A theme that always comes up in discussions with independent equipment finance companies is access to reliable and affordable capital. Monitor sat down with Kyle Shenton, managing director of the structured products group at Regions Bank, and Brock Wolf, managing director of asset-backed securities at Truist Securities, to discuss capital options available for independents today.
Types of Funding
Smaller independents that start off as brokers generally begin by placing loans and leases with banks or capitalized independents. When these small companies are looking to expand, they often reach out to local banks for smaller financing options.
“We tend to meet companies who have been doing this for a period of time as they’re growing their book of business and look to become more of a balance sheet player,” Wolf says.
The next step up the funding ladder, according to Wolf, is an aggregation line
with either a bilateral line from a larger bank — whether a commercial or investment bank — or a syndicated line from multiple banks. Wolf says these lines come with certain eligibility criteria that give independents a framework for the types of loans they can fund on the line.
Shenton notes that these lines can come in various forms, including recourse revolving credit lines and non-recourse warehouse facilities. “Both of those are bank funded; they can coexist,” Shenton says. Smaller independents may have one or the other, while larger players may take on a mixture of both options.
For non-recourse bank funding options, Wolf notes that many independents create special purpose vehicles that exist exclusively to own and finance loans and leases. Lenders like Truist provide financing to these vehicles.
Once an independent has amassed a portfolio large enough, it can begin to enter the asset-backed securities (ABS) market by working with an investment banking team to structure an ABS transaction and issue notes to the capital markets. Wolf says notes can be divided into tranches or come in a single tranche. The notes also can have the effect of matching liabilities to assets.
“If your underlying loans and leases have a seven-year term, this financing would have a seven-plus-year term,” Wolf says. “These securities amortize down over the life of the transaction as the underlying loans and leases themselves amortize.”
Wolf notes that the end goal for many independents is matching an aggregation facility that allows them to finance their business on an ongoing basis with a term ABS strategy. Once an independent reaches critical mass — anywhere from $100 million to $500 million — it will often refinance aggregation lines with a term ABS transaction and then start over again.
“When you see the long-term independents who are issuing once or twice a year in the ABS markets, that’s really what they’re doing,” Wolf says.
Shenton adds that smaller independents also can access the ABS market on a private basis with a 4(a)(2) private placement structure, which looks very similar to traditional 144A ABS offerings but with a smaller investor group involved.
Another funding option, which Shenton sees utilized more frequently in the fintech space, is what he calls “forward flow asset purchase arrangements,” in which credit funds, asset managers and insurance companies buy the full receivable and either gain leverage on that receivable or hold it on an unlevered basis.
The Quest for Capital
Wolf says independents in search of capital should reach out to banks that serve their markets for an introductory call: local banks and regional banks for small to mid-size lines of credit and larger national banks for ABS transactions or facilities of $75 million or more.
During that initial call, the independent will describe what it is originating, outline its strategy and underwriting criteria and present data regarding what its portfolio looks like today and what it hopes it will look like over the next six to 12 months.
Wolf says the performance of the assets in a portfolio — and the assets the independent has underwritten and sold — are a critical component of the evaluation process. Banks will look closely at levels of delinquency and loss to determine if they have the appetite to underwrite to the independent’s past performance.
Shenton encourages independents to view evaluation as a three-legged process consisting of the corporate credit strength of their company, the performance of the assets in their portfolio and the structure of the financing.
“We evaluate the asset and how is that company originating,” Shenton says. “How are they sourcing their leads? How have they created that top of the funnel? And how is that transaction making its way through the funnel? How are they underwriting it? What’s their risk management? What’s their front-end model? We’re going to evaluate to see if we think those are adequate in terms for predicting risk.”
Shenton notes that funding is also possible for de novo companies thanks to the fact that equipment finance is a well-banked and established asset class.
