A Masterclass in Asset Based Finance Part II of III. Raising Debt Capital for your Specialty Finance, Fintech Lending, or Alternative Lending Platform with Special Guest and Asset Backed Podcast Contributor Matt Edgar, Founder & CEO of Edgar Matthews
Welcome everybody to another edition of the Asset Back podcast. This is your host and creator, Andres Sendate. I am glad to be joined again for a second, conversation with Matt Edgar, the founder of Edgar Matthews and Company based in Manhattan. Good to see you again, Matt.
Matt Edgar:Likewise. Great to see you.
Andres Sandate:So, you know, we we are here to do part 2. We had our first conversation about a month ago, where we talked about, some of the sort of important notes and considerations for a specialty finance originator or fintech lending platform as they think about going to market. We covered quite a bit of ground, which we'll make available in, in part 1 and show notes. But in part 2, what we wanted to do, and this will be a 3 part, series or or sort of master class, if you will. But what we wanted to do in part 2 is Matt and I will sort of go through some of the main structures through which, a specialty finance originator, so somebody that's making loans as a business can access capital, talk about some of the key structural facilities of of what are called asset based loans or ABL facilities.
Andres Sandate:So we're gonna cover a lot of ground. And before we do that, I I I thought it'd be great since it's been maybe 4 or 6 weeks since we first spoke, Matt, if you could, number 1, share some of the, just highlights about what's been happening at Edgar Matthews because this is the world you live in every day, talking to originators, talking to lenders, talking to capital sources. Love to hear about developments at your firm, but then also I'd love to selfishly ask you if you could sort of share, any, you know, insights or thoughts about, current market conditions. I'll let you start with with whichever one you'd prefer.
Matt Edgar:Yeah. Happy to. I mean, it probably makes most sense to, to to hit on the market. So I think from from our perspective since the last time we spoke, I mean, I think it's much of the same. We're still seeing, you know, fairly significant activity in both, the financing markets on a private and public basis for Spec Fin and tech enabled lending businesses broadly, I'd say.
Matt Edgar:And I think that's really, you know, characteristic of a few things. I think, one, you're seeing, you know, some large asset managers continue to raise a significant amount of capital around asset based strategies really as a, you know, yield plus play to their existing, you know, private credit strategies holistically. So I think that from a, I'd say demand side or investor side is keeping, you know, activity in the space at a pretty, high volume, which is which is great to see. And I think on the other side of that as well, I mean, everybody sort of, you know, complains or mentions the the summer slowdown. So I think you're seeing a bit of that given we're, you know, just getting through July here.
Matt Edgar:But generally speaking, I mean, relative to where we were last year, granted, we were a new firm perhaps not seeing as much flow from, an adviser in the space, having just started out last summer, but we're, you know, significantly, I'd say, blowing past the volumes that we're seeing, last summer. We're staying very busy, across asset classes. You know, there isn't really a specific area, I'd say, in markets that are more active than others. It's pretty diversified across consumer, commercial, and, you know, more esoteric asset classes within, alternative credit, I'd say. So we're continuing to see, you know, a lot of activity.
Matt Edgar:And I think we kinda spoke about this last episode, but, you know, now thinking of the transaction docket that we're sort of looking at today, a lot of the capital or, capital interest that we're seeing is from, the insurance community or or sector, trying to figure out ways, typically rated to get exposure to various specialty finance asset classes. And I think that really ties to the previous comment that I made, in an effort to diversify away from pure, you know, cash flow based, what we know as, more vanilla private credit. So we're seeing a pretty significant inflow, of interest from that sector, which I think just, you know, creates, really a lot of activity broadly speaking. And then I know we were also chatting about, m and a right before we started this recording, so that's another topic that we're, you know, seeing some acceleration on that side. You know, the comment that I've made before, I think it was with you or on another podcast was, you know, the the bank bid for specialty finance companies has been reduced just given a lot of banks are, you know, more in defense than offense mode right now.
Matt Edgar:But that being said, I mean, we're seeing a pretty significant pickup, from more asset managers looking to get exposure to these types of asset classes. So we're starting to see, some sell side processes, either kickoff or prepare to kick off sort of post summer, which I think is, you know, sort of a positive data point and something that, you know, we're watching quite closely.
Andres Sandate:Yeah. For sure. Well, on the, on the firm front, you know, I I'd love to give you the opportunity to sort of talk about the evolution of your firm as a new, adviser to, spec fin originators and tech enabled Fintech lending platforms. This is a very, very specialized space, and, you know, new firms and new advisors don't necessarily pop up that are growing at at your clip overnight. So maybe, I'll put the spotlight on you and the firm for a second.
Andres Sandate:Like, what do you attribute to some of the traction that you guys have had right out of the shoot? You know, you you mentioned offline some of the success you've had in bringing on some experienced, folks to the team. So, you know, give you a chance to brag a little bit, because, you know, this this is an opportunity to get the word out about about you guys and and your offerings as well.
