Over the past year, there has been a tremendous amount of press regarding the difficulties faced by lenders and factors financing the energy sector. As a result, many lenders have pulled away or reduced their portfolios either deliberately or as a direct result of portfolio compression, through decreasing volumes of their clients, business failures, losses and bankruptcy.
Sallyport Commercial Finance, LLC (SCF) was established in July 2014. Backed by energy industry experts and run by factoring and ABL industry experts, SCF was set up to be an energy-forward factor and asset-based lender. Established in Houston, SCF was well placed to target the energy sector, and anticipated exponential growth … who knew the energy sector was about to implode?
The first wave of the downturn in late 2014/2015 saw oilfield service volume decline as rig counts reduced. The second wave in Q1 and Q2 of 2016 saw several small and mid-tier Exploration & Production (E&P) companies file Chapter 11. The third wave is happening now, where companies are losing funding lines from banks due to regulation and sector withdrawal and private equity investors who will not or cannot bankroll the losses any longer due to portfolio pressure.
As a result, energy-focused factors and asset-based lending portfolios have shrunk, revenue and income are down, and bad debts are increasing in this sector.
SCF was seeing energy deals in 2015, but they were very distressed, highly leveraged, with big equipment finance requirements, where the equipment was worth about 30% of cost. We were taking an aggressive marketing stance and a cautious underwriting stance. We were open for business, however we didn’t want to “catch a falling knife” as banks and competitors were offloading or turning down energy deals. Fortunately, our investors have a wealth of knowledge and contacts, and were able to share insights and information that would not ordinarily be available to a lender. As a result, we have access to rig counts, and increasing and decreasing activity in specific areas, as well as E&P comps, helpful in valuing the oil and gas companies. We also have access to high level contacts in many of the energy companies, whom were able to provide references on the service companies we were looking to fund, or direct access to CFOs who would give us the inside track on their own financial performance, to assist with funding decisions.
Having been in the industry collectively for almost 50 years, the senior management team has seen a number of recessions and depressions both in the UK and the U.S. We arrived in the U.S. mid-2008, so we seem to have a knack at awful timing. When the timing of the energy downturn threatened our entire reason for being, we were able to use our experience, react swiftly, diversify the portfolio and continue our steep growth curve despite the sector issues. At the end of 2014, 36 percent of our loan portfolio was energy related. By mid-2015, this had grown to 43 percent with funds employed in the energy sector having grown by 481 percent. Diversification is the key to not being too affected by a specific sector downturn and currently we have less than 30 percent of our portfolio in energy related companies, with funds employed to the sector continuing to grow.
Additionally, we were fortunate not to have a “legacy portfolio” of energy related companies, like many of our competitors. We were not affected by reducing volumes in the sector, or failing businesses as we were still in growth mode and were able to be selective. Also, we were able to diversify into other sectors due to the difficulties in doing energy deals, thus spreading the risk and continuing to grow.
Opportunities in the sector are changing and include areas that can recover quickly, like fracking and technology-driven areas. Efficiency is key, as there has been much consolidation and cost cutting, and using technology and new methods is attractive in the energy sector moving forward. There is risk however, as whilst there is opportunity for businesses to try new things, there is a downside if the new methods fail.
From a borrower’s perspective, what was a price driven commodity in the good times, is now more about having the confidence that a lender will continue to lend in the current environment. Banks are increasingly pulling out; therefore, availability of funding and risk appetite are the key considerations for borrowers.
Having a private equity group company behind it, Sallyport is able to step outside of the normal factoring and ABL criteria, where appropriate. We are also able to provide other private equity sponsors the confidence that they have a lender who understands the challenges and opportunities in the sector. Having investors with access to contacts that may be able to facilitate the sale of a business, equipment or an equity investment, allows us to be a little more aggressive in structuring and underwriting deals with a clear exit strategy in mind if required.
The unique collaboration of energy expert investors, the depth of experience in the management team, and what turned out to be perfect timing, has differentiated SCF from other lenders.