Asset-based lending is now firmly entrenched in the mainstream of financial products, yet its role in the market continues to evolve. Market participants are exploring new ways to use the low pricing and operational flexibility provided by asset-based loans, while lenders enjoy their low historical loss rate. However, new opportunities– and challenges – will require strategic forethought and flexible implementation by asset-based lenders. ABL markets, as with the broader loan market, have experienced a continuing imbalance between supply and demand, resulting in increased competition for funded loans and, ultimately, more borrower-favorable loan terms. Meanwhile, regulatory pressures constraining bank ABL lenders from leading or participating in deals with highly leveraged capital structures or in distressed situations may be softening, as demonstrated by recent developments regarding federal guidance on bank leveraged lending. As financial transactions become increasingly global, foreign ABL markets present new opportunities, while non-bank ABL lenders simultaneously challenge traditional providers.
Financial sponsors continue to influence the ABL marketplace – as with loan markets generally – pressuring loan arrangers to market transactions with tighter pricing and more flexible terms. Thomson Reuters LPC reports that in 2017, well before year-end, lending to private equity-sponsored companies in the U.S. market hit a record high – over 50% higher than 2016 levels according to the Loan Syndications and Trading Association. Their statistics also show that , the first three quarters of 2017, sponsor ABL loan issuance has accounted for 35% of the U.S. ABL market.
In addition to driving transaction volume, sponsors typically run competitive auctions for lead left roles in transactions. It has become commonplace for sponsor/borrower counsel to prepare auction terms grids and/or commitment papers as the baseline for the auction. This creates efficiency for the sponsors as they can compare loan terms on an even basis. This competitive dynamic results in loan arrangers presenting more flexible and borrower-friendly terms than they may have proposed absent the auction. In a further effort to control costs and negotiate documentation in an efficient manner, many sponsors base ABL transactions for their portfolio companies on pre-agreed precedents. The developing trend is that the precedent sets a floor for terms, but sponsors and their portfolio companies are often able to make improvements over the course of negotiations. Meanwhile, lenders that are unwilling to compete are likely to be frozen out of lucrative arranger and agent roles, not to mention ancillary business.
Similarly, modern loan markets have created pressure on ABL lenders to adapt terms to conform to bond or term loan market norms. The balance sheet of a modern business often has multiple layers of financing, serving different purposes. The more the terms of these products differ, the more complexity and less perceived flexibility borrowers have in their overall financial structure. Throughout this decade, the “convergence” of terms in the high-yield bond and term loan B markets has been well documented.