Matt Edgar:Yeah. I appreciate that. And I know I mentioned offline that, you know, since the last time we spoke, we brought on, 2 additional senior bankers really to focus on, specialty finance and I'd say alternative credit holistically, which there should be an announcement about that coming out in the next week or so, so stay tuned on that. But I'd say, you know, both of those individuals that we hired similar to myself came from what I would define broadly as large investment banks, which I think is critical as we're seeking to build our platform and really differentiate ourselves in the market. You know, as you may or may not know, our sort of or my thesis in starting Edgar Matthews was really to attack the white space where companies and originators need access to what I'll call broadly big bank capabilities, but are not yet on the radars of the large institutions due to relative size or asset class and, you know, myriad of other factors that sort of influence that.
Matt Edgar:So we really seek to fill that gap and bring our experience from our team spending, you know, years decades at large investment banking institutions down market to help service these more emergent or mid market type of originators. So I think that's something that has, played in our favor very well. And I think also being able to really bring the capabilities of a large institution on the financing and capital markets front is something that we like to think differentiates ourselves as well. You know, boutique investment banks typically, tend to be more m and a focused either primarily or exclusively, which m and a continues to be probably a 30 to 40% part of our business. We'll probably be increasing given some of the comments that I just made with what we're seeing in the market.
Matt Edgar:But I think being a financing first focused shop really helps us, stand out, I'd say, and being able to work in what I'll call more, you know nothing's vanilla, but more plain, private asset based financing facilities where we're approaching a bank or credit fund all the way up to, you know, the securitization markets. We closed a rated feeder transaction for a private credit manager a couple years or a couple months ago. So I think being able to have that connectivity with the insurance community and work on, I'd say, more structured rated situations as well, has bode very well for us. So, all that together, we think creates pretty powerful synergies across, those different lines of businesses and, you know, having talented folks from other, you know, renowned institutions, I think, just continues to help build our brand and, most importantly, help us serve our clients most effectively.
Andres Sandate:Yeah. I mean, like, we we spoke about before we we we went on the, you know, the expertise, is in high demand, particularly as private credit as a sort of asset class becomes, much more it's proliferated, right, over the last 10 years, especially over the last 5. And so now as these large platforms have amassed so much capital in the 100 of 1,000,000,000 of dollars, there becomes a need to find pockets, niches, white spaces, whatever we wanna call it, where they can extend origination capabilities, and that may be through m and a. Sometimes it can be organic that takes longer, as you're deploying tens of 1,000,000,000 of dollars. And so, so a lot of the areas that you're that you're focused in, I think, are critical to a healthy eco ecosystem, pardon me, because, a lot of these bigger platforms simply can't deploy capital, you know, down market as effectively, as midsize, shops, midsize investors, midsize firms, and somebody needs to be able to, you know, do the do the work, you know, put put the time and and energy and effort to understand that landscape.
Andres Sandate:And then, at the same time, I would imagine, like anybody that's been an investment banker, you wanna cultivate a relationship where you can do multiple, capital raises, assist strategically across an entire life cycle of that firm versus just hand them off, right, to to a bigger firm. So it would make sense that you offer those rated capabilities. You have your tentacles into the insurance company, space. The the insurance asset pools are gigantic and growing and and important to the space. So that's very cool.
Andres Sandate:And for me, like, it was great when we met because I'm focused at an early early stage with Yep. Groups that are, you know, call it raising their first million to $10,000,000. They're beginning to build a loan tape. They're beginning to implement new technology, and their aspirations are to get maybe that first asset based facility, maybe their first warehouse facility, and then ultimately graduate on to maybe, you know, bringing on a bank, maybe at some point down the road when they scale to to get, you know, into the securitization market, which I thought made a lot of sense for us to build the relationship, hopefully, so I can hand off transactions to you in the future. So
Matt Edgar:Yeah. Completely right.
Andres Sandate:So part 2, let's hop into this, and and really try to you know, for our listeners out there who are building origination capabilities, they're starting to build the loan tape. They've got some type of specialty finance business, or a tech enabled platform. In this second part of 3, what I wanted to do with you, is allow you to sort of articulate some structural, options through which these firms, these originators, can access capital. So could you sort of, to jump off, just talk about what are the structures, and and debt structures, I suppose, is what you mean through which, you know, borrowers can go to market to access, you know, lender capital.
Matt Edgar:Yeah. Absolutely. Happy to. I'm happy to give a a a fairly comprehensive answer because I think there's, you know, a number of what I'll call, you know, the more obvious well known structures, and then there's some, you know, gray space in between and some, you know, evolving markets as well. So I'll try to touch on on each of those.
Matt Edgar:But, you know, in summary, there's really, a pretty wide collection of markets and structures that specialty finance companies can consider. And each of those come with, you know, obviously, varying investor basis, varying cost of capital, and really objectives, I'd say, from from both sides. So, in in in thinking about the options available, I'd say, one, which is probably more of the focus of this podcast is what we broadly define as the non bank ABL market, and this typically includes lending against financial assets typically secured in an SPV where the investor, tends to be a non bank, typically a a credit fund or other investor. You know, we view this as probably, the first institutional financing that an originator will do sort of once they surpass the friends and family, perhaps, you know, the market that you're more focused in are ready to sort of, you know, go up a bit and, you know, partner with with their first institution. So Yep.
