May 22, 2020 / 4:15 PM / 5 days ago

ABL providers step up with capital in uncertain environment

NEW YORK, May 22 (LPC) - Middle market companies that have exhausted traditional funding sources are increasingly using their assets as collateral to access vital liquidity for their operations.

Investors' risk-aversion and direct lenders' demands for greater protections to make loans have narrowed the availability of capital for small or mid-sized companies compelling borrowers to pledge their assets as collateral to obtain asset-based loans (ABL).

Though banks have been traditionally the main lenders in the ABL market, the amount of non-bank financial providers in the space has exploded since the financial crisis. These lenders offer debt secured against real assets or receivables soon to be collected in the short-term to fill that gap in funding. They raise institutional capital to lend to sponsor-backed and non-sponsored companies alike.

"In today's environment, revenues for businesses may drop by as much as 25%. Furthermore, cash flows are going to be tight to negative, resulting in liquidity constraints for loans that were highly leveraged on an adjusted basis," said Andre Hakkak, chief executive officer at White Oak, an asset management firm. "Some of the opportunities we see in the market include providing leverage to unencumbered assets, or to provide increased liquidity on the working capital facilities.”

ABL has increased in popularity as a product. Since 2016 the number of committed credit lines increased by 19% to US$249.6bn recorded at the end of the fourth quarter of 2019, according to data from the research firm Secured Finance Network.

The proportion of outstanding ABL loans in the market on non-accrual status, or loans in default, has declined over the same period. At the end of the fourth quarter, 0.47% of loans were on non-accrual status, compared with 0.56% at the beginning of the first quarter of 2016, the data shows.

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The resulting shutdown of the US economy from the coronavirus pandemic has put middle market companies in survival mode. Many have drawn on existing revolving credit facilities as they look to preserve cash when facing an uncertain future.

"It's extremely difficult to underwrite cash flows 5-6 years out given uncertainties around the pace of recovery. Looking at the historical performance or pre-Covid run rates is not meaningful. It's much easier to predict what asset valuations are, especially receivables that turn over every 30-90 days," said Bruce Spohler, co-founder of Solar Capital Partners, a non-bank lender.

Borrowers that have tapped the broadly syndicated loan market on loose terms may allow for real assets to be carved out into a special purpose vehicle and serve as collateral on the loan providing an opening for ABL lenders.

Another popular trend is the sale-leaseback. An ABL provider takes control of machinery, trucks, planes or on-balance sheet equipment and leases it back to the borrower, providing immediate liquidity to the borrower.

Asset-based lenders are charging an additional 100bp-300bp on individual loans today compared with the rates available before the pandemic. They can also secure more attractive loan-to-values on deals.

Even though valuing receivables or inventories may prove challenging in times of Covid-19, firms may be able to find an upside should a company's fortune turn in the wrong direction.

But in a struggling sector such as retail, ABL providers can find upsides. TPG Specialty Lending (TPG SL), a publicly listed business development company, got repaid at 101.3, or above the original value of the loan, for an ABL first-in last-out facility provided to Sears.

Spokespeople for TPG SL and Sears did not immediately respond to emails seeking comment.

"If you've bought that asset as a lessor at the right price, one should be comfortable that asset recovery value will be yield-enhancing, assuming the lessee is unable to fulfill their lease obligations," said Hakkak.

The opportunity to provide asset-based loans may be short-lived as loan providers find themselves in competition with the government to provide liquidity to entrepreneur-owned businesses.

As part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, the US government unleashed its Payment Protection Program (PPP) in late-March to provide funding to small businesses in the US hit by the coronavirus pandemic and the resulting shutdown of the US economy.

"The challenge is that there has been substantial liquidity coming into our borrowers through the government stimulus program. With additional cash on their balance sheets, our portfolio companies and prospective borrowers are trying to predict whether they have enough liquidity to get through to the other side of the downturn," Spohler said. (Reporting by David Brooke. Editing by Michelle Sierra and Kristen Haunss.)

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