In recent years, asset-based lending (ABL) has intermittently been hailed as being capable of filling the void left by the perceived “shortfall” in leveraged debt. Following the onset of the recession in 2008, the industry was viewed by many as having been handed a golden opportunity to gain a greater foothold within private equity.
That year, senior debt seemingly became harder to secure in support of transactions, with cash flow lenders temporarily withdrawing from the market as a result of wider liquidity issues and an overall dip in business confidence.
Again, in 2011, uncertainty in the high-yield bond market, the gradual retreat of CLO funds and fewer mid-market businesses coming to market lessened confidence, ideally placing ABL providers within the private equity funding mix. The window of opportunity reopened, and some would argue that it is still open today.
ABL allows companies to leverage their current and fixed assets to release funds to support buyouts of various sizes and their working capital requirements. It is secured, meaning that current financial performance is not an overriding factor in funding decisions, and competitively priced at a time when debt pricing on the whole has increased. This should make it particularly attractive when a buyout house has invested equity for working capital with a view to refinancing this commitment later, when trading conditions improve.
ABL didn’t and so far hasn’t proved to be the boost to private equity that was hoped for, nor did it provide a quick fix in 2008 or 2011 to perceived liquidity issues. But what ABL has done since 2008 is gradually build its profile through a range of well-structured private equity-backed transactions, and maintained a secure footing in the turnaround space. This is unsurprising given that supporting transactions involving distressed assets has traditionally been ABL’s bread and butter.
The economic backdrop, too, creates the ideal environment for rescue funds to hand-pick the best distressed assets. Whether these businesses are acquired using ABL or refinanced later, the flexible covenants and pricing are favourable, and the secured product is naturally more readily available to these companies compared to other forms of finance.
ABL providers on the whole have not been knee-jerk in their response to conditions in private equity, despite market expectation. The fact remains that suppliers’ appetite for risk is aligned with those of firms and leveraged debt providers.
No one would argue that large European deals have been few and far between, but since the recession, those syndicated transactions which have come to market have generally funded highly successfully, with many being reverse flexed – illustrating appetite for debt tied to high-quality assets.At the lower end, again, only the strongest deals have secured backing, and, when applicable, clubbed or bilateral leveraged debt. This indicates that asset quality and pricing have as much to do with deal flow as debt availability.
The real opportunity
So, while ABL has significant growth prospects, the opportunities in 2008 and 2011 were overstated. The product will not, cannot and should not replace traditional forms of finance overnight. Why? Because ABL providers do not have an open cheque book and, like cash flow lenders, undergo rigorous diligence of firms to maintain strong credit quality. The product is, however, emerging to sit alongside senior debt, or offer a standalone solution to funding private equity-backed deals.
ABL should not be viewed in isolation. Rather, it should be considered as one potential facet in financing the buyouts and working capital requirements of companies. It is increasingly being explored and we expect gradual, modest growth to continue over the coming years.
Building advocacy will be central in continuing to encourage a sustainable future for ABL. This will involve refocusing its profile from a form of finance suited to lower mid-market turnaround deals, to a product capable of financing clubbed and syndicated transactions in excess of £100m (€125.7m). To achieve this, ABL firms must tailor facilities even more carefully to sponsors’ requirements while effectively working with joint arrangers.
Being able to seamlessly support cross-border transactions is another way in which they can gain more ground. The rules for putting security in place over financed assets differ between European jurisdictions. As such, lenders with comprehensive continental footprints and local market knowledge are well placed to put appropriately structured facilities in place quickly.
It is also important to put across how ABL has professionalised in comparison to the 1990s and early 2000s. The days of companies failing, and rogue ABL financiers being quick to seize their security without considering the wider implications on shareholders and employees, are long gone. Providers are making through-the-cycle commitments to sponsors and their portfolio businesses, with a clear focus on collaboration.
While ABL has received renewed focus in recent years, like the wider funding market it has proved sensitive to economic conditions. Rather than a barrage of high-profile transactions, the product has quietly gone about its business, undergoing technical and reputational improvement to strengthen its position within the community.
ABL has been used to fund a number of smaller transactions over the last 12 months, and with continued focus on through-the-cycle support to businesses and product advancement, should be used in similar deals over the next year.
While ahead of the curve, a concerted and sustainable move into mid-market transactions is only likely to come when economic conditions stabilise. In 2008 and 2011 we saw ABL continue to improve, and we have now witnessed the rise of a product which can sit comfortably alongside mainstream debt funders in supporting buyouts, without feeling like it crashed the party.
Martin Cooper is head of large and major corporate at Lloyds TSB Commercial Finance.