In a crowded and commoditised debt market, ABL providers are differentiating their offer by focusing on their strengths and adapting to borrower requirements… in good times and bad. A group of lenders, GPs and advisers sat down to discuss ABL’s potential in competitive but unpredictable times.

At the table:

• Ryan Whitworth, ABN AMRO Commercial Finance
• Andy Dimmock, FRP Advisory
• Jon Hughes, Independent Growth Finance (IGF)
• Will Stamp, Inspirit Capital
• Richard Babington, Mobeus Equity Partners
• Graham Barber, PNC Business Credit
• Martin Noakes, NatWest ABL
• Andrew Robbins, RedRidge Diligence Services
• Nick Leitch, Shawbrook Bank
• Tom Weedall, Wells Fargo Capital Finance
• Moderator: Nicholas Neveling, Real Deals

The debt market is competitive, capital is cheap and term sheets are loose. How is ABL positioning itself against that backdrop?

Andy Dimmock:

There are a range of options open to private equity, but where ABL has gained a foothold is in lending to asset-rich companies. However, whilst some of these borrowers may be earnings poor, not all are. The financial sponsors and lenders operating in the £5m to £100m (€112.7m) deal size range know what structures and sectors an ABL will work well for. The ABLs are very clear on the sectors they can fund effectively and that is where they focus their attention. 

Andrew Robbins:

The availability of funds from a variety of sources means ABL pricing and terms are under pressure. Pricing models for many ABL lenders allow them to be competitive on margin against unsecured lends to compete against a revolving credit facility (RCF), with what is perceived as a less onerous reporting.  As such, there needs to be a clear pricing advantage.

How do the providers see it? How are you positioning your businesses in the current market against the cash flow and unitranche offers?

Martin Noakes:

A trend I have noticed over the last three years is that ABL Lenders are now more often providing part of the capital stack, by partnering with other finance providers as opposed to providing all of it. At NatWest, we are working much more closely with our Leverage Finance teams. We will do the senior receivables financing, and our Leverage team will do the term loan, or there might be a need for a cash flow stretch. We weren't really seeing these structures three years ago, but that's certainly something I'm seeing more and more in the market.

Another observation is that although ABL absolutely lends itself to certain asset-heavy businesses, we are seeing a broader range of sectors looking at ABL financing now.  

Tom Weedall:

Picking up on Andy's point, at Wells Fargo we are very clear on where we want to sit in the capital structure. We are secured and we are collateralized, so often we are going to be at the cheap end of the debt stack, and that's fine.

If you look at sector experience and points of difference for our business, we've had a good run in retail. Traditionally the UK ABL market started from receivables and then built out to inventory, plant machinery, property, and cashflow. All these additional lines were bolted on. Whereas from our perspective, inventory is a revolving asset that is exactly the same as receivables, so we would be quite happy to do a standalone inventory deal, whereas others would have started out doing a standalone receivables and then building out from there.

We've done a £90m inventory only deal for Homebase, as a retailer. We also did a £50m package for Majestic Wines just before Christmas, and that would be primarily secured against all of the inventory in all of the store network. 

Retail is an unloved space. It gets a hammering on a daily basis. The cash flow market has pulled away and we've seen an opportunity for ABL to go into some of those transactions and work with some names that 12 to 18 months ago ABL wouldn't have had an opportunity to work with.

Jon Hughes:

A large part of what we as an ABL can offer is more predictability. The core asset base gives you stability and what we have focused on to differentiate our offer is an ability to stretch traditional ABL into new areas where the receivable is more contractual or complex, or where you are asked to consider the value of work in progress. One of the benefits of working with private equity is that you've got a common interest in how the deal is structured. That may enable us to put together a mix of assets we wouldn’t normally do because you have a higher degree of confidence that the shareholder will behave rationally when the business is working within tight margins.

