Asset-based vs. cash-flow lending
From weathering disruption to financing an acquisition, many mid-sized and smaller companies are turning to asset-based lending (ABL).
In many industries, the economic devastation of the pandemic came as a body blow, knocking down revenue, forcing layoffs and leading to several high-profile bankruptcies. A year in which the economy was expected to expand slowly suddenly saw it plunging, with projected negative growth of 6.5%, according to the Federal Reserve.1 As the economy recovers, fundamentally strong businesses — retailers, transportation and automotive businesses and consumer products companies — could see their prospects rebound. Yet obtaining capital as a bridge to better times may be challenging.
Cash-flow lending, for example, is tied to a company’s ongoing operations as the basis for repayment. “There is little visibility on earnings for 2020 and beyond,” says Seth Benefield, head of Bank of America Business Capital. “We don’t know when the health threat will subside, which leads to uncertainty around the timing of the economic recovery.”
In contrast, asset-based lending (ABL) offers an opportunity to use a company’s assets to gain access to needed capital. Although ABL lenders also consider a company’s ongoing operations, a primary focus on inventory and other assets as collateral can benefit many businesses. For the same reasons, ABL may also be an attractive solution for those seeking to acquire businesses through leveraged buyouts (LBOs), says Darryl Kuriger, head of ABL Capital Markets for Bank of America. “In a sense, asset-based lending was invented for times such as these.”
What asset-based lending can do
Kuriger describes one major retailer that in 2019 brought in more than $20 billion in revenue but as the pandemic surged, had to close its stores for three months and revenue was suddenly zero. They weren’t going to get a loan based on cash flow. And they were hardly alone in that predicament, Kuriger says.
For that retailer and another struggling with reduced sales and earnings, Bank of America acted as lead in arranging financing. ABL provided revolving lines of credit to help them meet immediate operating expenses, while additional financing came from high-yield bonds.
A key advantage of ABL is the flexibility to work in conjunction with other types of financing, such as Term Loan B or high-yield bonds, to maximize the amount of available capital. “ABL investors prefer inventory and more liquid forms of collateral, and high-yield investors are more comfortable with real property and equipment,” Kuriger says. “It’s like chocolate and vanilla ice cream. They just go well together.”
Moreover, ABL financing today is supported by banks with “plenty of capital to lend,” says Kuriger. That’s in stark contrast to the financial crisis of 2008–2009, when “banks were undercapitalized and the capital markets were closed,” he says. This time around, banks had more than $1.7 trillion in capital at the end of 2019, amounting to almost 10% of their total assets.2
Preparing for a rebound in LBO
Conditions may also be improving for an LBO market that was in high gear before the outbreak occurred, Benefield says. According to Bloomberg, LBOs dropped from more than 20 in May 2019 to fewer than five in May 2020.3 “Sponsors have largely been focused on stabilizing portfolios, and sellers have been reluctant to divest due to the pricing volatility,” Benefield says.
Yet target companies that are struggling in the pandemic may have sufficient assets to support a deal, and the LBO market could be positioned to rebound in the second half of 2020. “We are seeing signs of stabilization in terms of volatility and capital markets recovery, and green shoots of opportunity for new deals,” Benefield says. “By May 2020, private equity funds were sitting on a record $2.6 trillion in unspent capital.”
Head of Bank of America Business Capital
Factoring in the risks
Despite signs of economic improvement, the landscape remains full of risks, Kuriger says. “Question number one is, are we going to see phase 2 of COVID-19?” he says. If regional increases in new cases develop into a full-fledged resurgence in the disease, that could threaten the survival of many businesses that are already struggling, and also delay the recovery of the LBO market. A second question is whether and for how long the federal government will continue providing stimulus dollars. An end to stimulus could lead to new disruptions in consumer spending—putting further pressure on companies and their earnings.
While ABL is less sensitive than other forms of lending to earnings fluctuations, companies in industries facing extreme volatility, or that are generally unable to quantify the risks they face, may not be suitable for financing, Benefield notes.
Head of Bank of America Business Capital
Finding a strategic partner
Companies looking for capital to weather the downturn, or firms considering strategic acquisitions, may find that working with a major financial institution with extensive experience in ABL offers important assurances. “We have a strong balance sheet and maintain a mindset of disciplined, responsible growth even during bull markets,” Benefield says. “That allows us to continue to support our clients and key financial partners through a down cycle.”
And for all of the disruptions the virus has caused, some certainties remain. The pandemic will one day end, the economy will recover and the LBO market will return in force. Throughout that process, ABL may be a crucial factor in helping individual companies weather the storm, and in helping strategic acquisitions continue.