Receivables financing: the next big thing?

BY: NICK STAINTHORPE Private Debt Investor

PUBLISHED: 02 JUNE 2014

Reed Smith partner Nick Stainthorpe argues receivables financing might be unglamorous, but it’s an under-penetrated market that yields attractive returns.

Let’s suppose for a moment that 2014 is a time of uncertainty for investors. Renewed competition from banks and public debt is matched by an ever increasing supply of credit from the non-bank sector and the valuation of some collateral is beginning to look aggressive. Investors have seen margins on new lending erode and there always seems to be someone else who is prepared to overpay.

So before considering returning money to LPs or chasing the competition in a race to the bottom, it may be worth considering types of private debt investment which have not received so much attention.

One such product area is receivables finance. This is the unglamorous world of factoring, forfaiting, asset-based lending, even trade finance. This is the type of finance that has to happen if businesses are to grow. It does not depend on M&A activity or rising real estate values, it depends on businesses selling goods and services and being prepared to take a discount in return for getting paid sooner. Annualised yields in high single digits are possible.

So why don’t all debt investors diversify into receivables finance? Well, receivables finance brings with it certain unfamiliar challenges.

Receivables are generally short-dated. You can’t just buy one receivable and wait for it to mature if you want to make money – financing is generally provided on a revolving basis against a shifting pool of assets. It is possible to buy individual receivables, but this requires active management and constrains scale: you

need to start small and work hard, or find sellers with a lot of receivables to sell at once.

They are also generally unsecured. It is possible that receivables will be sold with retention of title of the sold goods or that they are covered by trade credit insurance, but there is no underlying real estate or equipment to foreclose on. If the debtor doesn’t pay, you are an unsecured creditor with a relatively small claim and no seat at the table in a restructuring.

Then there are some peculiar legal risks. For example, regulatory constraints prevent many investors from buying receivables from French sellers directly and there are circumstances in many jurisdictions where the sale of a receivable can be challenged by an insolvency official of the seller under certain circumstances. In that way the purchaser or financier of a receivable is exposed to the creditworthiness of both the seller and the debtor. What’s more, purchasing a receivable can expose the purchaser not just to credit risk, but also to performance risk, for example. If the goods in question turn out to be defective and there is a dispute, there may be no receivable at all.

There are solutions (partial or full) to all of these problems but ultimately this asset class requires expertise, structuring and considerable due diligence. On the positive side, receivables are self-liquidating and uncorrelated with other asset classes. Precisely because they are short-dated they allow a quick and hopefully complete exit. And while they are not secured, a trading business which doesn’t pay its suppliers may soon find itself out of business.

We are seeing an increasing number of non-bank financiers explore this area. Some, such as Falcon Group which provide supply chain and working capital finance on a large scale to businesses particularly in emerging markets, have achieved spectacular growth. Others, such as Aztec Exchange, act largely as intermediaries connecting private capital with corporate sellers.

We also expect to see more capital markets and fund products backed by trade receivables. This will open the market to more passive investors looking to take advantage of the yield opportunities without doing quite so much work, and allow the injection of leverage. Some of the hottest opportunities are in the areas where the banking sector is most dislocated, such as Italy, or in emerging markets where banks simply cannot keep pace with the growth of trade.

Receivables finance is unlikely to challenge leveraged finance or real estate finance as a destination for private capital any time soon. However, for investors looking for diversification and relatively high yields which are not correlated to exuberant markets, it presents some exciting possibilities.

Nick Stainthorpe is a partner at Reed Smith and is based in London. He specialises in complex finance transactions with a particular focus on derivatives and structured finance.

The entire article can be found at 

http://www.kpmg.com/global/en/issuesandinsights/articlespublications/frontiers-in-finance/pages/non-bank-credit.aspx

By:  Richard Hinton, KPMG in the UK

The rise of non-bank credit: Revolution or evolution?

Traditional bank lending continues to be constrained by tighter regulation, increased capital requirements and a more conservative approach to risk. This would appear to open up significant business opportunities for alternative sources of credit, but there are a number of factors that may hinder the much-heralded revolution in credit provision. Richard Hinton outlines some critical success factors for aspiring new entrants to the evolving world of primary lending.

