As appeared in the Philadelphia Business Journal

Gary Miller – Director, Specialty finance at Revere Capital

Not so long ago, loans fell under the purview of banks and credit unions. That is, until the Great Financial Crisis (“GFC”) and its aftermath, when stricter regulations drove banks to originate loans under more stringent guidelines.

Enter the non-bank lenders: private credit funds, fintech companies, consumer lenders, litigation finance, net value finance, insurance-linked loans and factoring companies. Since the GFC, these lenders have provided funds to borrowers unable to access the debt offered by banks or credit unions. However, the success of non-bank lending depends on having ample available capital. These entities can often struggle to source capital from equity raises or bank debt.

Enter lender finance.

With the right lender finance partner, a non-bank lender has the liquidity base to offer middle-market loans from $10 million to $25 million.

Lending to the Lenders

The target of lender finance companies is non-bank lenders who don’t have a capital cushion for consumer and business accounts, or those regulated by the Federal Reserve. Instead, these lenders rely on lender finance companies as their own type of Fed.

An experienced and liquid lender finance company supports borrower-lenders with fresh capital, which is then used to originate loans for end-use borrowers. That lender finance company also helps the non-bank lender grow its business. The more loans a borrower-lender originates, the more profitable they become.

Not so long ago, the lender finance category was regarded with suspicion. However, the tide has changed. Non-bank lenders—including asset-based lenders, consumer lenders, asset investment firms and fintech companies—are approaching lender finance companies to access capital. Some of these lenders are taking the strategy one step further to bring lender finance under their own brand names.

For instance:

• Alternative asset manager Bow River Capital of Denver, CO, acquired Dallas-based Park Cities Asset Management, which targets the lower middle market.
• Blue Owl Capital Inc., another alternative asset manager, acquired Atalaya Capital Management LP, which offers asset-based credit investments.
• Sixth Street, an international investment firm with over $115 billion in AUM, recently announced its pending acquisition of Global Lending Services, which handles automotive financing.

How Lender Finance Operates

Getting back to more traditional methods, bank lenders generally assess an individual’s or a business’s creditworthiness before originating a loan. These institutions also must abide by federal and state laws and regulations that mandate capital reserves and stress tests.

This isn’t the case with lender finance. This is because the non-bank borrower-lender uses its portfolio of new and/or existing loans as collateral when borrowing from a company like Revere Capital’s Lender Finance arm.

Rather than researching an applicant’s creditworthiness, we examine the borrower-lender’s loan portfolio’s historical track record. We also conduct a deep dive into cash flows, controls, the business model, and growth targets. Also important is how the borrower-lender plans to repay the loan. If everything checks out, the borrower-lender receives the capital.

Lender finance generally provides three loan structures:

There are generally three types of lender finance structures:

• Revolving credit line. The borrower-lender can draw capital to issue loans and repay the depleted funds through interest payments or loan maturities. The amount of available credit depends on the value of the borrower-lender’s loan collateral.
• Warehouse lines. These are short-term facilities, geared to hold new borrower-lender loans on a temporary basis. Eventually, those loans are securitized and sold to investors.
• Loan sales. In this case, the borrower-lender agrees to sell its loan portfolio to investors in a forward-flow arrangement. This ensures that the borrower-lender has cash to originate loans.

Finding the Right Lender Finance Partner

Given the increasing number of players in this space, referrals are a good place to start. Additionally, when considering working with a lender finance company, consider the following points.

• Experience. It probably goes without saying that a viable lender finance firm should have experience and preferably have gone through at least one economic cycle. It’s also essential to determine how the company handles issues such as loan defaults or deal triggers. Be wary of a company that can’t provide a track record or information.
• Understanding of the borrower-lender’s business. The right lender finance company will have in-depth knowledge of the industry, assets under management and how loans will be originated. A consumer-lending entity will have a different audience and portfolio than a fintech lender.
• Gut instinct. Many times, a decision comes down to how the borrower-lender feels about the lender finance company. This can require a qualitative assessment to measure issues such as trustworthiness, advice, and suggestions, as well as the overall approach.

Outlook for the Sector

Lender finance is an increasingly important source of capital.  While some traditional bank lenders are opening their debt coffers more frequently, others remain concerned about exposure, especially in the low- to mid-market segment.

Non-bank lenders are less concerned about exposure, nor are they heavily regulated. They’re more flexible about to whom – and how much—they can lend. More borrowers are turning to alternative sources for capital. And those non-bank lenders are turning to lender finance specialists to find that capital.

But it’s not all roses. Interest rate fluctuations could impact loan values and portfolio considerations, while growing delinquencies (especially with consumer and auto-loan debt) could be a concern, as well.

As long as non-bank lenders can provide liquidity to the middle markets, lender finance will have a place in the capital strategy.