Traditional liquidity alternatives for niche non-bank lenders are currently unattractive, creating the need for bespoke financing solutions.

New and non-traditional issuers’ access to the public securitisation markets has been limited or inexistent since March due to significant increases in investor return requirements and lower credit risk tolerance, limiting leverage potential.

This has resulted in loan portfolios previously due to be securitised remaining on issuer’s balance sheets.

Certain of these warehouse facilities, structured as private securitisations, are approaching the end of their investment periods and will enter into amortisation, forcing a deleveraging of the lender’s balance sheet. This, in turn, is causing a contraction in lending capacity across the non-bank lending sector.

Investment banks are keen to unwind their commitments to speciality finance lenders and are unlikely to extend the term of these facilities, whilst new warehouse lending from the structured credit divisions of investment banks are also being reined in, given such facilities no longer have a clear path towards a refinancing in the public securitisation market.

To put this into context, in the year to date 2020, primary ABS issuance through to the end of May is down 25% year on year.

Issuance has been limited to ‘blue chip’ repeat issuers primarily in the residential mortgage and auto loan sectors.

The few specialty finance platforms to issue a public ABS since March of this year are attracting higher pricing relative to prior deals, and these transactions have materialised due to the support of one or several sponsors.

Investors are now requiring significant size and new issue concessions for primary transactions, largely impacting the bottom end of the capital structure. Issuance expectations through the end of the year have reduced 35% versus pre Covid-19 forecasts.

Private markets

This leaves the private markets as the only near-term option available to a large number of lenders.

A number of credit fund managers are now seizing the opportunity to offer full balance sheet solutions, providing both the senior and the mezzanine facility and occasionally, will combine their investment with a participation in the equity or junior notes.

However, the dispersion of IRR requirements of whole loan buyers has increased since Covid which has primarily affected unsecured asset classes where the impact of Covid-19 on future credit performance is hardest to predict.

Cheaper funding

Managers of regulated capital, such as funds affiliated with insurance companies or pension funds, will sometimes be able to provide significantly cheaper funding than the rest of the special situations, credit and hedge fund community.

However, their own investors will be more risk averse and require further credit protections than in the pre Covid-19 world.

The key issue for companies is dealing with portfolio value erosion as it is difficult to assess value across a range asset classes and particularly with niche consumer and SME loans where security is not extensive.

To date, unsecured credit loan underperformance has been mitigated by government responses and widespread forbearance loans, which can represent 20% or more of certain speciality lender books.

While visibility will be difficult on how these loans will perform once government support measures end, buyers and lenders are likely to take a highly conservative view on their value.

A number of structured solutions are being used to bridge the bid ask spread, and phasing out the impact of any discount on sale.

In many cases, this will mean imposing some near-term burden sharing on junior creditors and shareholders, in order to provide long term optionality to the business as credit performance and loan market values recover.

Planning a strategy

How do you plan for growth resumption? Originations have been subdued since March and pricing on non-traditional asset classes has increased making loans less affordable to a large number of borrowers.

Compounding this, the large number of furloughed and dismissed employees has translated into a reduction of disposable income for a large number of households, which has in turn reduced their eligibility to access financing in both the banking and the shadow banking markets.

This has created an opportunity for credit funds and principal finance trading desks of banks to begin providing such facilities, often at a higher cost.

Banks who are still considering such opportunities will require a reputable asset manager or sponsor to take a mezzanine or junior position, in a subordinated tranche within the capital structure, in order to provide them with institutional subordination and sometimes earn syndication fees.

A key objective of the company should be to retain control in allocating the various pieces of the capital structure in order to provide greater long-term optionality to the business.

Different types of investors will be more impactful in funding various parts of the balance sheet and can be competed to optimise long-term value creation for the company via a well -planned financing strategy.

Daniel Oudiz is a senior vice president in Houlihan Lokey’s European Structured Credit Capital Markets Group, which focuses on providing debt advice to financial institutions and credit investors in loan portfolios of banks and specialty lenders.