Structured finance: Asset-backed lending

Asset-backed lending covers all manner of sins: from shipping to commodities, real estate to art. If there’s something that can be sold, lenders can secure debt against it. And, increasingly, institutional investors can finance it.

Tying the credit line to a specific asset that will cover the debt in case of default usually means cheaper financing for the borrower. Although, another inevitable outcome is that it introduces the potential for some of the most dizzyingly complex debt transactions, such as completely off balance sheet transactions that are structured as asset sales, but ultimately are a highly structured form of credit.

Commercial real estate debt is probably the most accessible form of asset-backed lending. Most people take a mortgage out to buy their house and the commercial end of the business, while more sophisticated, works on the same basic concept.

Start introducing different assets as security and the complexity quickly ratchets up.

The providers of asset-backed loans, from the vanilla to the most highly structured, are a mixed bag. Many European banks have large structured finance teams that break down into different specialities such as receivables, equipment or commodity finance. On the flip side, there are a substantial number of non-bank providers that have happily operated in this area for decades.

Most of those, though, focus on invoice discounting or factoring, which both fall under receivables financing where the lender secures the debt against money owed to the borrower. Around 80 percent of the ABL market in the UK and Ireland is secured against receivables, according to the Asset Backed Finance Association.

Growth in asset-based lending for mid-market corporates is focused elsewhere, however, and borrowers and investors alike view the market as an opportunity as ripe as the vanilla leveraged finance markets that have attracted the bulk of institutional investment.

And while the market is expanding in a wide sweep of different directions (see panel), on the corporate side, there’s a clear trend for private equity-backed companies to finance their acquisitions or refinance more expensive debt with asset-backed loans.

“Over the last six years, ABL has gone through a journey whereby, given Basel III, it has become more expensive for lenders to cashflow lend, and if they lend against an asset the capital charge is much lower for banks,” says Floris Hovingh, head of alternative lender coverage at Deloitte.

“So increasingly we have seen ABL being used more for positive situations like M&A, refinancing and to finance private equity-backed companies. Ten years ago ABL was either used by companies with large debtor books trying to obtain the cheapest form of financing or, alternatively, used by companies facing cashflow problems and being locked out of other debt products.”

That trend extends to unsponsored companies too but for private debt managers still focused on mid-market leveraged finance, its use by sponsored companies is interesting. So much so that London-based ICG has poached Wells Fargo’s Steven Osborne, who was until recently a director in the US bank’s European technology finance group, PDI understands.

While ICG declined to comment on whether it has hired Osborne, market sources say ICG is widening its offering to include asset-based loans alongside more vanilla senior secured cashflow loans.

Already active in that area is Investec. Gary Edwards joined to set up the private bank’s asset-based lending capabilities in 2005 from GE Commercial Finance Europe.

The growth and acquisition finance team that Edwards is part of offers UK-based corporates with EBITDA of £2 million ($2.8 million; €2.5 million) and up a combination of revolvers, receivables and inventory finance to cover working capital but topped up with cashflow loans to support investment.

“We spend our time competing with the leveraged finance market and look for businesses where we can out-structure the leveraged finance market because that’s one of the most limiting things in UK banking,” says Edwards.

Traditional leveraged loans take a debenture over the whole business. But loans with top-line security over specific assets that have been through full due diligence and valuation, offer borrowers cheaper terms and better allow for working capital needs.

“Our structure sits in the middle [of pure asset-backed loans and standard leveraged loans]. It is not only able to provide a greater quantum of debt than either of those two groups, but we can do it in a way that means the amortisation requirement is a lot less and the working capital is evergreen,” says Edwards.

The pricing of Investec’s combined ABL and cashflow financing packages varies from deal to deal, says Edwards, adding that interest rates are roughly 300bps-400bps, but the bank has charged both more and less depending on the structure.

With juicier returns up for grabs from the same borrower in a straight corporate deal, some may query the choice to invest via the more structured route. Andreas Povlsen, chief executive of Breakwater Capital, sums it up: “We try to add an element of structure that we believe gives us a different type of comfort [over straight, corporate-style lending].”

Breakwater Capital is not a mid-market corporate lender, but through its partnership with UK-based alternative lender Hayfin, the deals Povlsen and his team source are funded by a pool of capital that also deploys into mid-market European leveraged credit, namely Hayfin’s European direct lending fund.

Some of the roughly $400 million-$500 million deals Breakwater has executed and is currently working on with Hayfin were also financed from Hayfin’s special situations pooled fund and separately managed accounts run by the lender.

Lower yields are not the only issue that many institutional investors may struggle with when contemplating the asset class. They, and any managers looking at ABL must count the cost of doing it properly.

“It is a very operationally intensive process in terms of monitoring. It’s not like a cashflow loan where you put out the money and six years later you collect,” says Hovingh.

Running, not to mention building, the infrastructure to support the labour-intensive monitoring of assets is expensive. 

For those willing to combine cashflow and ABL finance, though, there is a rich seam of companies with strong asset bases to use for financing. These days Deloitte’s debt advisory practice ignores the ‘lender of last resort’ tag that used to dog ABL and presents secured options to likely borrowers.

Deals showcasing the strength of ABL for private equity include the financing for Sun European Partners purchase of flower and vegetable grower Finlay Flowers; Exponent’s acquisition of Scottish whisky distiller Loch Lomond (where asset value increase, rather than depreciation was a factor at play); and the €37 million financing package for

IGM Resins provided by unitranche lender HIG Whitehorse and ABL provider Deutsche Bank (which won PDI’s European deal of the year for 2015). 

IGM Resins has a complex corporate structure and assets scattered across the globe, building a deal with a series of intercreditor agreements took two lenders, five law firms and debt advisor Altium to get over the line.

And just like unitranche deals provided by more than one lender, the intercreditor issues are the biggest problem, says Hovingh.

“This is where the main friction is. At what point in time can the ABL lender step in? The cashflow lenders will want to separate the ABL assets from their collateral and have no cross linkage between the two products except for cross acceleration. In short, cashflow lenders would like the ABL lenders to keep funding, as long as there is sufficient collateral protection to avoid a liquidity hole for the company,” says Hovingh.

And that’s why, for the moment at least, the lenders like ICG and Investec and some of the high street banks that can structure and provide both the asset-backed slice and the cashflow loan, will retain an edge with asset-rich mid-market borrowers. 

ABL SECURITY PICK ‘N’ MIX

“A ship is not just a ship,” says Breakwater Capital’s Povlsen. “A product/chemical tanker can, for example, have a different number of tanks, different coating that can mean it can carry different types of cargoes, it can be built at a top tier Japanese yard or a tier three yard in China… Those different factors will have a huge impact both on the resale value but also the liquidity of that asset in case you need to enforce or perfect your security. Detailed asset knowledge is really crucial.”

And in shipping finance, supply and demand dynamics play a massive role. Lenders must also understand the scrappage value of an asset just as they have a view on the resale value and what markets it can be used to serve.

In October, The Carlyle Group teamed up with Geneva-based asset manager Pictet Group on Athena Art Finance Corp, a specialty lender focused on providing secured loans for the acquisition of fine artworks. The pair put $280 million in equity capital into the new joint venture which will provide loans with a loan-to-value of up to 50 percent. 

Aircraft finance is the core offering of ablrate.com, a marketplace lender. It also finances container leasing, marine and trade finance, among other asset specialisms. While open to retail investors, the platform is seeking strong capital partners to help back the substantial aircraft leasing deals the founding team source and syndicate on an online platform that includes a secondary market.