The day after tomorrow – Article

The day after tomorrow is a 2004 science fiction film starring Dennis Quaid and Jake Gyllenhaal. The film depicts a series of extreme weather events that cause most of the Earth to be covered in ice, except for a small portion. To connect this to the world of commercial finance, a series of events, or in this case acquisitions, led to the market being covered by larger banks and non-bank ABL firms focused on scale. The clear end result of the series of events in commercial finance is the consolidation in both the bank and non-bank ABL world. This has of course led to fewer but much larger firms covering the majority of the market, resulting in $20 to $30 million facilities becoming the new $10 million facility. These trends create opportunities for firms that can now service companies that are still large but need a smaller facility from a sophisticated lender. While there are certainly companies that still offer smaller venues, it’s not like it was before the wave of consolidation that occurred over the past decade. That means there’s a lot of competition in the high-end and low-end ticket markets, but less competition for mid-range venues that still require advanced technology.

A decade ago, banks and nonbank ABLs like First Merit, Marquette Business Credit and First Capital, among others, were established as leaders in the lower middle market of ABLs, defined as $20 million or less in facility size. Let’s examine the series of events that led to each company becoming larger. Within a few years, the First Merit team went from managing First Merit’s ABL group to managing Huntington National Bank’s ABL group, which included the acquisitions of First Merit, TCF and Chemical. The end result of these acquisitions is now a bank-ABL group with the scale, national reach and ability to compete with the largest banks in the country. Marquette was acquired by UMB, and First Capital and Keltic were acquired by Ares. All of these companies are now multibillion-dollar ABL groups. The regional bank-ABLs wanted the ability to compete nationally and compete with the largest banks in the country, and the BDCs wanted the ability to go to market and build larger platforms. Remaining small and serving a smaller segment of the market would not allow them to achieve this goal. These trends are undeniable when you look at the purchase prices paid, the significant increases in transaction size and the ultimate desire of banks and non-banks to move to the next level.

There are many other examples of consolidation creating scale because it is difficult to grow serving smaller customers. This trend has clearly affected both banks and nonbanks in exactly the same way. Just look at recent bank consolidations that compete with nonbank consolidations: Truist (SunTrust and BB&T), Fifth Third Bank and MB Financial, Columbia and Umpqua, People’s and M&T, CIT and First Citizens, and the list goes on. Compare this to the equally long list of ABL acquisitions of nonbanks that created much larger organizations in the race for scale. The challenge of properly serving the lower end of the market is that it requires the same level of sophistication as $100 million ABL facilities. The same team that can originate, underwrite and manage a $10 million facility is just as capable of managing a $50 million or $100 million facility. Many companies prefer to focus on scale because the current market is characterized by greater sophistication, lower risk premiums, and greater risk.

Contrast this with the really small deal lenders who are typically pure AR lenders who may even use a factoring-like structure, advertised as ABL, to protect themselves from potential bankruptcy risk. There is a confluence of “factoring” firms in the small deal space, but this solution often doesn’t work for firms that have become underserved by larger firms. This helps explain why there are many pure AR small deal firms and many large deal firms, but fewer true ABL firms serving the lower middle market. To effectively serve the lower middle market with a traditional ABL product, you need the capital, team, and credit expertise to handle it.
Most cycles tend to be the same, as companies that start small end up migrating to a higher market segment as they scale or are acquired. This has happened massively in the ABL world and have created pockets of competition for both big and small tickets, but in turn have created opportunities. Expect new companies with an entrepreneurial approach to the market to fill this void. Big ticket ABL has taken on a life of its own with product changes and sponsors calling in, but serving lower-middle-market entrepreneurs hasn’t changed. Companies may have less liquidity, but they’re also less complex and want a lender comfortable with handling smaller loans. This void won’t last long.

The end of the film begins with a satellite image of the Earth showing a transformed surface of the Earth, now with ice sheets stretching across most of the Northern Hemisphere. We have already been through a decade of a series of consolidation acquisitions that have blanketed the market with many large companies. If someone took a satellite image of the industry from above, they would see that much of the industry is blanketed by larger companies focused on scale and a smaller number of advanced companies focused on the lower middle market. The change in scale will create new opportunities in the market for advanced companies capable of serving the lower middle market. The day after tomorrow has arrived – take off your jacket, because as the ice melts, another land grab will occur.