A growing number of banks are providing hybrid facilities that combine asset-based loans (ABL) with special purpose vehicles (SPV).
These facilities, which multinational European companies have been using for more than a year, could give asset-based lenders in the U.S. safer choices in the market, their proponents say.
While they have many of the characteristics of traditional asset-backed loans, these facilities' hybrid nature provides access to funding in a wider range of overseas jurisdictions. Also, these facilities could become a popular way for distressed U.S-based companies with European subsidiaries to find much needed capital during the credit crisis.
These hybrid transactions combine revolving asset-based loans - which can be collateralized with a range of assets, including trade receivables (the debt that a company's customers owe it), inventory, real estate, plants and machinery - with SPVs.
The purpose of packaging a company's securitized assets into SPVs is to protect lenders in European jurisdictions with weak insolvency rules. This has been a classic technique in the commercial paper market, where CP conduits would regularly purchase short-term assets through SPVs. This new hybrid structure has been coined by some lenders as "securitization-lite," and does not require any approval from the rating agencies in the ABL framework.
Insolvency is an asset-backed lender's biggest concern; European countries do not have the same type of protection Chapter 11 provides in the U.S. These hybrid structures open up the possibility for corporations, including some in emerging market countries with multiple operations and subsidiaries overseas, to get larger loans.
"This is something that has developed organically out of necessity. Certainly, if you're a collateral-based lender - if you lend against the value of collateral - and you want to go into other jurisdictions that you're uncomfortable to lend into, this hybrid is the natural progression for you," said Dominic Griffiths, a partner with Mayer Brown International, an international law firm which has been the primary law firm involved in the development of these hybrid structures.
Mayer Brown's role is to act as consultant and to create the documents needed to do these types of transactions. "I think in troubled times like these, and in particular where there's a need to gain more depth in terms of syndication, third-party providers like [Mayer Brown] assist in helping the market - meaning ABL lenders - understand that these types of deals needn't be too complicated," Griffiths said. "There is a way of executing them to be efficient. We are looking to simplify the loan documentation, making it U.S.-friendly, thus getting the wider investment community more comfortable with European deals in general."
The main players in this hybrid market are JPMorgan, GE and Bank of America. HSBC in September expanded into the European ABL market, appointing Graham Moffitt, who has more than 20 years of experience in ABS lending, to lead the group. It couldn't be determined if HSBC and the other banks are working on any new hybrid structures; calls to the banks were not returned by press time. Bank of America and JPMorgan reportedly arranged hybrid structures in August and September, respectively.
For U.S. ABS lenders, and subsequently the institutional investors that invest in the facilities, the introduction of hybrids means more choices.
The benefit of wrapping assets into an SPV is that it protects the lender in the event that the borrower goes bankrupt. The jurisdictions for the SPVs in these hybrid transactions are often in countries like the U.K. or Ireland, where "the laws are sensible with protected regimes. So that way, the lender is less likely to be caught up in insolvency proceedings," said Griffiths. "Another benefit may be the ability to send back cash from European subsidiaries to the U.S., through the ability to fund more of the European assets."
As cash-flow lending becomes increasing difficult to find, distressed companies in the U.S. could see this hybrid structure as a way to access much-needed liquidity. The level of U.S. speculative-grade corporate defaults could be higher than 8% by this time next year, according to Moody's Investors Service, exacerbating the credit freeze in the U.S. Therefore, "inevitably, companies will increasingly be looking at ABL as a funding source, and hybrid structures like this can bring in more liquidity," said Griffiths, who also said that the ABL and hybrid structures are increasingly being looked at by lenders and sponsors in the European acquisition finance market.
Asset-based lending in the U.S. has been steady over the past several years, but surged in the past quarter. From the first quarter of 2004 to the first quarter of 2008, the quarterly volume of asset-based lending averaged around $16 billion every quarter, according to Reuters Loan Pricing Corp./DealScan. During the second quarter of 2008, the volume passed $20 billion. Market participants say that trend will continue.
In Europe, the ABL market continues to be driven from London, where domestic laws help make this type of financing possible.
The number of European companies using asset-backed lending increased by 56% to more than 48,000 in 2007, according to the Asset Based Finance Association.
Attracting buyers to these hybrid structures will center on simplification. Typically, the documents for receivables-purchase facilities, in particular the securitization documents that the CP conduits and rating agencies were used to, can be cumbersome to go through. One would suspect that adding another layer on top of that would make things worse.
However, "[Mayer Brown] has converted the documents into more ABL-friendly forms, so when ABL lenders come into the syndicate they can pick up documents for receivables that look like secured loans," Griffiths said. "There are fundamental differences between the two (asset-backed loans and securitization), but our role is get ABL syndicate lenders comfortable with the securitization part of the structure."
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