Ryan Whitworth:

First and foremost, we're a working capital provider, but from time to time we will step up and provide some additional funding. ABL is well-suited to providing the working capital, alongside the debt funds and leverage finance and certainly at ABN AMRO I believe what differentiates us is that we have cross-border expertise at the higher end of the market. We can structure facilities on a relatively straightforward, seamless basis across four to five European geographies and sometimes more if necessary. In-house we have also built up specific asset expertise around plant and machinery, so we can bring a lease approach to plant and machinery that sits alongside receivables.

What is coming through is that ABLs are differentiating their product and are flexible in their approach to structures. Given that flexibility, are the providers moving away from thinking of ABL as a product, and looking at how to come up with a solution to a client’s requirements instead?

Nick Leitch:

We use the same advisors and appraisers to value deals, so all we're doing is working from the same valuations, asking how far we are prepared to push the margin in our house, and then building a structure from there.

In its purest sense ABL has metrics and assets applied to metrics. What we've added to that is cash as an asset. We will do cash and cash flow only type deals, and anything that sort of sits between because cash is an asset. Now it's a different asset to manage, and it has different risks associated with it, but it is appropriate for certain needs. 

Why are we doing that? Because the market is more complex and driving us to find more solutions. If we could just nail it to assets all day long we'd be very happy, but that's just not the way world is working. It has evolved.

Graham Barber:

If you want to continue to grow organically as a lender, and you want to stay relevant, you have to move with the times. Receivables only gets you so far in the process. It is great for some working capital, but you're going to need more behind that if you're working with private equity. 

Andrew Robbins:

Coming from a US-based market you see far deeper penetration of ABL into the transactional space than there is here. I know banks in America are working with various private equity funds and debt funds to get ABL onto their radar. 

The key thing is that if you have worked with ABL before and you have had a successful outcome, you are probably more likely to go back to those people again. And whether it is just for working capital, or whether you're pushing out to provide more acquisition finance, you're seeing more and more of that.

How do the GPs see ABL in relation to the other options on the table, and what makes you choose an ABL loan against the alternatives?  

Will Stamp:

It does depend on where you are in the private equity market. GPs take on debt in order to maximise returns and they will focus on the options that offer the optimal debt capacity.

If you're in the vanilla growth buyout part of the market, target companies tend to be asset light and a cash flow lender will probably make more sense. At the special situations end of the market, though, you are generally more focused on asset-heavy businesses where cash flow won't be as strong. ABL will more often make sense in those kinds of scenarios.

There is a middle ground though. In carve outs, for example, earnings could be very strong but there is often difficulty in getting all the diligence reports typically required by a cash flow lender because of the deal complexities. These are scenarios where ABL can be useful for mainstream private equity deals.

Richard Babington:

At Mobeus we like running yields through the piece. Cash flow lenders are less comfortable with that, but we have found the ABLs to be quite pragmatic about it.

Another evolution is that the main ABLs are now integrated providers, whereas 10 years ago you had to go to individual providers to do stock, debtor finance and asset finance.

Finally, from a personal perspective, I just find the ABLs quite straightforward to deal with. You've generally not got a distant credit committee who might let you down at the last minute because they haven’t been involved throughout the deal.

For the ABL if there is an asset there, then it can be lent against. When we're at the sharp end of the deal and trying to put it together, I don't see a lot of emotional waxing and waning in the opinion of whether the ABL lender would want to lend on it. On a cash flow lend side I have been let down a couple of times.

That is an interesting point and raises the perennial questions about whether ABL’s reporting and due diligence requirements ever put private equity firms off?

Babington:

There are disallowables in any ABL facility, and it’s about making sure that both sides understand what actually presents a risk, versus a technical disallowable that limits borrowing capacity unnecessarily. But as long as you've got clear lines of communication between the lender and the principal it generally works out fine.

