The New Dawn of Portfolio Management
Link to article here.
Portfolio management has become the most dynamic position in the asset-based lending industry. It is also the most powerful position in ABL because it comes with the power of the red-button: liquidation. The complexity of this position went from the equivalent of a two-lane road to a six-lane highway in just a matter of years. The demands and responsibilities on portfolio managers have increased exponentially as the ABL product has become more mainstream within the institutional lending community. Private equity and credit funds are leading the charge as they incorporate ABL structures into more deals. Another driver that should not be underestimated is that in today’s day and age most lower-middle market businesses get their working capital stretched, which just adds to the risk involved. This creates a much more challenging and dynamic environment where ABL firms have to deal with tighter working capital, more financial products, and multiple constituencies that are not always aligned.
Portfolio managers might now deal with three different constituents in any given sponsor backed deal: a unitranche partner, a private equity owner, and company management. Each of these different constituents has a different agenda and is in constant communication with the portfolio manager (PM) or the relationship manager (RM) who works under the PM.
As an example, just look at an increasingly common private equity structure with a unitranche solution that partners a business development company (BDC) or credit fund with an ABL. The PE firm is clearly looking to maximize value within a typical hold period. Meanwhile, management (or in some cases the founding family) has a different agenda; and, the unitranche split-lien partner is looking to make sure its capital is secure. Now, magnify this across a sizeable portfolio.
This scenario is playing out all over the lower-middle market now, and it is transcending the industry. The modern-day portfolio manager has to have a full understanding of complex deal structures, new legal documents such AALs, and intense time management skills. Most successful PMs at larger ABL shops manage a team of ten RMs that collectively manage 50-100 credits. Assuming each handles the low end of 50 credits, at a low-dollar amount of $10 million per funded facility, we’re talking about a total of $500 million in funded facilities. This is just for a regional division of a large ABL shop.
In today’s environment those 50 credits would include a constant stream of mergers and acquisitions, refinancings, and a wide array of unforeseen working capital needs, among other things. This creates a busy environment as these teams are always dealing with requests ranging from amendments to more complex transactions to evaluate such as acquisitions.
Portfolio managers need to rely on a good team; but they must also demonstrate tactical skills and conceptual thinking in order to keep the training running. It also helps to have a minor in psychology for the relationship management involved when it comes to dealing with internal and outside constituents.
Judgement, leadership, strong financial and structuring acumen, quick thinking and ability to make decisions are the fundamental qualifications in order to be successful. Judgement, among all other qualities, is the “X” factor. No PM can ever have access to perfect information and needs to make a decision under real duress. There is no upside for the ABL, given current market spreads. There is only a downside.
The costs and burdens of bankruptcies and liquidations are high for already over-worked teams. Successful portfolio management involves having the judgement of knowing when to finance an over-advance, when to call in a firm like Super G to do the stretch piece, or when to pull the plug and know reverberations that will result. This is typically a decision involving a sponsor-backed company, and is not so prevalent among family-owned businesses.
On one-hand, PMs are dealing with highly sophisticated credit funds and PE partners who have strong documents, the ability to take their business elsewhere, and the best legal counsel money can buy. On the other hand, many portfolios still contain mostly family/entrepreneur-owned businesses. This is the exact opposite scenario. Most of these folks are highly unsophisticated when it comes to finance and have little intellectual curiosity for it. These folks are also typically highly illiquid, as their capital is tied up in their business and/or real estate. Their ABL is their main capital provider, and plays the role of capital partner since there is typically not a lot of other capital support.
These are typically longstanding relationships that go back years. Talk to a PM in the Midwest and ask how many businesses they and their teams have saved given the cyclical nature of many of these businesses. The non-PE backed businesses pose the greatest risk, but they also form the bedrock of many of these portfolios. Despite these business owners having accountants, lawyers and investment bankers they all seek the counsel of their PM. We have seen this first-hand where the PM had the final say when it came to the financing options of a portfolio client.
The PM has skin in the game and, at heart, has a strong desire to see each client succeed. In today’s world there are so many financing options for companies seeking capital–including real estate sale leasebacks, second lien loans, mezzanine debt, and equity, among others. Most business owners simply can’t discern the potential implications and ramifications. The PM is literally the last line of defense to stop a business owner from entering into a decision that cannot be undone.
PMs have played a seminal role in Super G’s success in terms of shaping our product and helping us to become a mainstream product. Consent is needed from the senior lender in order to structure and provide a stretch piece. The PMs have to be comfortable recommending the product to a client and they need to know how to administer it. Our business has gone through several iterations as part of PMs sitting down and auditing our business model.
The role of portfolio manager will continue to evolve as more products and funds pop up. These folks and their teams do the hard work each day while all other parties get the credit and upside.