Recalibrating How Businesses Approach Collateral Valuation and Realizations
By Jeff Wacker, Head of U.S. Asset Based Lending Originations, TD Bank, with contributed insights from Bob Maroney, President – Commercial and Industrial, Gordon Brothers, David Peress, EVP, Hilco Global Retail Solutions, and Mike Petruski, EVP & General Manager, Great American Group.
The economy is growing steadily, but asset values have continued to fluctuate. These fluctuations present a challenge for businesses and lenders trying to properly evaluate the value of assets in support of an asset-based loan.
At the 2018 CFA Asset Based Capital Conference, Jeffery Wacker, Head of TD Bank Asset Based Lending Originations, led a panel which discussed this challenge and potential solutions for businesses. On the panel were several experts in collateral valuation and disposition who shared their views on what drives actual values and what to expect in 2018 based on their experiences across various industries ranging from Retailers to Industrial companies, including inventory, equipment, intellectual property and trademarks valuation.
The panelists included:
● Bob Maroney, President – Commercial and Industrial, Gordon Brothers
● David Peress, EVP, Hilco Global Retail Solutions
● Mike Petruski, EVP & General Manager, Great American Group
Amongst a wide-ranging set of topics, some key questions surfaced.
Q: What have we learned from last year in terms of valuation and liquidation, aka a “realization”?
Jeff Wacker: The last year has seen continuation of a multi-year trend of relatively low default rates in the financing markets, which means that not a lot of asset realizations are being tested. But this won’t last forever; the economic expansion has been underway for several years. We have seen the most activity first in energy-related fields and also in the retail sector, ranging from strategic store closings, reorganizations in bankruptcy to liquidations.
The overall lesson is the accelerating rate of change in many industries. For those specializing in asset valuations or relying on assets for lending, this change means that it is increasingly important to understand the current value of collateral and to have a robust appraisal process. Having a security interest in everything pledged as collateral is a must. Equally important are the requirements necessary to support the valuations in the event that you must realize the assets pledged. These support mechanisms should be put in place on day one and maintained throughout the realization event. Good coordination and communication between the lender, borrower and appraiser is needed to make sure the appraisal process provides all invested parties with the best options that can be implemented with confidence.
Fortunately, technology has contributed to a more efficient process in conducting appraisals. It’s now possible for some companies to have a real-time listing of key working-capital assets like accounts receivable and inventory, allowing for efficient reporting to both lenders and appraisers.
Q: What are the biggest disruptions affecting the retail and consumer products industries today, and how will these disruptions impact realizations in 2018?
David Peress: Technology continues to be the largest driver of change in the consumer products market. Consumers now have enhanced accessibility to brands across multiple channels, which include digital channels, social media, virtual and interactive media. The most successful retailers are those that are able to provide customers with positive experiences across channels while at the same time extracting and using customer data and customer-generated content to hone marketing messages and drive activation.
The need to pursue liquidation continues to be driven by companies that have been too slow to pivot successfully into multiple channels, as well as by those retailers in categories where disruptive purveyors of similar goods and services have undermined the retailer’s principal value proposition to its customers. To respond to these challenges, some retailers have been compelled to commence formal insolvencies more quickly to shed stores, rationalize working-capital investments and eliminate debt. The value of some consumer brands have plateaued or are decreasing as fewer doors exist for the distribution of branded products and technology giants such as Amazon and Walmart continue to compete for dominance in the omni-channel retail landscape. That said, the consumer continues to respond positively to going out of business (GOB) and Final Sale messaging across channels, specifically the e-commerce channel in GOB events, supporting inventory recoveries in multiple distribution platforms.
Q: Do you anticipate an increase in M&A activity this year? If so, which sectors will see the most consolidation?
Mike Petruski: In 2018, we expect to see an increase in M&A activity in the construction and energy industrial verticals. Companies with strong balance sheets will look to acquire complementary assets and services that will keep pace with infrastructure spending, industrial plant construction and maintenance, and E-commerce build-to-suit properties. There have been a number of such deals in recent weeks. For example, Granite Construction Inc., one of the nation’s largest infrastructure contractors and construction materials producers, recently acquired Layne Christensen Co., a leading water management, infrastructure services and drilling company, for $565 million. And in late January, H&E Equipment Services agreed to purchase Rental Inc., a non-residential construction equipment rental company, for $68.6 million in cash, building on a similar $122.4 million deal late last year.
The U.S., in particular, is seeing increased foreign investment in manufacturing, with Toyota Motor Corp. and Mazda Motor Corp recently announcing a joint plan for a $1.6 billion automotive manufacturing plant in Huntsville, AL that will employ over 4,000 employees and produce 300,000 vehicles per year.
All this M&A activity has far-ranging implications for future dispositions and liquidations. Although industrial inventory and machinery & equipment appraisals typically involve the liquidator selling the assets on a fee basis, more lenders, typically represented by a chief restructuring officer (CRO) in an orderly liquidation, are requesting guarantees on the asset values. The composition and condition of the equipment assets at the time of liquidation may be lower due to deferred maintenance, or lack of use, etc.
Q: How are the current lending and liquidation environments impacting appraisals for asset-based lenders?
Bob Maroney: One of the more interesting developments we continue to see in the ABL market is the narrowing between a “fee-based” approach to the appraisal and the expectation that, in a liquidation, equity bids will be received in line with the appraisal. There is also an absolute expectation on the part of most lenders that the firm that performed the appraisal will offer an equity bid should there be a liquidation of those assets. Although many appraisals are performed only as a "fee-based" assignment and do not reflect equity risk on the part of a liquidator, the definitive expectation by most lenders is that the appraisal firm will bid equity if asked to do so at a later date.
Of course, there are still some instances where a firm’s appraisal is not supported by an equity bid or, in some cases, no bid at all. This has ultimately forced some appraisal/valuation firms to work much closer with their in-house liquidation partners. The result is that more ABL appraisals are becoming reflective of real-time liquidation results.
The premise for an appraisal – equity bid or not – should be considered as part of a lender's strategy. Frequency, scope and premise for the appraisal are important components of determining value and recovery.
Q: What should companies do to capitalize on the current lending environment?
Jeff Wacker: The lending environment is always changing, so companies should keep an open dialogue with their lenders to gain a better understanding of how their assets can help support their financing needs.
I think there’s also a growing realization among businesses that collateral is more than just accounts receivable, machines and inventory. Some borrowers have entered into ABL loans that include intellectual property and trademarks. Given the still-evolving economic landscape in the U.S. from an inventory-intensive manufacturing focus to a leaner just-in-time inventory model, even for distributors, I believe we’ll only see more of these types of agreements. In particular, both foreign-owned businesses with a U.S. presence and U.S. importers that may not have domestic factories could still use ABL to help finance their working capital needs in a very efficient and flexible manner. Financial executives in this position should identify a strong, strategic partner who brings deep industry expertise and has the ability to provide extensive collateral experience.
Companies can benefit from the relative health of the current economic environment and the increasing sophistication of the asset-based lending community to reevaluate their balance sheets and best position their business and meet their future financing needs.