Funding Strategies to Meet Today’s Liquidity Challenges

by S. Scott Gates and David D’Antonio October 2008
Every quarter we are seeing the effects of a shaken economy — whether from rapidly decreasing earnings reports or in millions of dollars in write-downs. But how is the economy affecting independent financing companies? How have they had to change their lending practices?

According to the financial press and reporting agencies, the major banks have reported massive cuts in the value of their debt portfolios. The Asset-Backed Alert dated July 25, 2008, reports that the write-downs of the value of asset-backed investment of the worlds’ largest financial institutions have exceeded $300 billion. This list takes into account 44 financial institutions that have reported pre-tax write-downs of $500 million or more on structured securities and assets since the beginning of 2007.

Subsequent to the publishing of the source material, Merrill Lynch announced that it will record a pre-tax write-down in Q3/08 of approximately $5.7 billion related to the sale of a substantial majority of its U.S. ABS CDO positions.

The table on the left includes many lenders to the specialty finance industry including structured/capital markets lenders, which have provided commercial paper facilities and have structured asset-backed securities. Along with the above detailed write-downs that lenders have experienced, the credit insurance companies, which have traditionally provided insurance on structured term securitizations, have also recorded substantial losses.

Many regional and community institutions that also lend to the specialty finance industry were not listed on page 38, but they are being impacted by the events in the capital markets. The impact on regional and community lenders was not immediately seen, as many of these lenders continued to lend, in many cases aggressively, to the industry. In recent months these once aggressive lenders have also shown less of an appetite for lending to this industry.

Non-bank lenders to the specialty finance industry, which are largely dependent upon the capital markets to fund their businesses, have attempted to remain active lenders to the industry, but have been forced to scale back their activities.

All of this points to a contraction of the pool of funding available to the specialty finance industry. Smaller … yes. None … no.

Below are a couple of examples of how the contraction of funding and the unrest in the credit markets have impacted the funding of independent finance companies.

A five year-old lessor has a partial recourse funding relationship with a lender that has aggressively lent to the this market in the past couple of years and was scheduled to fund its fourth takedown in Q1/08. The funding proceeded as typical with borrowing documentation prepared and executed. The day before the scheduled funding the lessor was informed that funding of the schedule would not take place on the following day and had not been rescheduled for a future date.

After additional discussions with the lender it became clear that they had no intention of rescheduling. Because the lessor had planned for this funding, they had limited capacity to fund a new origination. The lessor traveled to the lender’s offices to appeal its case. The visit was fruitful, but came at a cost. Historically, the lending structure had a rate between 150-350 basis points over like-term swaps, an advance rate equal to 105-110% of the lessor’s investment and with a recourse position of 15%. The lender agreed to provide the funding at a rate in excess of 500 basis points of like-term swaps, an advance rate equal to 75-85% of the lessor’s investment and with a recourse position of 50%.

A 15-year-old leasing company has grown its funding relationships to include commercial finance companies, banks and structured/capital markets lenders. The access to a larger pool of funding partners, capable of providing larger funding commitments, had enabled the lessor to grow originations and increase its managed portfolio to more than $250 million. A large structured/capital markets lender committed to provide the lessor with a facility of more than $100 million, of which 45% was outstanding under term borrowings as of the end of Q3/07. In Q4/07 the lender indicated that borrowings under the committed facility were not available.

In Q1/08 the facility was not renewed and repayment of the term borrowings were demanded contrary to the terms of the borrowings. In order to allow the lessor to continue to fund new originations, it has had to enter into borrowings with other lenders, having to structure smaller loans at lower advance rates and at borrowing rates in excess of 450 basis points over the like-term swap, as compared to borrowing spreads in 2007 of 200-300 basis points.

These examples demonstrate the fact that securing funding has grown more difficult, but not impossible. Lenders are incented (compensation, promotion, etc.) to make loans and while this fact might seem hard to believe right now, it is the truth.

In today’s funding markets the borrower needs to do a little more work, companies need to be proactive in their efforts to establish funding relationships. The majority of information needed by funding sources is neither mysterious nor complicated. Companies need to assist prospective funding sources so they can completely and accurately present a company to their credit committee. This is important because members of the credit committee are aware of the rash of write-downs detailed above and probably are aware of other lenders that have been hurt by extending credit to this industry.

Because credit officers involved in the approval process might not be particularly knowledgeable of this industry or these specialized structures, they need a complete presentation. Because these people involved in the approval process are skeptical of lending to this industry, they will not stand for an incomplete presentation and will simply decline proceeding with a transaction. When these credit officers are given full disclosure and complete information they are able to offer the most advantageous terms to the prospective specialty finance company.

For all lenders, borrowers should provide, on a quarterly basis, a financial summary, including at a minimum the following items:

  • Financial statements
  • Detailed aging of their entire managed portfolio
  • Static pool loss analysis
  • Reposed equipment inventory analysis
  • Debt facilities usage schedule
  • Management overview discussing the activities of the past quarter, and commentary of the events that will impact the company going forward

The funding market has drastically changed in the past year with companies in the market needing to understand that structures and terms have become less advantageous. Just as in good funding environments, companies should not only pursue terms and structures, when considering entering a new funding relationship, that work for their businesses, but a goal of the process needs to be to diversify funding sources and develop new ones. As we have seen in recent history, funding sources have come and gone, specialty finance companies should look to develop and maintain deep and mutually beneficial relationships with their funding sources.

S. Scott Gates is a director at Diversity Capital LLC, and joined the company in February 2000. He is in charge of arranging and advising on financing products for Diversity’s clients. Prior to joining Diversity as a founder, he was a vice president at First Union and CoreStates Bank for more than nine years, where he handled client relationships as a lender, securitization manager and as a commercial officer. He has implemented and managed asset-backed securities financing, commercial paper financing, limited recourse lines, treasury management products, warehouse lines, committed facilities and derivatives. Gates holds Bachelor’s degrees in Economics & Government and Law from Lafayette College. He can be reached at 856-303-8100 or by e-mail at

David D’Antonio is managing director and founder of Diversity Capital. He is in charge of marketing and Diversity’s overall corporate strategy. Prior to forming Diversity, D’Antonio was a director at First Union Capital Markets and a senior vice president at CoreStates Bank, where he was responsible for the management and development of the Lease Finance Group. During October 2001, D’Antonio completed a four-year assignment on the board of directors of the ELA, and has been involved in a number of finance industry groups at the most senior levels. He has also recently written a number of articles about liquidity and leasing in The Equipment Finance Journal and the Monitor. D’Antonio graduated cum laude from LaSalle University in Philadelphia (B.S./Finance) and Drexel University (M.B.A./Finance). He can be reached at 856-303-8100 or by e-mail at

Diversity Capital LLC (, is headquartered in Cinnaminson, NJ, and is an eight-year-old boutique investment bank that specializes in asset-backed advisory, origination of structured credit facilities for specialty finance companies, portfolio financing, M&A advisory, crisis management, individual transaction structuring, and portfolio liquidation/workout. Diversity has assisted in over $1.5 billion in financings for a variety of companies including commercial, consumer and other specialty finance companies.

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