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What a difference a few years can make. Interest from senior lenders, mezzanine capital investors, institutional equity investors, and strategic buyers in the commercial finance sector has improved significantly since the recession, particularly in the last year to 18 months. If you didn’t have access to a calendar, you might think it’s 2007, given the free-flowing extension of credit, intense competition, and pinched margins.

But, alas, it’s 2014, and many independent commercial finance companies—including asset-based lenders, equipment lenders, and leasing and factoring companies—are struggling to grow assets year over year. This is due to the availability of cheap and seemingly loose structures from all areas of the competitive market environment, including banks, other finance companies, credit funds, and business development companies (BDCs). The silver lining, however, is that these same types of institutions also provide funding to the independent commercial lender.

In this article, I’ll provide an update on what we’re seeing in the debt and equity markets as we seek funding for our commercial finance company clients.

Senior Debt – More Alternatives Today

When the credit markets seized in late 2008 and into 2009, many banks and other lenders who had been focused on providing lines of credit or warehouse facilities to specialty lenders either stopped extending new term sheets or pulled out of the market entirely. Wells Fargo Capital Finance was one of the few, if not the only, significant players to continue providing new lines in the lender finance market, leading to a perception that there was market share to claim once the market improved post-recession.

Today, a broad variety of players have returned to the sector or have entered for the first time, creating a competitive market for senior financing much like the environment the finance company borrowers themselves are seeing as they look to grow assets. The greater number of lenders to finance companies has impacted pricing and financial covenants to the benefit of the commercial finance company borrower as newer players such as Everbank, Alostar Bank, RBS Citizens, Bank of Internet, and BB&T compete with the traditional market leaders of Wells Fargo, SunTrust, Bank of Montreal, and others.

Specifically in the equipment finance sector, the asset securitization markets have recovered nicely, leading many of the traditional money center bank lenders to again show significant willingness to lend to leasing company originators. Banks like Deutsche Bank, Credit Suisse, Natixis, and others who prefer an asset-backed security take-out have been back in the market, providing improved debt terms for many equipment lenders and leasing companies, as well as another alternative to simply building an on-balance sheet portfolio of assets.

Subordinated Debt & Mezzanine Capital – The Emergence of the BDC

Many smaller commercial finance companies have historically utilized “friends and family” capital that is structured as subordinated debt with a lower-than-market coupon. This “friends and family” capital, which oftentimes comes with equity risk but not an equity-like return, is expressly subordinated to the senior lender in the capital structure. Thus, it counts as equity for minimum tangible capital and maximum debt to tangible capital purposes. But for larger finance companies planning for growth or acquisitions, a larger capital infusion may be necessary.

To be sure, many mezzanine funds will look at investments in the commercial finance sector, seeking double-digit coupons, sometimes with equity upside, and collateral coverage such that total loans, leases, or receivables are greater than the sum of the company’s senior debt and mezzanine capital. However, the BDC community has emerged as a major factor in the commercial finance space, whether as a structured lender to the finance company, a partner in a dividend recapitalization transaction, or as a pure equity investor or 100% platform acquirer. Many BDCs have enlisted dedicated personnel to seek senior debt, subordinated debt, and equity investment opportunities in a variety of specialty finance sectors, including not only the various commercial finance sectors, but even the consumer finance industry.

Equity Investment and M&A Activity

Given the positive activity in the senior and subordinated debt financing markets, it’s no surprise that various equity sponsors, led by the aforementioned BDCs, have demonstrated increased interest in the commercial finance sector. Private equity firms, hedge funds, and family investment offices know that their equity return hurdles are easier to hit when the companies they are backing have access to efficient senior financing.

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