Mining the Balance Sheet

In late February, Levitz Furniture emerged from bankruptcy and merged with rival Seaman Furniture, a deal made possible by an asset- based senior loan instead of a traditional bank loan against cash flow. The $95 million loan, extended primarily by Heller Financial Inc., of Chicago, using Levitz's and Seaman's inventory and receivables as collateral, helped the Woodbury, New York-based Seaman buy out its minority shareholders and the Boca Raton, Florida-based Levitz pay off the debtor-in-possession loan that provided operating funds while it was in reorganization.

Why an asset-based loan rather than a traditional cash-flow loan? Although Seaman is profitable, Levitz had no recent history of positive cash flow. Equally important, economic conditions had turned precarious. "With the economy slowing down, the environment is not conducive to getting a cash-flow loan for companies whose earnings may be impacted by the general economy," says Peter McGeough, former CFO of Seaman and now CFO of Levitz.

Yet the same poor economy leaves midsize companies that have been unstable or are experiencing a drop-off in sales in need of liquidity — most often to finance a turnaround, pay down high levels of debt, carry out a bankruptcy reorganization, or finance the write-off of an underperforming operation. And while cash-flow-based, or unsecured, bank loans are not appropriate for these companies, capital from the shaky stock and bond markets may also be unavailable. But for Levitz and a growing number of companies, asset-based loans are increasingly filling the gap. That's reflected in the total number of outstanding asset-based loans, which more than doubled from 1995 to 1999, the most recent year for which data is available.

A Blank from the Bank
In fact, cash-flow-based loans are increasingly out of reach even for many flourishing small and midsize concerns. That's because banks, under pressure from regulators and hurting from problem loans, are imposing tougher standards and higher rates on all borrowers. As a result, borrowers of all kinds are finding asset-based loans more attractive, and the stigma once associated with this type of lending — that it signified a company down on its luck — has all but disappeared.

In the process, companies are finding that assets other than inventory and receivables can be mined for liquidity. Today, asset-based lenders will lend against the value of practically any asset. And these loans are flexible to the borrower in that they include few if any covenants, though some require control over a company's cash. When seeking to extract liquidity from their real estate, moreover, companies will find that yet another alternative — a sale-leaseback transaction that will not encumber the balance sheet with added debt — has also become more attractive.

While demand for asset-based loans has been growing in the past 9 to 12 months, the growth has been most pronounced since the end of third-quarter 2000. In February, Heller's credit committee was discussing two potential transactions a day, compared with one or two a week one year earlier. The increased demand, lenders say, is coming from all regions equally. Over the past several months, Heller has established new lending teams in Boston, Atlanta, San Francisco, Philadelphia, and Toronto, which broaden its scope beyond Chicago, New York, and Dallas.

"We foresaw a little bit of weakening in the economy, which meant a window of opportunity," says John Goldthorpe, an executive vice president at Heller Corporate Finance. Industrial conglomerate Tyco International sees so much potential here that it announced plans in early March to buy The CIT Group, a New York­based commercial finance company, in a deal initially valued at $9.2 billion.

To be sure, troubled companies still account for most of the demand. CIT says that 80 percent of its new business involves debt restructurings, compared with 50 percent a year ago. Not surprisingly, this demand is greatest in the industries experiencing the most stress — specifically, retail, telecommunications, technology, and media.

But asset-based lending is also attracting young growth companies that don't have a long enough history with a bank to get an unsecured loan, especially in a tight credit market. Case in point: CLP Resources Inc., a Reno, Nevada-based staffing services firm. CLP has more than doubled in size since the late 1990s, to $114 million in revenues last year, and has been pumping profits into working capital to fuel growth. Last November, the company needed to borrow to acquire another temporary-staffing firm. It was able to get a $25 million, three-year facility from Fleet Capital Corp., a unit of Fleet Financial, that was not as restrictive as some asset-based loans in that it allows the company to control its cash accounts, says executive vice president and CFO Bud Little.

While most borrowers are small and midsize companies, large, cash-starved companies have become a definite presence in the market, borrowing $250 million and more at a shot. For example, the $800 million that U.S. retailer Ames Department Stores Inc. recently secured in senior secured financing from General Electric Capital Corp., the finance arm of General Electric Corp., is backed by its inventory, receivables, and real estate. Xerox Corp., struggling to reduce a crushing debt load, is another example, having received $435 million in 18-month financing, also from GE Capital, against the company's U.K. portfolio of lease receivables.

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