The global scale of bank lending is so large that if banks retrench their activities by even a few percentage points, it will open up a significant market for non-bank lenders. But if there are any concerns about a potential explosion in non-bank lending leading to another credit bubble, these should be balanced against the countervailing constraints: the market is globally fragmented, the barriers to entry can be high and it is hard to identify and implement the right business model for the right market. For example, the differences between Europe, North America and Asia are stark.

North America

In North America, by contrast, there is a mature non-bank lending sector – from community banks to micro-lenders to accounts receivable financing to peer-to-peer or social lending – and it would appear this increased diversity is one of the reasons why the supply of credit is not such an issue in the US as it is in Europe. The diversity also increases the capacity of the credit market to fill any gaps that emerge as the banks come under pressure. There is less of a sense of stress; simply a natural progression as market mechanisms react to changed circumstances. However, it also means the US market is very competitive, with returns being squeezed, so funds are being forced to look beyond their home market. We see this reflected, for example, in a focus from US investors on markets such as Spain and Ireland, where they have recently transacted for the first time.

Evolution, not revolution?

We are entering an era of opportunity for alternative credit. Just as in the past we have seen the leasing industry flourish as firms looked for more flexibility in their use of capital and a securitization boom as banks seized the opportunity to free up their balance sheets, now there is an opening for non-bank lending to achieve a step change. But success for a new entrant is not a given. It will only come from detailed analysis of particular opportunities in the context of a clear understanding of their own business model – and how flexibly it can be shaped to meet the local needs of markets, regulators and customers. In the end, what we may be witnessing is not so much a revolution as an evolution.

Nonbank Lenders Step Into a Void

REITs, Investment Funds Ramp Up Commercial-Property Mortgages

By

Eliot Brown of the Wall Street Journal

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Updated April 29, 2014 6:57 p.m. ET

When Los Angeles developer Jeff Worthe first searched for a loan to finance his purchase of the empty 32-story office building Tower Burbank north of Los Angeles, banks balked at offering large mortgages.

So he turned to Starwood Property Trust Inc., STWD -0.23% a publicly traded lender that gave him an $85 million loan for his $109 million purchase last month.

Starwood Property Trust financed the purchase of Tower Burbank. CoStar Group

"These guys can stretch a little bit more," said Mr. Worthe, who plans to spend tens of millions of dollars to renovate and recast the tower that was home to Walt Disney Co. DIS +0.85% 's offices.

Starwood is part of a crop of investors that are expanding rapidly to fill a void left by a banking sector that has grown averse to chancy bets: mortgages on riskier investments such as skyscraper construction, ailing malls and high-vacancy office buildings like Mr. Worthe's.

The nontraditional lenders—including mortgage real-estate investment trusts like Blackstone Mortgage Trust Inc. BXMT +0.42% and private equity-style debt funds like Mesa West Capital—are being lured by yields that generally are one to five percentage points higher than loans on well-occupied buildings.

Commercial-property lending in 2013 by mortgage REITs, other REITs and investment funds rose 332% over the prior year to $23 billion, according to a Mortgage Bankers Association survey. That surpassed the $17 billion lent in 2007 and included investments such as $350 million in debt from Starwood to build a new Manhattan headquarters for Coach Inc. That loan has an interest rate of 7.5 percentage points above the benchmark London interbank offered rate, or Libor.

Banks also increased their lending during the same period, originating $100 billion in loans in 2013, a 76% increase over 2012, according to the MBA.

But that level was below the $109 billion lent in 2007, and banks generally are eschewing the types of risky bets in property they made before the recession.

For instance, banks at the end of 2013 held $210 billion of high-risk construction and land loans, down from a peak of $631 billion in 2008, according to the Federal Deposit Insurance Corp. At the same time, banks held more commercial mortgages—excluding construction and land—than ever, with $1.11 trillion in holdings.

This lower appetite for real-estate risk largely reflects a postcrash regulatory environment in which banks have been told to increase their capital reserves.

Private-equity funds and REITs, on the other hand, are "free to fund any kind of loan they want, within reason," said Anthony Sanders, a real-estate finance professor at George Mason University. "You regulate one sector and the risk merely transfers to another."

Similar loosely regulated lenders exist in the broader financial system. Some regulators have raised concerns that risks could rise in this so-called shadow-lending system.

Landlords also have turned to other debt sources including a government program that allows foreigners who invest $500,000 in certain projects to gain a green card. Meanwhile, some insurance companies including MetLife Inc. have increased lending for higher-risk debt that can supplement a bank loan.

