Timing of maturities is one reason. According to Thomson Reuters, there were 65 deals sized over $500 million that were originated between 2006 and 2008. As of the end of Q1, just under half of them have not yet been refinanced. Given the maturity of these deals most of them will need to be addressed within the next twelve months. Add to that the ABL financings that were done at higher spreads in the immediate post-Crunch period that will certainly be teed up for future mark-to-market repricings.
The Sears deal proves the point. That giant retailer has a long history in the ABL market, with the most recent venture in April 2009. Back then, the company tried to amend and extend its $4 billion RC. Only $2.4 billion extended, which was still the largest deal of the year in the asset-based market. The three-year transaction was priced two years ago at a lofty (for ABL) L+400 with a 1.75% floor.
This time around was a different story. The deal was upsized from $2.4 billion to $3.275 billion and priced at L+225 with no floor. And it got extended out five years.
Structure, Price & Sale
The same sell-side-friendly behavior driving the institutional market these days is trickling into the hard-asset crowd. While ABL discipline hasn’t quite been jettisoned, it’s eroding at the margin, as we found speaking with top ABL players recently.
While they may be casual about cash flow, ABL lenders are fanatics about asset quality. Because they count on collecting 100% of their loans by liquidating accounts receivable and inventory, these providers swap leverage and coverage controls for rigorously monitored “eligibility” tests of current assets. It’s all about ensuring asset values hold up.
One measure of recent softening relates to “excess availability” under the borrowing base. This requires the client to keep a minimum cushion of eligible assets minus debt outstanding. Two years ago that number might have been 25-30%. Today it’s 10-15%.
Also shrinking are cushions below which a financial covenant might apply. If excess availability declines below a certain level, a fixed charge ratio might kick into an otherwise covenant-free structure. That level, once at 25%, is now 15%. This “springing” test has become a regular feature of upper-end (and a few mid-cap) ABL loans.
Other signs of watered-down ABL structures range from fundamental (extent and longevity of collateral over-advances) to administrative (frequency of inventory appraisals) to market-driven (allowance of sponsor dividends). Of course, much of this weakening is due, not to difficulties with the borrowers or the assets, but to aggressive lenders trying to stretch collateral for purposes other than supporting working capital.
One way arrangers are bridging that gap is to increase the advance rate on receivables, say from 85% to 100%. This over-advance can be governed by a higher fixed charge ratio in years two and three, bringing the borrower back into compliance down the road.
Another approach creates a term loan outside the typical borrowing base RC. Lenders are still secured by all the corporate assets, but the TL is allocated to the company’s enterprise value. That provides, for example, an additional half-turn of leverage which can also be “pulled back” via a higher fixed charge hurdle.
Dividends, de rigueur for cash flow deals, are increasingly seen in ABL land. For smaller deals, dividends are allowed as long as the borrower is in compliance with two tests, fixed charge and excess availability, after giving effect for the dividend.
All these trends undermine collateral value to some extent, driven by banks under pressure to book new loans, not watch existing ones go away. When a private equity sponsor wants to pay a dividend or make an acquisition under an ABL format, the house banks are compelled to tweak their structures to allow it, or risk losing the business.
Ironically, one hard-asset veteran tells us that the middle market is less disciplined than large caps when it comes to controls. “We’re finding a lot of less experienced lenders trying to marry a cash flow deal with an ABL deal, just by slapping ABL features on it.”
Randy Schwimmer is senior managing director and head of capital markets with Churchill Financial.