Banking & Financial Services Law : Canadian and U.S. / Cross-Border Credit Market Lawyers & Attorneys : Osler Hoskin & Harcourt Law Firm

I attended a round-table discussion last week in New York that focused on the US asset-based lending (ABL) market.

Observations made during the discussion included:

• the volume of 2010 financings are ¼ of the volume in 2007
• 90% of those financings are amend and extend transactions with some cash flow financings converting to ABL deals
• loan demand is anemic as a result of little capital expenditure (capex) and business expansion
• pricing floors generally have disappeared
• based on 2006/07 experience, the return of a robust M&A market would increase financing volume more than has resulted from the debtor-in-possession/plan of reorganization (DIP/POR) market; the volume of DIP financings expected after the financial crisis hasn't developed
• the institutional second lien facility has generally been replaced with secured bonds (better pricing and more flexibility)
• absent a significant economic shock, the high yield market is expected to be strong until US Thanksgiving
• cyclical industrials, which traditionally have accessed the cash flow lending market, are accessing the ABL market because of the absence of covenants in ABLs
• springing cash management and covenants ( vs. operation from the "get go") are the norm today
• regional banks are the new liquidity providers in the ABL space; finance companies are exiting the ABL platform due to cost of capital and “wind downs”
 

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This outlook for the market for asset-based loans in Canada was drafted by Scott Horner in January, 2010.

Canada has experienced some economic turbulence as a result of the recent global economic crisis. However, Canadian banks have not suffered the losses experienced by many of their competitors in the US and European markets and their stability was not an issue during the financial crisis that has occurred in other markets. The reasons for the Canadian banks’ stability in the face of the financial crisis elsewhere are beyond the scope of this article. However, the banks’ stability; demand for the ABL product to fill the void created by cash flow lenders tightening credit availability; some US lenders repatriating some of their resources from the Canadian market in order to focus on resolving problems at home arising from the recent financial crisis there; and the ABL product working well with an active high yield bond market to fulfill issuers’ capital requirements have contributed to steady Canadian asset-based lending activity for lenders in the ABL business.

Factors Driving ABL Employment

One of the significant strengths of the ABL product is that it can withstand earnings volatility. The key to ABL’s employment is that the borrower owns quality current assets. Accordingly, the product works well with capital intensive businesses like retail, distributors and industrial manufacturers regardless of these businesses’ decreased earnings, or even losses, as a result of the recent recessionary period. Another significant strength of the ABL product is the flexibility that it may afford borrowers by way of its “covenant lite” aspect which may be appealing to borrowers whose financial performance has been adversely affected by the recent recession. Recent Canadian consumer surveys have shown consumers are increasingly confident about their employment, specifically, and about economic recovery, generally. We expect demand for the ABL product will further strengthen during the ongoing economic recovery as borrowers build inventory stock to satisfy increasing domestic consumer demand.

Risk Reward Profile of ABL for Borrowers and Lenders; Impact of Legal Developments on Such Profile

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