By: Ward Mooney, Chief Executive Officer, Crystal Financial
Back in the spring of 2000, in a conversation over dinner with my good friend and industry colleague, I predicted that yields in the world of asset-based lending would begin to slowly return to the “good old days” and therefore our industry would be able to achieve our traditional financial returns during the next decade. My friend was skeptical that there would be a return to the “good old days,” and we made a bet on where spreads would go over the next several years. It did not take long for both of us to realize that Peter had clearly won the bet.
The asset-based lending industry has been on a methodical and steady journey towards enhanced respectability with the capital markets, as well as broad transparency in the risks associated with true asset-based underwriting. Asset-based lending is now perceived as a “flight to quality” as lenders in diverse institutions allocate capital using complex risk/reward models. This new reality is not necessarily a direct result of the financial crisis that may continue to redefine lending policies, but more the result of a heightened understanding of the value of an issuer’s assets, and the appraisal expertise that has developed during the last twenty years, that clearly articulates the downside risks associated with the asset valuations, and strategies to mitigate the risk of declining value.
Asset-based loans have become a preferred underwriting, both for the lending institution whose primary objective is to manage risk while enhancing revenue, and for the issuer who wishes certainty of execution at the best possible price. Asset-based loans have finally become a respected security that is now aggressively pursued, and respected within the capital markets. The market is assessing the perceived risk of an asset-based underwriting that has not been fully appreciated in the broad capital markets and possibility of risk of loss.
It would appear that asset-based loans are on a path to become a true security that will be easily traded (no covenants), and distributed to investors who appreciate the risk/return that have existed for over 30-years in the asset-based lending community.
It has been a long and remarkable journey for the asset-based lender. Once relegated institutionally, and within the industry as “lenders of last resort,” the asset-based lending teams are now highly respected providers of flexible and low prices debt capital. Ten years ago investors and buyout firms discovered for the first time, that an asset-based debt execution not only provided, in most cases, more capital than the traditional cash flow execution, but also that the structure, economics and flexibility (dividends) were extremely advantageous to returns and capital turnover.
Today, responding to the unprecedented demand for assets and some yield, financial institutions are competing vigorously for asset-based paper, not only first lien secured, but also second lien secured. The recent successful, over-subscribed second lien underwriting by the asset-based lending community for BJ’s Wholesale Club is a remarkable example of the effectiveness and depth of the asset-based execution.
The debt capital markets now recognize asset-based underwriting as a highly sought after security that performs with certainty and can be distributed effectively to a wide variety of investors. Underwritings now utilize a sophisticated, transparent valuation process for assets which is continually updated to withstand various micro and macro economic uncertainties. In addition, large accessible databases now exist that allow for high and predictable advance rates to be ascribed to a wide variety of asset classes which can include accounts receivable, inventory, real estate, leases, equipment and intangible assets.
Asset-based lending is now monetizing the left side of the corporate balance sheet and creating an opportunity for a market eager for yield to invest with confidence. If this trend continues there is a possibility that the mutual fund industry will create “floating asset-based debt funds” as an alternative to other bank loan funds and high yield funds.
Is asset-based lending on a path to the big leagues?