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The Void in ABL … What Ever Happened to the Stalwarts?

Date: Sep 11, 2013 @ 07:00 AM
Filed Under: Industry Trends

What ever happened to the stalwarts of the ABL business, the likes of Congress, LaSalle, Foothill, Heller, Sanwa and Commercial Credit, just to name a few? What did they all have in common? They were all ABL’s that made their names doing collateral intensive deals and getting paid for taking risk. They also were innovative shops with a deep talent pool that focused and, more importantly, relied on collateral to potentially get repaid.

Granted getting paid has a little different meaning in today’s post-Great Recession market. That seminal economic event had a major impact on riskier companies’ ability to borrow at yields just a step above bank ABL credits. It widened the void already in the ABL market where bank ABLs and non-bank commercial finance companies are shying away. The void has largely been filled by private capital, much of which shifted from investment in private equity transactions moving up the right side of the balance sheet and finding attractive secured risk-adjusted returns. Such are the capital markets.

There are a number of obvious reasons for the void: changing risk/return profile, bank consolidation, bank acquisitions of non-bank ABL’s, shifting cost of capital, human capital, prolonged bull markets, investor expectations, competing investment choices, market liquidity – and certainly regulation has played a large role in both the rise and fall of the iconic ABL firms of the past.

The rise of the ABL’s of the 1980’s and 1990’s coincided with the success of Heller, GE, Commercial Credit, Sanwa and CIT, among others. I throw these names around because they were of my era. Many of these firms were led by ABL veterans that had cut their teeth at these and predecessor ABL firms.

I began my career at Fremont Financial as a field examiner. My first assignment was to open mail looking for accounts receivable checks at an unfortunate borrower in liquidation. I say to this day that the experience I gained from working as a field examiner formed the basis of my understanding of ABL and commercial lending as a whole. I learned the nooks and crannies of collateral ... the fundamental basis of ABL. Sure we cared about cash flow and viability, but ultimately, if cash flow failed, the ABL got its principal back through the collateral. I might also add that, at Fremont, the firm was not afraid to lend into what it felt may soon be a liquidation. I guess this is what you call a lender of last resort. What’s a company to do otherwise?

That’s the problem for many companies today. Back in the day, Congress would fund into a troubled credit at P+400 bps, underwriting to its ability to ultimately recoup through liquidation of the collateral, if liquidity depleted over a two to three year period of time. The borrower got a chance to live to see another day, to turn the business around, and to eventually refinance back into a lower-priced deal. The lender received a fair return for taking the risk that things didn’t turn around and there was a loss of principal.

Marian Kammerer, who introduced me to collateral examination at Fremont in 1988 on that liquidation in Dayton, Ohio, and who now works as a senior underwriting executive at FirstMerit Bank Business Credit, has this to say, “You can’t do hard collateral deals unless you are willing to liquidate, or if you are afraid of a bankruptcy filing.” Mike Sharkey, head of asset-based lending at Cole Taylor Business Capital, and who was the senior credit executive at LaSalle Business Credit, refers to the ABL of old “bare knuckle ABL.” Sharkey was an integral part of this widely successful bank ABL subsidiary that was acquired by Bank of America in 2007.

The fact is, in those days, ABL lenders, in addition to seeking out growth and higher return, took more risk and possessed the ABL talent pool, the credit discipline and the deep knowledge of and access to their collateral. Sharkey also points out that, “revised bankruptcy laws and subsequent changes over the years have made it more difficult to get your hands on the collateral.”

That’s not to say that today’s ABL’s don’t have talent and discipline. There are just not enough of them offering pricing in the mid to high single digits on substandard credits with exposure in the $10 million to $75 million range.

What about substandard credits and how regulation post Great Recession is impacting the business? First, let me frame substandard as a troubled credit requiring tight monitoring on the relationship line, or even one that is in the workout department. The fact is that bank ABL’s have a very difficult time booking substandard credits simply because of the capital required, as well as more stringent regulatory oversight these days. Even as aggressive as we find the debt markets today, particularly ABL, banks have enough pressure just to meet stress tests. Therefore, I don’t see any movement from them into substandard any time soon.

Where the ABL firms of the past would underwrite credits at pricing a step above bank pricing, these credits now face a market with very few lenders at that pricing, particularly above the $10 million commitment level. Many of these credits find themselves with higher-priced choices offered by credit opportunity funds. Higher pricing aside, these capital providers have stepped in to fill the void and provide an important capital source for middle market companies, particularly through the depths of the Great Recession.

I’ve been watching the market closely over the last decade, waiting for the next wave of commercial finance companies to enter the market. For the banks, regulation is making it impossible to get more creative, take more risk and fill the void. It’s going in the wrong direction ... that's clear. They’re constrained. Core Business Credit merged with Newstar and is taking risk. AloStar’s ABL unit, led by ABL industry veteran, John Rosin, is doing tough ABL deals at decent pricing. Marquette Business Credit has reemerged. Tygris attempted to launch in 2008, but the Great Recession thwarted that effort.

Cost of capital plays a big role in the void. I would contend, however, that taking other factors into account, particularly tightened regulation, investor yield expectations have changed. This drives pricing up for tougher credits in the middle market. For privately funded ABL’s, availability of cheap equity capital and debt financing is thin. Debt lines for these private lenders also come with more restrictions, again due to tighter regulation.

What’s ahead? More of the same, I suspect. Consider the current ABL market. Mark Looft, group senior vice president and regional executive for the Western U.S. at Cole Taylor Business Capital, observes, “Competition is frothy once again. Some lenders are reducing their pricing to 2007/2008 levels and even doing no-covenant deals again.”

Where does this put us in the cycle? Does it point to a peak? Many analysts say stocks are overvalued. With the Dow hitting record highs, they may be on to something. Whatever the cycle, tougher ABL credits in the middle market will continue to face higher pricing with few choices available. Higher yielding private capital will continue to take the lead on those credits. They serve a critical role, providing a bridge through a company’s turnaround and return to lower pricing.

Many of the ABL folks that I reached out to for input to this article are people that I’ve worked with over the years, or that I’ve observed and respected professionally. They pointed out as an aside that the heady days of ABL back then were different. Mary McGuire, who came up in the business through Congress, Barclay’s and Manufacturers Hanover, puts it like this, “The olds days of ABL were so much fun. The market knew the personalities of the various non-bank ABL shops and lenders were able to bring their signature approach to deals.”

Ah, the old days. Let’s all meet for a drink at Lloyds and … oh, that’s right. It’s not there anymore.

Christopher Gentry
Managing Director & Partner | Monroe Credit Advisors, LLC
Christopher Gentry is a founding partner and managing director of Monroe Credit Advisors. He has 25 years of commercial and investment banking experience. Gentry is responsible for originating and executing client engagements. Prior to co-founding Monroe Credit Advisors, he was a director at Concord Financial Advisors where he focused on private placements and buy-side mergers and acquisitions. In 2000 he founded and ran Capricorn Technology Partners Inc., a financial advisory firm focused on high technology private placements of equity. From 1998 to 2000, Gentry was a vice president and business development officer for BankBoston and Fleet Capital where he focused on syndicated senior secured and high-yield bond financings. He also held positions at Mellon Business Credit, Sanwa Business Credit and Fremont Capital Corporation in loan originations, underwriting, relationship management, workouts and field audit.

Gentry is a graduate of Arizona State University with a Bachelors of Science degree in Finance. He holds and maintains FINRA licenses Series 7 (General Securities Representative) and Series 63 (Uniform Securities Agent State Law). Gentry is a member of the Turnaround Management Association, Commercial Finance Association and Association for Corporate Growth.
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