Asset-based lenders – like most other loan providers – are winding down or closing their books for 2009. Although only November and still a month and a half before year-end, many lenders are heaving a collective sigh of relief that they have already met budgets amid a slowing pipeline. 

Despite deep skepticism around the loan market at the beginning of 2009, at $33.8 billion, 1-3Q09 ABL volume is down just 7% year over year ($36.4 billion). While this is a far cry from the $56 billion in ABL issuance raised in the first nine months of 2007, lenders concede that things could have been worse. After all, total leveraged lending at just over $150 billion in 1-3Q09 represented a 71% decline over the same period last year.

If the lending gap in the leveraged market remains an ongoing concern in the context of an absent CLO investor base, the asset-based market has also had to contend with its own unique challenges. These include uncertain market capacity and the difficulties associated with securing commitments for lightly used or undrawn revolving credit facilities.

“There are no longer open checkbooks,” says one lender. “It’s a different world.”

At roughly $9.8 billion, 3Q09 ABL issuance was down 17% over both 3Q08 and 2Q09 figures. While sources point out the absence of new money transactions (3Q09 new money loan assets totaled less then $3 billion) as one of the major factors that have capped issuance, several lenders remain focused on positive news in the ABL market. 

For example, so far this year, ABL lenders have pushed at least eight deals of $1 billion or more through market − including Sears, Toys R Us, Lyondell Basell and Barnes & Noble. Not bad given the state of the loan market in 2009 – and, in particular, the leveraged loan market.

More significantly, asset-based lending in 1-3Q09 made up over 22% of total leveraged lending for the period – the highest level in the last five years. This dramatic pick-up can best be explained by what is probably the biggest story of 2009: The return of the high yield bond market and its impact on loan market liquidity. 

HY bond, ABL combos sustain market
The rebound in the high yield bond market and the role it has played in mitigating both concerns around the leveraged refinancing cliff as well as lender balance sheet constraints has been well documented. What is perhaps overlooked – but no less important – is the impact the pairing of asset-based loans and high yield bonds has had on the market both in terms of providing liquidity and expanding the lender universe in what is still a highly selective lending environment.

The ABL and high yield bond combination harks back to the more traditional capital structures associated with asset-based borrowers. Yet more notably, in 2009, the paired financings have provided arrangers with the incremental flexibility required to bring in new lenders, by virtue of the fact that they marry bond economics to loan participations. The result? Investment banks, for example, that would otherwise be shut out of the market are now able to rationalize commitments.

Adding to this blended capital offering are the accommodating terms and conditions in many high yield bond offerings, including the increased number of secured instruments and even bonds with sinking fund features. The net impact has been that with the exception of a recapitalization structured for NCI Building Systems in October (the deal combined an ABL revolver with an existing term loan), high yield bond issues have rounded out ABL syndications.

Retail syndication still thin
Of course, the good news has to be tempered by taking a closer look at how deals are getting done. Arrangers say that although big deals have worked their way through the market, “lender groups are a lot different [requiring] chunkier holders at the top.”

In fact, retail syndication is still thin, according to lenders, and market depth remains unpredictable. A recent $1 billion financing for equipment rental company Ashtead hit the market with $100 million tickets.

And Ashtead was not alone – a number of deals of $1 billion or more, slated to hit the market later this year or in early 2010, have been clubbed with five or six banks and are expected to stay top heavy if the retail market does not open broadly.

Those who survived the market upheaval are looking at deals on a selective basis. At issue, of course, is their access to the market in order to fund themselves and their ultimate cost of capital.   
At the same time, although several banks (including Sovereign Bank, PNC, Regions and TD BankNorth) have stepped up commitments and accelerated regional competition, arrangers concede that there is very little predictability when it comes to selling down in the retail market. There is “a lot of head scratching going on,” says one lender, when it comes to building out a syndicate. “It is difficult on any given deal to determine what a regional bank may do.”

“I don’t know that there are a lot of professional participants out there anymore,” a second lender explains.

And this can lead to fickleness from deal to deal and credit to credit – especially among participants who have traditionally bypassed large corporate syndications in favor of relationship-based, smaller, clubbed financings. 

As one lender explains, “Barnes & Noble and C&S Wholesale were fine deals,” but his institution passed on them due to the lack of ancillary business.

So while most lenders feel better about the market today, their sentiments are qualified. “I get the impression that people feel that the market is better,” says one lender. “But only marginally better, and that it will continue to get marginally better.”

