Borrowers shifting toward asset-based loans; lenders holding upper hand, panelists report

By Jennifer Lanning Drey

Portland, Ore., April 7 - The current credit markets are being defined by a shift toward asset-based loans for conforming borrowers and an environment where lenders have most, if not all, of the leverage in negotiations, panelists speaking at a Turnaround Management Association presentation said Tuesday.

While asset-based loans were typically used in the leveraged-buyout and merger-and-acquisition markets in 2008, that volume is being displaced on a percentage basis into the debtor-in-possession loan market in 2009, panelist Jeff Kolke of GE Commercial Finance said.

In the DIP financing market, the trend is for pre-petition lenders to control DIP loans by rolling over pre-petition borrowings where possible, panelist Colin Cross of Crystal Capital Fund Management LP said during the discussion.

The role of private equity in the credit markets is increasing but varies widely with regard to the approach taken by the various players, panelists said.

Shift to ABLs

The shift toward an asset-based loan environment has become more prevalent as credit deteriorates and putting valuations on EBITDA becomes a harder task than in the past, Kolke said.

In addition, asset-heavy companies are finding it easier to manage under the less restrictive covenants offered by asset-based loans, he said.

"You're reducing the ability to manage toward three or four covenants to managing toward one covenant," Kolke said.

The "sweet spot" for asset-based loans is seemingly recession-proof industries such as medical and health care and food and beverage packaging, he said.

The printing and publishing, transportation and automotive industries will have a harder time, he said.

Lender leverage

Due to their immediate need for liquidity, troubled companies are finding that lenders have the upper hand in negotiations, which means banks can make more demands related to covenants, rates, terms and paydowns, Jeff Marwil of Proskauer Rose LLP said Tuesday.

"I think the lenders have a lot of the leverage, if not all of the leverage, and there's no alternative," Marwil said.

He also noted that bankruptcy has become a last option for companies due to changes in the bankruptcy code and the associated costs.

Accordingly, many lenders are stepping up their enforcement rights in terms of revising covenants and tightening their diligence and monitoring, much to the dismay of some managers who are unaccustomed to such scrutiny, Marwil said.

DIP loan markets

For companies unable to find an option outside of bankruptcy, the DIP loan markets have become a predominately defensive market being controlled by pre-bankruptcy lenders who are rolling over pre-bankruptcy borrowings wherever possible, Cross said.

Potential new entrants, such as distressed funds, are considering coming into the DIP loan market, but there may not be much room for them with DIP financing lenders looking for rollover opportunities.

The biggest hurdle for new lenders wanting to come into the market is that most companies have been taking out subordinated debt in the past few years, which takes away from the potential new lenders' ability to create new liquidity, Kolke said.

Panelists agreed that traditional lenders are still active, but many of the alternative lenders of the past five years are no longer active.

"I think there are more and more folks getting comfortable as banks get healthier and their balance sheets get healthier, but frankly, folks are being very conservative today and there's a flight to quality," Kolke said.

In addition, second-lien players are no longer putting out primary paper but are instead choosing to go to the secondary market, he said.

Cross also noted that DIP financing is often being used as an acquisition tool for bondholders or strategic buyers who are writing tight requirements into the DIP loan structures.

First vs. second lien

Another trend noted among troubled deals is that first- and second-lien players do not have common interests, the panelists said.

Within the first-lien group, agents are often playing to the lowest common denominator, meaning whatever will get sufficient support within the group, which could include a sale or liquidation, Marwil said.

However, that lowest common denominator is typically unattractive to second-lien lenders, he said.

In the end, if the bulk of the security sits with the first-lien lenders, the second-lien lenders will be effectively wiped out, making their agenda simply to live to fight another day and defer any kind of restructuring, he said.

The equity players are typically aligned with the second-lien lenders in that regard.

Signs of life

While the credit markets have not seemed to thaw, they are beginning to show signs of life, Kolke said.

"Secondary markets all appear to have at least bottomed out and are moving toward more reasonable trading range and volume, which can only indicate that those yields have been good for investors to come in and buy in the secondary market recently," he said.

"As those markets continue to improve, that yield will come down, and it will make going back to the primary market more available to a lot of investors, and I think that will create a lot of interest into issuing new paper."

At the same time, banks continue to deleverage, which will create more liquidity on their balance sheets to issue new paper, he said.

However, there is probably still more downside in the economy than upside, as more confidence is needed before the economy can begin to pick up, Cross said.

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