Asset-backed finance (ABS) is increasingly popular among private equity houses, because it permits them to reduce the burden of expensive senior debt and improve the liquidity of companies that have been subject to a Leveraged Buyout. Or so says a survey from research house Demica, who add that private equity houses also anticipate that debt is getting more expensive- 57% of respondents surveyed estimated that the cost of leveraged finance would increase over the next two years.
Interestingly, 62% of top private equity organisations stated that securitisation is becoming a more important source of replacement capital to ease debt repayment schedules and respondents estimated that a significant proportion (12%) of deals already employ trade receivables securitisation. It was actually the growing demand for flexible post-LBO refinancing structures (‘carve-out’ provisions) that was found to be fuelling the take-up of trade receivables securitisation among private equity houses across Europe.
The Demica study encompassed both primary and secondary research, including interviews with 40 top European PE firms to ascertain views on the role of securitisation as a post-LBO financing tool. Given the current surge in LBO activity, the cost of debt burden is a growing issue for LBO firms. The majority (57%) of respondents felt that leveraged finance would become more expensive over the next two years; and two thirds pointed to a consequent focus on the terms of ‘carve out’ provisions in buy-out financing agreements, building in the flexibility to accommodate future alternative financing structures.
Interestingly, 62% of survey respondents stated that the role of securitisation in providing alternative sources of liquidity and its impact on amortisation/repayment schedules was becoming increasingly important. They estimated the proportion of post-LBO transactions to be using securitisation today to be some 11.9%, rising to 16.3% by the end of 2006 – a growth rate of 37% in the use of post-LBO securitisation over the next two years.
“There is a convergence in the market between investors and portfolio companies for financial sponsors looking to complete securitisations to satisfy a strategic objective,” says Alex Gress, Vice President at J.P. Morgan Securities. “That objective may be to lower funding costs or put in place non amortising term debt structures. Relative to AAA credit card or mortgage backed paper (that is 60% plus of the structured finance supply in Europe), this type of corporate asset-backed paper offers investors a strong spread pick up compared to what they’re currently seeing in the market, so there is significant demand. The convergence of issuer objectives and investor demand will continue to fuel a growing trend for these types of deals – satisfying a demand that currently exceeds supply.”
Brian Feighan, Executive Vice President at Demica, says the research confirms the trend witnessed over the last 18 months – corporations that have undergone a leveraged buyout are under substantial financial pressure and their private equity shareholders are urgently seeking ways to stabilise their capital structures and diversify the funding mix. “Executing a trade receivables deal requires a widely distributed debtor book evidenced by low concentrations and performance characteristics in terms of ageing, dilutions and write-offs,” adds Feighan. “Although best suited to larger transactions (typically €250m of gross receivables) the benefits are proving too beneficial for financial sponsors to overlook. Funding cost savings of 100-150 basis points are typically achievable when compared with the cost of normal senior debt.
Equally important is the ability to refinance early amortising senior debt with a softer amortising or renewable facility which significantly eases the cash flow burden. Flexible structures in trade receivables securitisation also ensure that both the term and the funding amount can be optimised to best suit the exit strategy of the financial sponsors.”
Demica specialise in trade receivables securitisation and invoice discounting solutions. It is a wholly owned subsidiary of the J.M. Huber Corporation, one of the largest privately held companies in the United States. Demica has offices in Dublin, London, and Tokyo.