"Who's on First?" is a comedy routine made famous by American comedy duo Abbott and Costello.  The premise of the sketch is Abbott comically trying to identify to Costello the names of players on a baseball team that simultaneously leads to misunderstanding and frustration between the two.  Today, there are now enough ABL products to fill an infield with the latest one, First-Out ABL, being on first. The First-Out product is simply an asset-based loan within a term loan originated by a traditional cash flow lender.  It’s also a novel way for a cash flow fund to book a deal without needing to source an ABL upfront.  This product solves many pain points for both sponsors and borrowers in that one term loan can solve for the leverage need and also finance the working capital. The innovation and uniqueness of this product is that term lenders are able to use this structure as a way of getting more liquidity to their borrower without themselves having to write a check. Meaning the term lender now has a built-in, but outsourced, revolver that can fund the working capital.  This product’s rise is correlated with the growth of private credit funds and could not have existed even five years ago.

While this product is new to ABL, the actual product is not new and has long existed in the cash flow world with banks and term lenders partnering together.  What’s new is that the advent of asset managers controlling insurance capital has partly enabled the creation and proliferation of this product in the ABL market. Insurance capital, although just one source, has provided a diversification of funding sources for several of the large fincos to add to their product mix. Prior to insurance companies entering as a significant capital source, the large ABL platforms were all senior-bank funded and many could not get eligibility for the First-Out product in their borrowing bases. This is where today’s new ownership groups, comprised of asset managers, with diverse funding sources and divisions has shaped today’s commercial finance market. Specifically, many asset managers now have both direct lending and ABL groups so the cash flow group is able to source the underlying cash flow loans and bring in their ABL groups to provide the First-Out structure. The diversification and presumably lower cost of capital created a profitable way to fund first-out ABL structures within a cash flow deal. Lastly, the revolver structure within a term loan does provide greater liquidity management flexibility for the client. This essentially provides continuity to the borrower.

The First-Out ABL works pretty much the same way it would on a stand-alone basis.  The ABL sets the availability just like they would in any deal and if things go sideways there is a traditional Agreement Among Lenders (“AAL”), which is the document that governs the relationship between the ABL and term lender.  The risk for the ABL lies with having fewer rights. Unlike most ABL deals, here the last-out lender has more control from a legal documentation perspective. Compared to most situations, the ABL is more worried about the company, rather than the last-out, due to the effective low LTV of the deal. This is largely because the origin of the product and market is really a byproduct of the sponsor-driven leveraged lending world trying to deliver a one-stop solution. Further to that, some of these deals are starting to get done within different groups within the same asset management firm.  Meaning, the direct lending arm might sign up a cash flow and, rather than run a process for an ABL, they simply sell a First-Out to their sister ABL group owned by the same firm. Certainly not always, but it’s starting to happen and the concept works irrespective of whether the term and ABL lenders are owned by the same parent.  It’s really a sponsor coverage cash flow group signing up a deal and having a few go-to ABL groups who have the First-Out product capabilities.

What’s unique about the structure is that it’s really seamless to the client and let’s the term lender achieve its targeted, higher IRR buy letting the ABL get the asset coverage in return for a lower rate typically S+ 400% compared to S+ 700%.  So a three to four hundred basis point spread for the cash flow portion for exponentially more risk.  The math works for both parties as most ABLs are financed by a leverage line and most term lenders are fund structures with a pref model.  The blended math enables the cash flow term lender to deliver one structure to the client.  This is as opposed to split-lien deals where the pricing might ultimately blend, but the pricing and structural differences are transparent to the borrower.

The structural differences between a First-Out and split-lien are meaningful as the First-Out lender truly has all the assets whereas the ABL in a split-lien does not.  The borrower in a split-lien situation also has two different loan agreements and covenant packages to deal with compared to the First-Out product.  The First-Out ABL structure is not a new or novel concept, but the application of it is due to the rise and proliferation of credit funds which specialize in traditional sponsor coverage cash-flow structure.  There are simply too many of these firms out there that have longstanding relationships with the sponsor world that typically does not prioritize ABL.

In the meantime, this new product growing in popularity is a contrast to traditional ABL, enterprise value ABL, split-lien and last-out ABL. True ABL practitioners consider the First-Out product a true enterprise value loan although higher up in the capital stack.  The argument is simple in that buying into a term loan, even with a borrowing base concept, is not true ABL.  Ironically, and to the frustration of in-the-box ABL lenders, First-Out lenders are getting bank-rated credit at more attractive pricing when it’s done this way.  In exchange for bank-rated credit, The First-Out ABL deal ironically faces more legal risk and lack of control risk mitigated by low LTV than liquidation risk.  The true strength of staying power will be when these deals get tested in court and the First-Out ABL lender might either have to liquidate or force the term lender to buy them out or pay them down.

Time will tell if the First-Out product is a cyclical or secular trend, but for right now the product is getting a lot of attention powered by the growth in private credit.  We now know who’s on first, but the question remains what’s on second?