Growing evidence suggests that U.S.
companies are poised to increase capital
spending after years of restraint. In
fact, The Wall Street Journal and the
Equipment Leasing and Finance Association have identified 2014 as the year of
renewed capital investment.
Unfortunately, thousands of middle-market and mid-corporate companies
that operate with elevated financial
leverage may not be able to participate
in this long-anticipated growth. Although
the asset-based lending community has
traditionally been the backbone of liquidity for highly leveraged companies, asset-based lenders and their facilities have
limitations that in some cases may not
adequately address the increasing capital
needs of highly leveraged companies.
First, ABL facilities limit the extent to
which borrowers can optimize the value
of fixed assets. Available advance rates
on these assets are either non-existent
or—at best--significantly lower than the
advances for accounts receivable and
inventory. Even when ABL facilities allow
companies to margin fixed assets, caps
or baskets usually limit eligible amounts
within the borrowing base.
Further, financing equipment on an
ABL line does not efficiently match a
borrower’s assets and liabilities. It simply
does not make sense to fund longer-lived
assets with a shorter-term, floating-rate
funding facility whose collateral consists
largely of short-term assets.
So who can help highly leveraged
companies acquire the essential equipment they need to grow? The answer
may surprise you: Asset-based lenders
working in partnership with equipment
Equipment Financing Challenges
Both asset-based lenders and equipment
finance companies have had difficulty
financing large-ticket equipment purchases for highly leveraged companies,
albeit for different reasons.
It makes sense that asset-based lend-
ers have played a vital role in providing
liquidity to single-B rated credits. Lever-
aged companies pose a higher prob-
ability of default. Highly collateralized
structures such as ABL facilities provide
lenders with a very low loss-given-default
But asset-based lenders are traditionally more comfortable lending against AR
and inventory. They are understandably
reluctant to finance equipment for highly
leveraged companies in a meaningful
way, especially since their traditional
underwriting methodology and collateral
analysis have been based predominantly
on the value of short-term assets.
Improving asset-based lenders’ ability
to provide meaningful equipment financing would require that they become more
liberal with eligibility requirements or
attach equipment term loans to existing
Neither is likely to occur. In addition to
being a departure from typical ABL structures, the current regulatory environment imposes increased capital requirements and leveraged lending guidelines
that will likely limit the extent to which
banks can address highly leveraged
companies’ growing capital needs –even
under ABL structures.
Until recently, asset-based lenders
that looked to the equipment finance
industry to serve their highly leveraged
middle-market clients found few willing
partners. The reason lies in structural
changes to the industry.
Before the financial crisis, commercial
finance and independent leasing companies provided much of the equipment
funding capacity for single-B credits. But
the dislocation in the capital markets had
a sustained impact on providers’ funding
models and made it very difficult, if not
impossible, for commercial finance and
independent leasing companies to fund
into highly leveraged companies. The
only truly available equipment financing
has been, and continues to be, provided
by bank-owned leasing groups that are
generally restricted to financing higher-rated companies.
As a result, since 2007, most highly
leveraged companies have had few real-
istic equipment-financing alternatives.
They could either stretch their fixed asset
replenishment cycles or fund equipment
acquisitions on a limited basis through
their ABL facilities, albeit at a significant-
ly lower advance rate.
The New Partnering Solution
This landscape is changing. The equipment finance industry is beginning to
see the emergence of providers that offer viable solutions for highly leveraged
companies. For the first time in many
years, ABL lenders can partner with non-bank equipment finance providers to
address the cap-ex needs of their single-B-rated middle-market clients.
These new equipment finance
companies understand the challenges
facing highly leveraged companies and
specialize in funding into them. Not only
are they prepared to advance a higher
percentage of the underlying equipment’s fair market value, these equipment finance providers also understand
the critical-use nature of the equipment
and often rely on structures that permit a
broader underwriting approach especially suited to highly leveraged companies.
True leases are the most common
equipment financing structure for single-B-rated companies and offer lessors the
statutory protections of an executory
contract in a bankruptcy. True leases also
include provisions that generally require
a debtor to decide whether to assume
or reject the lease within a short period
of time. This is significant. By taking the
structural protections of a lease into account, equipment finance companies can
not only consider the value of the underlying equipment to mitigate credit risk
but also–and often equally important–
consider the equipment’s significance to
the lessee’s operations.
This widens equipment finance providers’ underwriting box, because they need
not assume that a Chapter 11 filing is a
doomsday scenario. Rather, an equipment finance provider may determine
that the equipment is so essential to the
debtor’s operations that, even if a Chapter 11 filing occurred, the debtor would
continue to make lease payments and the
lease would likely be affirmed.