“If we have the right corporate credit strength and the right management team with the right experience, we have been able to assess what we think is a comparable analysis and base our asset assumptions off of a market comparable analysis on how we think the company will originate their asset,” Shenton says.
After presenting its case to various banks, independents can expect to receive term sheets outlining the proposed terms of the financing. After evaluating their options, independents can often select one or two options, which is when a bank’s due diligence process, usually taking four to six weeks, will kick into high gear.
When due diligence is complete, Wolf says the independent and the bank will choose an experienced law firm and begin to draft and negotiate the revolving credit facility. And as the closing date approaches, the independent will sit down to determine the amount of its initial borrowing. After the deal closes, the bank will expect monthly service reports outlining how much the independent collected that month and what the collateral looks like, among other things.
Over time, Wolf says the independent will submit additional borrowing requests and eventually max out the line and refinance it with a securitization.
Accessing the ABS Market
Wolf says many independents who are unfamiliar with ABS transactions are afraid that the process will be more complex than it really is. On the flip side, he says the ABS process also tends to be more work than independents initially estimate as well. Choosing a trusted and seasoned investment banking partner as ‘structuring agent’ for the ABS transaction is important.
“The issuer and structuring agent work hand-in-hand, day-to-day during the process. You want a team who knows not just the equipment industry and your particular company’s story, but also the ABS structuring options available, the investors to approach and the third parties who can make the process as efficient as possible,” Wolf says. “We’ve been structuring agent on four ABS transactions in this space over the past 12 months, and each client is unique.”
The process for ABS starts off very similarly to the steps an independent will go through to secure a revolving facility, but Wolf says it will involve more third parties, the first of which will be a rating agency.
Shenton says the rating agency process, which is very data intensive, will examine the same criteria banks review during their due diligence process to assign a rating. Wolf notes that the rating could be on multiple tranches of notes.
Other third parties involved in the ABS process are attorneys for both sides who build deal documents.
“Because this is going to be a bond offering, you have to have disclosure documents and marketing documents,” Wolf says.
Typically, Wolf says the key document is the preliminary offering memorandum (POM), which describes the transaction as fully as possible, including how the deal works, what the risks of the transaction are and what the specific portfolio looks like.
Finally, Wolf says an accountant will complete a “tick and tie” of the data tape back to the underlying files and review marketing materials against the data tape and other information provided to confirm that the information being disclosed is true and correct.
After the rating agencies, attorneys and accountants have wrapped up their work, it’s time to take the offering on a roadshow. Shenton says underwriters will create a list of targeted investors and sales teams will schedule meetings with capital market ABS investors. Wolf notes that these meetings are typically one hour per investor. And what was once a one-to-two-week process of flying from meeting to meeting has morphed into a four-to-five-day process of back-to-back virtual meetings during the COVID-19 pandemic.
“There’s a large and deep institutional investor community that likes this type of asset class,” Shenton says. “So, with the strength of the market today, that process is fairly efficient.”
Finding the Right Option
Ultimately, every independent should be able to find the best funding strategy for its business.
“If you’re an independent finance or leasing company in this market, there’s a structure out there for you,” Shenton says. “You should really be focusing on how to get that first bank credit facility, how to get your cost of funds down and then how to efficiently build to scale because with better cost of funds, you can target more of the market and become more competitive and efficient.”
Wolf points to the recent M&A market for independents in which most acquirers are banks.
“If you’re an independent who ultimately thinks that the end goal is to sell your origination company to a bank, the way to maximize the value of your company is going to be to build a balance sheet, to have assets, to have a history that is your own from both an underwriting and a servicing perspective. That’s the maximum value that you can really create from your company.”
Wolf notes that over the past year, the market has demonstrated a significant amount of interest in small-to-midsize independents looking to become balance sheet players, seeking their first credit lines and getting on the road to securitization.
“Depending on what your origination volumes are and how much history you have,” Wolf says. “That path might not be as long as you think.”
Rita E. Garwood is editor in chief of Monitor.