Avoiding the crunch

The much publicised recent credit crunch has restricted the appetite of clearing banks, other finance houses (funders) to lend to secondary lending and sub-prime funders (secondary lenders). In many cases, property and asset finance agreements will be provided on credit periods, which are greater than those agreed by the secondary lender with its funders. These funding structures, whilst common, only work well in circumstances where the secondary lender is continuing to write new business with the support of its funders.

If the converse applies, or where the funder seeks to restrict the level of debt available to the secondary lender. A funding gap may well arise which in return is likely to result in a confidence gap, between the funders and the secondary lender.

So how should a secondary lender act now, to mitigate the risks of its funder losing confidence at the next round of facilities renewal?

Invariably, secondary lenders will have several layers of debt or equity. In the first instance, funders may consider it appropriate to reduce their gearing in the business, and place a greater weight of responsibility upon the mezzanine and equity providers. However, this clearly conflicts with management's objective to provide a balanced funding structure that offers optimum levels of risk/reward for the stakeholder groups.

Act early
It is therefore important for secondary lenders' management teams to take early steps to predict the approach of their funders, and, so try to minimise the risks of any hostile negotiation of their facilities. After all, like any sector undergoing some turbulence, threats bring opportunity and players who predict, react to the threats will benefit to the expense of those who do not.

How can MCR help in this process? Firstly, we understand the business dynamics of independent secondary lenders, and the need to maximise gearing to optimise return to management. We understand the need to be
innovative in order to penetrate the control of the institutional players. Furthermore, we recognise the dilemma faced by funders to organisations, who in turn lend to clients to whom the banks would not lend themselves.

By working in the ABL sector acting for both independent and institutional players, MCR has become a trusted advisor to a broad spectrum of lenders and borrowers alike. We can help ensure that funders retain confidence in the performance of their customers, without that advice being financially punitive.

In cases where senior debt facilities require renewal. Funders increasingly seek independent verification, often from a big four accountancy firm, that the covenants of the ultimate borrower, and the credit processes of the secondary lender are being complied with.

This work, if imposed, may be carried out by inexperienced staff at considerable cost, without adding real value to either secondary lender or funder, without demonstrating a true understanding of the needs of the customer chain.

We have engaged a team with specific sector expertise to undertake independent verification work, prepared in a format required by senior debt providers. By pre-empting the requirements of the funder group, secondary lenders will be in a position to introduce their own reporting systems. These should act as a powerful management tool to ensure covenant breaches are identified early and managed effectively. They will also incorporate trend analysis techniques, to enable users to identify portfolio risk factors at an early stage.

We often undertake independent portfolio monitoring at the request of management. This enables us to ensure, where appropriate, when facilities are due for renewal, and, it allows management to demonstrate to their funders, that their portfolio has been verified and well managed. Independent monitoring ensures, that risk issues and covenant breaches are identified early to ensure maximum opportunity exists, to deliver proactive strategies to manage problems.

Leading this initiative is David Grier of MCR Business Consulting. Supporting David, we have engaged two senior players in the ABL sector, who have successfully grown and sold finance companies.

By structuring our team in this way we can approach the monitoring process with a clear understanding of the needs of the funders, whilst also sharing and maintaining a clear interest in the needs of the secondary lender.

The credit crunch has put a huge amount of pressure on the financial community as a whole, with little sign of this abating in the months ahead. Acting early in this way could prove a real lifeline, and help ensure that the credit crunch doesn't have to automatically lead to confidence and relationship breakdowns.