Innovative asset-based lending is on the rise as a means of attracting new lenders while maintaining the strategic support of existing creditors.
Raising fresh capital for portfolio companies in times of financial stress is always a delicate balancing act between attracting new lenders and maintaining the strategic support of existing creditors. The almost instantaneous halt in cash flows and scramble for new capital injections precipitated by the COVID-19 pandemic has significantly changed traditional approaches to collateral — giving rise to new financing opportunities for sponsor-backed deals and businesses. Regardless of debt market buoyancy, these new financing techniques are here to stay, having demonstrated value in overcoming creditor scepticism during times of economic uncertainty and bringing a new way to increase leverage.
In recent years and prior to the COVID-19 pandemic, the typical blueprint for emergency fund raising had been the “JCrew” financing technique, through which assets are shifted to an unrestricted subsidiary and pledged to new money providers. However, the JCrew technique has taken on markedly negative connotations for frequently rattling debt investors (by removing valuable assets from the original credit support package) and ultimately resulting in disputes. So perhaps unsurprisingly, bondholders revolted when sports car company McLaren addressed its pandemic related liquidity shortfall by seeking to use an unrestricted subsidiary to raise debt against its head office and heritage car collection.
A More Consensus-Driven Approach
In response, we are now seeing borrowers shore up their balance sheets and raise capital on a less confrontational basis, without compromising the allegiance of debt markets.
This has been achieved by revisiting the concept of “permitted lien” or “permitted security”, utilising an explicit but overlooked permission commonly included in financing documents to take unencumbered assets that are not already pledged to existing creditors as collateral for securing new funding. Although this permission tends to be narrower than the capacity allowed for unrestricted subsidiaries, it is unquestionably intended for the purpose of raising incremental secured finance. The unassailable legitimacy of this approach puts it well beyond the criticism or risk of legal challenge directed at the more controversial JCrew technique, bringing greater certainty.
Using this approach, Great Stirrup Cay, a Bahamas idyll, gave investors comfort to buy almost US$700 million of Norwegian Cruise Lines bonds — heralding what would soon appear as a broader trend. With a sufficient loan-to-value ratio, borrowers discovered that they could raise cash and keep businesses afloat by pledging all sorts of unencumbered assets — from idle ships and airport landing slots to Caribbean real estate and frequent flyer miles.
The buyout of UK supermarket chain ASDA illustrates the growing importance and wider application of innovative asset-based lending. The deal, primarily funded by the largest ever Sterling bond issuance, was underpinned by additional slices of debt secured over real estate collateral. In addition to standard LBO financing, ASDA’s buyers were able to parlay noncore assets (forecourts and distribution centres) into stand-alone collateral to raise several strips of interim financing, bridging to the eventual sale of the assets making up the stand-alone collateral.
This creative approach to takeover finance struck the right balance by allowing the buyers to increase leverage beyond the typical boundaries of leveraged lending, without alarming debt investors. On the contrary, the £2.75 billion bond sale was oversubscribed and priced at very tight levels.
Application to Other Deals
To tap into new financing opportunities, PE dealmakers must creatively scan a target or portfolio company’s asset base for pools of liquid collateral that can be detached (which can include a lease back, where necessary) from the business without affecting long-term prospects.
Preparation is key — dealmakers should work with legal counsel to review financing documents, prepare asset reports, and produce in-depth structuring papers that credibly spell out the monetization potential and viability of a quick sale of the identified assets. As the ASDA deal demonstrates, markets will give a fair hearing to investment propositions that ring-fence the security offered to mainstream investors from the collateral set aside for incremental specialty finance.