This article also appeared in Business Insider
“The object of life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane.” – Marcus Aurelius
We have commented before on the difficult position commercial and industry (“C&I”) lenders found themselves in at the end of the 2008-9 recession. The economic recovery was tepid at best, and growth prospects for small and mid-sized companies were poor. Nonetheless, with banks and commercial finance companies having recovered, there was eagerness to lend. The simple dynamics of supply and demand manifested themselves, and over time lending standards have loosened, and some of the troublesome practices of years ago, such as PIK toggles, have made a comeback.
There is now increasing evidence that middle market companies are struggling with under-performance, signaling an increase in the default rate in coming months. This prompted us to think through just what restructurings will look like during the next recession.
We start with the current crop of asset based loans made since 2011:
- Deal Trends: Average deal size is up nearly 140% since 2011, as lenders gravitate to the companies that have an appetite for loans: private equity backed companies and larger private companies seeking growth through industry consolidation, international expansion, or both.
- Deals by Size: Though deals over $250MM accounted for approximately 75% of ABL commitments since 2011, there is still an important portfolio management component to the loans that have been extended. More than 500 loans with a commitment size below $25MM were made in the ten quarter period assessed (Q1-11 – Q2-13).
- Deal Statistics: Deals below $50MM were nearly 60% by number but less than 6% by amount committed.
As the C&I market has skewed toward larger deals in the wake of the recession, the outline of the restructuring market for the next recession has begun to come into focus. Increasing exposure to larger deals (there is considerable evidence, anecdotal and otherwise, that lenders are seeking to raise their hold limits on syndicated deals) will create an uncomfortable dynamic in which the failure of some deals will be too painful to contemplate, suggesting drawn-out turnarounds as an approach to increase enterprise value and bailout lenders unable to take severe haircuts on large exposures. On the smaller side of the market, we believe that the move toward distressed M&A as a means of credit risk transfer will continue, as lenders address the portfolio management challenges of troubled credits by insisting on a quick sale, rather than backing a more time-intensive turnaround process.