Dimmock:

Many, many years ago when I started as an advisor you would see so many financial due diligence reports that were really aimed at a cash flow provider without any reference to the balance sheet. Those areas are now better covered, earlier in the process, enabling the lender to provide a meaningful indication. A borrower will know what reserves will be applied and what availability that the asset should generate. It’s not as simple as if you have a £10m receivable, you can just assume a 90 per cent advance rate and a loan of £9m.

Leitch:

If I was working with an FD and a finance team that weren't up to operating an ABL structure, that would be an alarm bell. All the disciplines are about managing the collateral and understanding the real value of that collateral in relation to available funding.

So ABLs can accommodate more sophisticated clients without all the mainstream diligence processes that you would find with another structure, and again that's part of the way the markets have had to evolve competitively to fund better credits.

Hughes:

There are cases where private equity will bring us in to instil a bit of discipline in the management team. They believe in the management team, but they may also know that they haven’t been focused on the end column of their receivables, or the value of inventory they are holding. The ABL monitoring processes can help companies to improve their cash position and reduce costs by shining a light on these areas.

Andrew Robbins:

I would echo that. If somebody buys into it from a sponsor side, things like covenants and, standstill agreements do come into it, but ultimately we're going out and meeting FDs on a regular basis. If they can't provide you the information you're looking for your collateral diligence, you've got a problem.

While some FDs may not be familiar with the specific requirements of financial diligence or the reporting requirements, most lenders do not require additional reporting in order to satisfy these requirements as they are typically part of the regular reporting and the operational monitoring of a business – debtor ageings, stock reports, vendor ageings et cetera.

As we work with a number of sponsors on the M&A side as well, we oftentimes see how similar the diligence streams actually are. We’ve even had cases where the ABL field exam brings out issues that had been overlooked by the investor’s financial diligence that had a material bearing on the deal.

Noakes:

The timeliness of collateral information is also a factor. Historically we wouldn't see the Balance Sheet and the aged debtor reports up front to enable us to compete with the cash flow lenders in time-sensitive, event-driven acquisitions. More generally we are coming into refinance events, although we can turn around a deal in a short time frame if Advisors have the diligence completed up front. We are also seeing more and more Advisors provide this information at the start of a process.

Dimmock;

I still think it's an issue in data rooms on most transactions. The document pack is still very much aimed at a cash flow lender. One of the challenges I think ABL does have in terms of acquisition and working capital finance is very often you do want to go see it, feel it, touch it, and quite often vendors are reluctant in that regard.

Stamp:

In an auction process ABL is actually easier from a diligence perspective compared to cash flow products, but there is that intrusive element of the process of needing to go and sit down with the credit controller to understand how the systems work et cetera. This can be tricky, particularly in the second round of a sensitive auction process where there are multiple bidders - but from our perspective, it’s important as we want to have a deliverable ABL term sheet by the time we've submitted our final offer in a process. It can be difficult, but it points to educating dealmakers about ABL and how the product works from a diligence perspective. Dare I say it, but at some point in the future, the sell-side due diligence reports may actually include a collateral review as part of the process.

Barber:

The question tracks the economic and credit cycle. If you go back to 2008, 2009, 2010, when the liquidity available in the market from the cash flow lenders completely dried up, no one had a problem about doing collateral due diligence and making it available.

Hughes:

If you go a long way down the route of a cashflow loan, and then have to change because an ABL facility works better, the additional diligence needed around the balance sheet may seem onerous, simply because it is being done later in the process. As Andy says, ideally that information would be in the data room from the beginning. 

Weedall:

In the US the ABL would just be used for working capital, and you would put an acquisition cheque in, probably not from the ABL provider, to fund the acquisition. The diligence on the balance sheet is usually absent from the pack of information that you get. 

It all comes down to headroom. If you've got headroom and liquidity in a transaction, then we're comfortable, but because you need certainty of funding to allocate a level of the ABL to the acquisition price on a day one consideration, then that's when it becomes a bigger issue. 

