by Joe Terfler on Wednesday, July 23, 2014
Reprinted with Permission from Equipment Finance Advisor
It was only six years ago that many independent financing companies and captives woke up to find tremendous pressure on their funding sources. Many long-time sources stopped funding and/or significantly raised the cost of the funding they did provide. Those who made it through this window vowed to be better prepared for the next market disruption.
Fast forward to 2014 and there is again a free flow of credit in our post-recession economy, and the securitization market has returned to a very robust level. There is great demand for securitized assets by both bank funders and non-bank investors. This friendly environment has helped newer lessors tap the market and successfully execute transactions. It has also become more common to see new asset classes that historically didn’t securitize now access the market.
Some financial advisors also feel the time is right for manufacturers to take control of their financing destiny by starting their own captive finance company. This may be a wise idea for those who understand the complexities of underwriting and selling a financial portfolio or when it comes to tapping into bank backed securitization facilities and/or the Asset Backed Securitization (ABS) market.
There are some critical elements to be aware of if a company is considering securitization as a significant funding strategy. When we talk about securitizations, for simplicity I often divide the market into two primary segments: the bank warehouse securitization product, which is either funded directly by or backed by a bank, and the ABS bond market, where the funding may come from a broad array of investors.
For both, it is critical to have the systems and processes in place to support the data availability and reporting requirements. It also goes without saying that in both there will be great scrutiny on the strength and expertise of the primary servicer for the asset portfolio. Whether it’s a bank, or a multitude of bond investors, they are thinking about the same thing: “How much confidence do I have that the assets I am lending against are going to be serviced in a manner that ensures my interests are protected.”
One of the big differences between a bank facility and the ABS market is the involvement of rating agencies (Standard & Poor’s, Moody’s, Fitch Ratings, DBRS, etc.). It is less common for a bank to involve ratings agencies in their transactions, and if they do, it is typically for regulatory purposes. With the ABS markets, you are basically introducing an independent third party that will put a level of scrutiny on your organization similar to what the bank will do in a direct lending facility. Although individual ABS investors will unquestionably complete their own diligence prior to investing, especially in this post-recession market, they practically are not able to get down to the same level as the bank. Like the banks, the rating agencies and the ABS investors will consistently look for key factors such as the experience of the leadership team, the strength and consistency of the originator’s underwriting processes, the makeup and consistency of the assets originated, the strength and experience of the servicer including processes and systems, and the consistency of the collateral performance. There’s no question that consistency in your business and consistently tapping the ABS market aids your credibility and the quality of your execution.
If an organization is ready to stand up to the scrutiny, there is also no question that the benefits of tapping into the ABS market are quite strong. The ABS market provides a very efficient venue for an issuer to structure their portfolio in a way that provides an attractive cost of funds. Additionally, one clear lesson learned in the last credit crisis is to maintain funding diversification. The ABS market provides a very effective way to expand your funding partners from one or a small number of banks, to a much broader pool of investors with a much more diverse funding and regulatory background. Through the structuring process that is available in an ABS transaction, an issuer can attract money market investors, asset managers, insurance companies, corporate, bank and other investors and enable them to invest in the class of bonds that best matches their tenor and risk appetite.
As an entity navigates the securitization path, I would highly recommend leveraging the expertise of experienced resources and advisors. The securitization groups of the investment banks provide strong advice on the structures that are in demand by investors. They also facilitate the introduction of the issuer to the investor community and the ultimate placement of the bonds. Experienced, securitization-savvy legal counsel, will be a key resource as you navigate the complex, but manageable legal structures and documentation necessary to execute a transaction. Another less obvious but important resource to consider is a strong party to service and support your portfolio. The level of scrutiny on the servicing and reporting needs is high. If you do not have the in house expertise, why not leverage the platform and experience of someone who has been down the path many times?
The ABS market can be a very attractive way for equipment finance companies to fund their business. Although it is not something to fear, hard work and experience are required to be successful. And, credibility in the market is essential. Consider leveraging the reputation, knowledge, processes, and platform of experienced resources and advisors who have been down the ABS path before. They can make your journey more manageable.