Deal terms ease for better-quality names
Nonetheless, signs of a stronger ABL market cannot be overlooked – or taken lightly. Both the Barnes & Noble and C&S Wholesale deals flexed down (C&S was also upsized by $50 million to $800 million), which seems to argue for a better market. There are caveats, of course – namely, these are better-quality names with more of a following and therefore more market depth.

One source says the success of these deals has less to do with capacity and more to do with strong relationships; well-structured, good credits may be able to tap the ABL market to maximize liquidity and secure good pricing.

This was certainly the case of Barnes & Noble. The retailer saw spreads rolled back 25bp on its $1 billion, four-year credit, which was originally priced at LIB+400. Of course, Barnes & Noble is a 1.0 times leveraged company that probably would not have gone the ABL route at all had it not had to deal with the looming refinancing cliff.

“Banks are coming back,” a lender explains. “But [they] don’t want to deal with troubled credits.”

Market demand for quality credits has inherently contributed to a number of trends in the asset-based space − first, a market bifurcation in which the better credits are able to tap liquidity; and second, a slow but unmistakable loosening of deal terms. There are no longer fast “no’s” points out one lender: “It is still a difficult and time consuming process,” but people are looking at deals closely.

More importantly, the consensus is that although certain industries are having a tough time (automotive and building products, for example), lenders are looking at the market leaders in those industries, determining who the ultimate survivors will be, and banking them.

Arrangers and participants are comfortable that things have calmed down. Deals that are hitting market have better structures for better credits, and nothing crazy is being done. In this context, spreads on asset-based loans did come in modestly in 3Q09, much to the consternation of some lenders. At just north of 390bp, average drawn spreads were down from levels north of LIB+400 in 2Q09. And while this is a far cry from year-ago spreads that hovered at roughly LIB+255, the thinner spreads do have an impact – especially in the context of current Libor rates.

After a brief flirtation with Libor floors, asset-based loan structures have largely abandoned them as a tool for bolstering returns or attracting lenders. 

“Generally speaking, arrangers do not want to lead with them,” says one arranger. And ABL deals have a limited history of applying them. 

“It is unbelievable how quickly pricing has come down,” says another lender. “We were at 375-400 at the beginning of the year with Libor floors and now we are at low 300-ish with no floor. I understand why Libor floors have gone away, but cannot understand why banks are in such a hurry to give pricing away again.”

There is arguably more grumbling among some lenders when one considers that the leveraged cash flow market has only lately begun to show signs of recovery. Until recently, the high yield and ABL markets have been the primary sources of liquidity. Asset-based deals continue to provide a cheaper source of liquidity for leveraged issuers who would otherwise be constrained by OIDs, Libor floors and substantial spreads if they opted for (and were able to secure) traditional cash flow term loan structures. Although yields on BB rated credits have come down in 3Q09, at just under 570bp, they are still significantly above that of comparable asset-based deals.

“There is no natural level to spreads,” a source explains, and although “spreads are tightening, they are holding up”.

Nonetheless, the recent spread compression in the ABL space has raised questions around long-term market capacity. 

Many lenders have asked the same question: “If prices stay high, you should have more entrants, but if it comes down, will this hold?”

More significantly, if third- or fourth-tier lenders do not come into deals because they either cannot lead or cannot win ancillary business, are there concerns that they may pull back a year from now? Who will be in a position to step in to fill the gap if one exists?

Spreads were not the only deal terms to see adjustment in 3Q09. Tenors also were pushed out, and although new five-year credits have still to make a showing, four-year tenors worked their way into the market. In 3Q09, 58% of ABL financings that came to market included a four-year maturity (up from roughly 7% from 2Q09).

Despite the easing terms and conditions – and again, this is largely for better credits only – maximizing lender capacity remains a key concern. In this regard, arrangers note that amend and extends will remain critical to getting deals done – especially in view of the volume of credits expected to mature in 2012.

Additionally, cash flow lenders who have been a trough for a while may continue to restructure existing credits via the ABL market (as appropriate), providing dealflow and − in the case of ABL loan assets − new money.  Less certain are prospects for M&A financing opportunities heading in to 2010. 

“The M&A market has to pick up based on where we are now,” says one lender. “Shops have to put their money to work right now, but we may not see big deals.” 

This concern, of course, comes back to the issue of depth in the loan market at large. If a deal requires a $1 billion asset-based tranche to round out a large M&A financing, is there confidence that a TLB of substantive size can be raised for a multi-billion dollar deal? 

There are hopeful signs, but nothing is a given.

Maria Dikeos is Vice President - Senior Market Analyst with Thomson Reuters LPC in New York