The Day After Tomorrow is a 2004 Sci-fi film starring Dennis Quaid and Jake Gyllenhaal. The movie depicts a series of extreme weather events that lead to the majority of the earth being covered by ice except for a small portion. To connect this to the world of commercial finance, a series of events or in this case acquisitions, have led to the market being covered with larger bank and non-bank ABL firms focused on scale. The clear end-result of the series of events in commercial finance is consolidation in both the bank and non-bank ABL world. This has of course led to fewer, but much larger firms covering the majority of the market resulting in $20 to $30 million facilities becoming the new $10 million facility. The aforementioned trends are creating opportunities for firms that can now serve companies that are still substantial but need a smaller facility from a sophisticated lender. While there are definitely firms out there that still provide smaller facilities, it’s not like it was before the consolidation wave that took place over the past decade. Meaning, there is significant competition in big-ticket and small-ticket, but less so for medium-ticket facilities that still require sophistication.

Ten years ago, bank and non-banks ABLs such as First Merit, Marquette Business Credit and First Capital, among others, were entrenched as leaders of the lower middle market ABL defined as facility sizes $20 million or less. Let’s walk through the series of events that led to each firm getting bigger. In a matter of a few years, the First Merit team went from running First Merit’s ABL group to now running Huntington National Bank ’s ABL group that encompasses acquisitions of First Merit, TCF and Chemical. The end result of these acquisitions is now a bank-ABL group with scale, national reach and the ability to compete against the nation’s largest banks. Marquette was acquired by UMB and First Capital and Keltic were acquired by Ares. These firms are all now multi-billion dollar ABL groups. Regional bank-ABLs wanted the ability to compete nationally and compete against the nation’s biggest banks and BDCs wanted the ability to go upmarket and build bigger platforms. Staying small and serving the smaller end of the market would not let them accomplish this goal. These trends are undeniable when you look at the purchase prices paid, significant increases in deal sizes and the ultimate desire for banks and non-banks to go upmarket.

There are many other examples of consolidation creating scale as it’s tough to grow when serving smaller customers. This trend also clearly affected both banks and non-banks in the exact same way. Just look at the recent bank consolidation that rivals non-bank consolidation: Truist (SunTrust and BB&T), Fifth Third Bank and MB Financial, Columbia and Umpqua, People’s and M&T, CIT and First Citizens and the list goes on. Match this with an equally long list of non-bank ABL acquisitions that have created much larger organizations in the race for scale. The challenge with properly serving the lower end of the market is that it requires the same level of sophistication as $100 million ABL facilities. The same team that can originate, underwrite and manage a $10 million facility is just as capable of managing a $50 or $100 million facility. The preference of many firms is to focus on scale, as there is now more sophistication in the market, lower risk-premiums and more risk involved.

Contrast this to the truly small-ticket folks who are typically AR-only lenders that might even employ a factoring like structure marketed as ABL to protect themselves from potential bankruptcy risk. There is a confluence of “factoring-ish” firms in the small-ticket area, but this solution often does not work for businesses that have become underserved by larger firms. This helps to explain why there are many small-ticket side AR-only firms and many large-ticket firms, but fewer true ABL firms serving the lower middle-market. To effectively serve the lower middle market with a traditional ABL product you need the capital, the team, and the credit know-how to do deal with
Most cycles tend to be the same with firms that start out small end up migrating upmarket as they scale or get acquired. This happened en masse in the ABL world and created clusters of competition in both big-ticket and small ticket, but in turn created opportunities. Expect to see this void filled by new firms with entrepreneurial approaches to market. Large-ticket ABL has taken on a life of its own with product changes and sponsors calling, but serving lower middle-market entrepreneurs hasn’t changed. The companies might have less liquidity but are also less complex and desire a lender happy serving smaller credits. This void won’t last long.

The end of the movie starts with a satellite image of earth, which shows the earth’s transformed surface now with ice sheets extending across most of the Northern Hemisphere. We have now lived through a ten-year run of a series of consolidating acquisitions that has covered the market with many large firms. If one took a satellite image of the industry from above, they would see much of the industry covered with larger firms focused on scale and fewer sophisticated firms focused on the lower middle market. The shift to scale is going to create new opportunities in the market for sophisticated firms capable of serving the lower middle market. The Day After Tomorrow is upon us – take your jacket off as there is going to be another land grab as the ice thaws.