.
Despite funding challenges, the banking sector is unlikely to sit out of the commercial finance M&A market completely in 2024. Several banks do in fact have healthy liquidity positions and a desire to improve fee income and net interest margins, which are now almost back to all-time lows. A well-run asset-based lender, factor or equipment lender offers an opportunity for a bank owner to take advantage of its lower cost of funds, even in this high-rate environment, to drive substantial earnings accretion upon acquisition.
Expectations for the remainder of 2024
While the broader M&A market awaits a drop in interest rates to reinvigorate the sleepy deal environment, a slight drop in rates is unlikely to have a dramatic impact on commercial finance M&A activity. Credit quality unknowns, reluctant bank buyers and even some presidential election uncertainty should combine to keep deal flow at a measured pace. However, we do predict an increase in closed deal activity as the year progresses, particularly in the latter part of the year. It is not unreasonable to expect an uptick in distressed, or at least stressed sellers seeking to exit as the weight of third-party debt, impatient investors and/or rising credit losses impacts seller attitudes. Non-bank buyers with access to capital are well positioned to take advantage of these situations, particularly those who have a platform on which to add incremental borrowers and employees.
Plus, some sellers who have been sitting on the sideline are likely to test the market to see if they can find a buyer willing to pay an attractive price. Other sellers will adjust their valuation expectations in order to consummate a transaction in the near term as opposed to continuing to wait over an undefined period for a true sellers’ market to return. We don’t see an imminent return to the above average activity of 2021 and 2022, but it’s hard to imagine 2024 turning out to be as slow as 2023.