Now clearly, we would like to be deeper into the capital structure, and not just be working capital providers, but that issue is there because private equity needs to know how much they're allocating from the ABL facility to the acquisition price.

Babington:

On the diligence side, I think I've got to be critical of my own industry. The lenders are hampered because some private equity houses aren’t able to give them the necessary metrics on the bid targets that they need to make a decision. I can't believe that there are people starting funds up and looking to invest in businesses that haven't got even the most basic reporting metrics tied down. If any of my team have a board pack that doesn’t have a comprehensive set of reporting metrics I am not going to be very happy, but I think that situation exists in our industry.

Stamp:

As a GP we are familiar with the fact that at certain times of the buying process you're not going to have all of the relevant information. Over the years I've learnt to leave plenty of headroom when considering ABL debt capacity, because depending on where the collateral review comes out, it can be anywhere within a range. So, leaving headroom from an acquisition finance perspective is vital, and over the years we've seen the importance of being flexible on this point.

Whitworth:

There is a comfortable way of financing transactions at the moment that's tried and tested. At the special situations end of the market, the ABL path is well trodden and understood, and therefore that work is done. Further up the chain it isn't. 

I was talking to a couple of sponsors recently who have started in special sits and moved into more transformational deals and beyond. We spoke about ABL in those growth spaces, and although they like ABL, down the track they want to move away into an RCF because the secondary market would prefer it to look like that.

Its incumbent upon us to not just look at educating the advisor community around the benefits of ABL, and where it sits within the chain, but also work with the sponsor community to do the same and start to build confidence in what we can provide, how timely we can do it, and the pricing we can deliver.

Robbins:

The big point is it's been 12 years since anyone has had to really rely on the balance sheet to get their money back. Lenders may to need to rely on the assets at some point, so it’s advisable to have some level of ABL diligence performed to understand the quality of those assets. You don't want to wait until it is too late to find out the assets aren’t what you initially thought they were.

That leads on to how ABL performs during times of volatility. Is it a product well-suited to a market that is choppy and unpredictable? 

Whitworth:

We are well placed in difficult times to control the collateral and to control the assets. We're a good source of information for a sponsor that might not be as informed as we are around managing that in difficult times.

Barber:

It's a product that's well suited to any market. It's just that when things become more choppy, ABL gains more traction. It doesn't gain less traction when everything's growing nicely, because when it's growing our revolvers are growing with the company. But where we excel and do more business is when it's choppy, because cash flows are less predictable and then the leverage providers tend to go: “I haven't got the visibility, I don't know how I'm going to do that” and retrench.

Noakes:

Money doesn't disappear when the markets change.  I believe that’s why a lot of the ABL teams here see their portfolios increase when liquidity in traditional markets is tight and there are some leading indicators that might suggest we could be in a position where that is happening now. The customers in our portfolio, whether they are ABL or cash flow, are still going to be our customers and we're here to support them through both the good times and the bad. 

Weedall:

Private equity firms will come and talk to you when there are fewer other options out there. Our challenge is to get those conversations happening when there are still myriad of other options out there. ABL will work in good and bad times. It is just that there are fewer alternatives to ABL in bad times. We do prosper in volatile markets, but it is because we are secured and less reliant on choppier cash flows.

Hughes:

If you're trying to manage a business through a difficult situation, managing something such as receivable or inventory levels may be easier than resolving a covenant conundrum; knowing that as long as the business is performing at a basic level, and that there is value in the assets, that the funding will be there.

Babington:

What hasn't necessarily been tested in a widespread downturn is the cash flow addition to the base ABL product. I'd be interested in everyone's perspective on those businesses that you're already in with a cash flow loan that is amortizing. How do you deal with that when the earnings become a bit more stretched?

Whitworth:

I think it's a difficult one to answer. We take a partnership approach and I'd like to think we'd continue to be supportive and we'd keep a very close understanding of the way in which businesses work. We've got a really strong watch function that would ultimately intervene in that scenario to manage the situation.