Nontraditional property lenders say they are still more conservative than many banks were before the bust. Landlords at the market's peak often could borrow 90% or more of a building's value. Today, even nontraditional lenders rarely lend above 80% and construction loans aren't the bulk of their holdings.

Still, much of their focus—so-called transitional properties with high vacancy—could be hit hard by a downturn. In addition, these lenders generally offer more generous terms than banks do on issues like recourse, which puts a borrower on the hook if the property's value falls below that of a loan.

The new lenders also are benefiting because many of the banks that flocked to high-risk lending have failed or exited the business, including Lehman Brothers Holdings Inc.

When Starwood Property Trust—led by investor Barry Sternlicht —was formed in 2009, it made just $105 million in loans for the year. Last year, it originated $2.6 billion in loans. Starwood is financing construction of three New York skyscrapers, including a 65-story apartment tower at 252 East 57th Street.

Blackstone Group BX -1.13% LP entered the field a year ago after it rebranded a company it bought as Blackstone Mortgage Trust, which lent $2.5 billion in 2013. Other fast-growing firms include lender Ladder Capital Finance LLC, which went public in February in an offering that raised $225 million.

Some big banks continue to make riskier loans, but can struggle to compete against nontraditional lenders. For example, M&T Bank Corp. MTB +0.83% makes construction loans, but generally requires more equity from borrowers than nonbank competitors do. That has "created opportunity" for those lenders to step in, said Peter D'Arcy, M&T Bank's regional president for New York City.

Global distressed activity has fallen, but signs point to a re-emergence of opportunities.

BY: SAM SUTTON 
PUBLISHED: 11 APRIL 2014

No-one has ever said that fundraising is easy, but for distressed managers, it was certainly less of an uphill struggle a few years ago than it is now.

With the global economy on the brink of ruin, a handful of general partners with experience investing in distressed debt managed to stockpile $101 billion in committed capital in the five years leading up to and through the financial crisis. That amassing of dry powder proved fortuitous, given the circumstances. With many large companies poised to breach their debt covenants, "distressed investors had a choice array of companies in which to invest", according to Bain & Company's 2010 private equity report.

Adding credibility to that claim, Bain went on to report that distressed funds had $50 billion in dry powder going into 2009, a total that shrank to $41 billion by the end of that year. Firms were spending capital faster than they could raise it.

Times have changed. The economy has improved, and investor demand for distressed debt funds has declined. Bain's 2014 report found that falling default rates and an improved global economy contributed to a 16 percent decline in commitments to distressed private equity funds last year.

This week, Thomson Reuters released data confirming that decline in fundraising was mirrored on the deal front. Global distressed debt and bankruptcy restructuring activity fell to $22 billion during the first quarter, a 6.8 percent decline from Q1 2013 totals.

In the US, deal activity fell by 26.2 percent to $4.5 billion during the first quarter. Asia-Pacific deal volume declined by 71.2 percent from Q1 2013 totals to $1.7 billion.

The only region to see a spike in activity compared to the same period last year was EMEA, though more than half of that region's volume was accounted for by the $10 billion restructuring of UAE-owned investment company Dubai Group, which was the largest single transaction of the quarter.

But even as investor demand for distressed debt funds has fallen, concern over the possibility of another crisis on the private equity front has grown. Earlier this week, The California Public Employees' Retirement System released an investment memo indicating that they were cautious about deploying too much capital into the asset class. The retirement system will consider decreasing its target allocation to 10 percent at its meeting next week.

They have good reason to be cautious. Private equity firms have amassed record amounts of dry powder, driving up prices on buyout assets and pushing debt-to-EBITDA multiples to decade highs in the US, according to Pitchbook.

And although the economy is slowly recovering, the pace of that recovery has been far from robust. Should the market experience another shock, the data on increasing leverage multiples will be cited as evidence of the industry's failure to learn lessons from the crisis. In a precursor of what may be around the corner, S&P has already reported that Europe's leveraged loan market is overheating.

Of course, that same environment would also provide a boost to distressed managers. Although commitments to distressed funds fell last year, distressed firms were sitting on an estimated $76bn in dry powder as of December, according to Preqin. Should the market take a turn for the worse, managers would still be very well positioned to acquire troubled assets.

Demand may not be what it used to be, but that's the beauty of a cyclical investment product. New opportunities may arise sooner than one would expect.