Dimmock:

The reality is that a cyclical downturn can put stress on debt service, and then that client has to be looked after and managed. But if you then contextualise that against the same business with a pure leverage structure, you're still typically going to have a larger proportion of debt to service in a leveraged structure than in an ABL with revolving elements

Leitch:

I think you're even more supportive if you've got a cash flow loan in there. All that's happening in a downturn is that there's a redistribution. Economic activity will probably contract a little bit, the leverage guys won't be as comfortable with the market landscape, so they won't be lending as much because the earnings won't be as consistent, and ABL just keeps going

Barber:

We've probably got more in a cash flow purely and simply because of the volume of private equity deals we've done over the last 10 years and it's a relationship thing. You don't want to be putting money to work as a lender and then relying on your collect out fees for your returns. You can't grow and build a sustainable lending business by doing that. The cost of acquiring clients is too high and the cost of running a business is too high. You have to be supportive. Occasionally, deals don't work. We're in a risk business. You work it through and we all move on.

Robbins:

When things are volatile, lenders will probably want to keep a closer eye on asset performance with an increased frequency of field exams, for example. When other lenders might be wary, ABL lenders should be able to work through cyclical movements.

To the sponsors around the table, are you happy to deal with someone you've dealt before if the ABL is keeping it on demand, or are you pushing towards having that facility as a committed facility? So, assuming a committed facility will be for three years and limit the power of the floating charge and appointing an administrator. I know the bigger sponsors look for that sort of buy-in if you like.

Leitch:

It is difficult for an ABL to be truly committed, but we have seen documents crimped quite significantly with the compression of ineligible components and more clarity on what is deemed as eligible and ineligible. It means the ABL doesn’t have free rein to wake up one morning and decide to pull a lever. That's being flippant, but the point is that if you are building relationships, it is counter-productive to take an aggressive approach.  

Dimmock:

From an advisor’s perspective making sure that the documentation aligns to the commercial terms is a focus. You can't get to an LMA-style document entirely, but you can balance it out, and the ABLs have moved mountains over recent years to have a far more balanced structure to documentation. 

Noakes:

This is the direct conversation you have with the customer. It's important that they understand the type of commitment we are providing, whether it's tenor, funding limits or covenant controls. We've seen the line blur quite a lot between what is an uncommitted and a fully committed facility. As long as our conversations with the client are super clear on how the structural features work, then differences between the two should be fine.

Babington:

I think a relatively common scenario in a cash flow lend is post-completion the bank trying to retrench its position. There is a far better ongoing dialogue with the ABL provider that recognizes that a business will evolve in that five years, and that the parameters that they've put in place, assigning the debt to certain parts of the asset base, will need to modify over time. It is more of a constant dialogue and facility evolution.

Hughes:

The ABL players want to do much more work with private equity and will work extremely hard to develop relationships and open dialogue.  We know these partnerships won’t work if one party believes the other is going to behave badly. 

Robbins:

You're probably coming up for a testing time, because things have been good, and these structures are in place and everybody's been working to them and it's fine. I guess in the next few years, and who knows whether the credit cycle does turn, these structures and relationships are going to be tested. We're going to find out who the supportive lenders really are, and essentially there are many around this table.

Leitch:

I think it's a matter of the scale of the economic challenges. I think we have been through numerous tests with private equity in the last two or three years, and those tests are live now. What you are alluding to is the scale of those challenges. If we see market movement or a downturn, then we're just going to be busier dealing with that, but I don’t think we will be any less supportive. 

Stamp:

I think the onus around good behaviour applies to the sponsor as well. There will be times when things don't go to plan, and the earlier you speak to your ABL provider, and the more transparent you are, the easier it is to sort these problems out. There are a lot of examples out there of private equity funds in denial that their business isn't going the way it should go, and as a result, that conversation is pushed too far down the line. Sometimes it becomes too late, so it is about sponsor behaviour as well.