Matt Edgar:I think similar to that is the bank ABL market, which similar exact same structure actually. Financial assets typically secured in an SPV. But in that case, the lender is a bank or other depository institution. You know, banks, generally speaking, tend to have I don't wanna say a higher bar, but, a expectation to lend to a more mature, more scaled company in most cases. So we see a very typical, you know, graduation from the non bank to the bank market.
Matt Edgar:And, also, oftentimes, there's an opportunity to, you know, have both. Right? We see a lot of a b structures, which I think we chatted about last time where perhaps the bank is the first out in a facility, and you have a non bank credit fund with a higher return hurdle sitting in more of a second lien or mezz type of position, which I think is kind of an interim step between, the the those 2 markets to really bridge them together. And then, you know, going down, I think, you know, forward flow is something that we've seen, picking up a bit more. And broadly speaking, I mean, forward flow, there's a lot of different levers to pull to make the economics work, but these are really structures whereby platforms are funding new originations with capital from a third party.
Matt Edgar:And they sell qualifying originations to that 3rd party, typically retaining servicing of those assets. So it enables the company really to become more asset light and more fee driven, and we view that as typically a good complement for, you know, balance sheeting assets through, you know, one of the warehouse options we sort of mentioned or, another principal option. And then I'd say the other big one is the securitization market. Obviously, this is sort of I don't wanna say the holy grail, but what a lot of originators, ultimately shoot for, and this involves taking out, an existing portfolio through the capital markets simply. So through this, you, really tranche or separate different exposures to a given portfolio and typically sell off those different exposures to investors depending on their risk appetite.
Matt Edgar:This tends to offer very efficient pricing, not to mention depth of market. So this is where we see a lot of insurance companies, asset managers, even hedge funds for some of the more junior tranches and securitizations, participate here. And the, you know, benefits of this market are you can, know, issue on a fairly programmatic basis. Like I said, there's significant depth and demands to the market, and you're gonna get, you know, significantly improved execution, I'd say, relative to some of the, other private options. So those are sort of the, you know, 4 main buckets, I'd say, but we also spend a lot of time in, you know, other structures recently.
Matt Edgar:So one, I'd say, is the, corporate note market, which these are structures that are typically issued at the corporate or opco level of an originator. And these include bonds that can be secured or unsecured, have fixed maturities, have set financial covenants, and are based on, a combination really of cash flow characteristics and asset based characteristics. And these can be unrated or rated, but we typically see them rated and also sold off to insurance companies, which can be, you know, another way to access that type of capital. And then, I'd say the last one that's probably worth touching on is more, what we define as joint ventures. I'd say everybody hears joint venture and has a slightly different definition of what that ultimately looks like.
Matt Edgar:But we're involved in in many of these right now, and this typically involves capitalizing effectively a new origination vehicle that look more fund like than balance sheet, and there typically is a contribution of capital from both the originator and the investors. And the way economics are typically working is there's, you know, a preferred return sort of sold off to repaid to, the investor, and then there's some sharing on the backside of any excess return sort of north of that, you know, preferred hurdle. So that's something that we've seen, you know, more popular, I'd say, with the folks probably looking at a non bank ABL facility as another, way to really, you know, build different economic profiles for investors and tend to be reserved for what I'd say, you know, are more nascent scaling platforms, but, you know, a notable development from our side. So those are, you know, kind of the the big groups from our perspective. You know, I'm not mentioning the mezz market, the, you know, corporate equity and corporate preferred market.
Matt Edgar:This is the asset backed podcast, and I view those more as, you know, growth equity type of investments, but for the sake of completeness, probably worth mentioning and, something that we've, seen as additional, I'd say, compliments of a broader financing strategy.
Andres Sandate:Yeah. I mean, that there's a lot to digest there. If if you're a, a growing and quickly maturing platform, and you're, you know, fortunate to have an experienced CFO or, you know, VP of finance, you know, that knows how to navigate these different structures. And then also the second piece, that we're gonna talk about are the pools of capital. Right?
Andres Sandate:Who who are the actual lenders? Who are the represented by, you know, those 6 or 7, different structures? Because I would imagine some crossover, but some are very different and and distinct, which we're gonna talk about. But before we do that, going to, you know, the actual originator when thinking about where to begin? The size of the company, the size of the the loan tape, how much origination that's happened so far.
Andres Sandate:Does that are those sort of some of the markers that are gonna indicate where, a firm like yourself comes into play and and where they can get support? What are some of the markers that are gonna allow this, originator to start to get the attention of real professional help to navigate what is clearly a highly complex process and, you know, getting the right support is gonna matter greatly around structure, fees, the timing, and ultimately the success of the raise.
Matt Edgar:Yeah. I mean, not not necessarily a surprising answer probably, but track record is probably the main one that we look for. And track record, ideally, can mean on the platform or issuer that you're looking to work with, but we also come back you know, come across, teams that have been in various spaces of lending for years years, and they're on their next act, if you will, and are looking to capitalize, a new venture where, I guess, you can almost port over a prior track record, which I think some lenders can look through to. So I think that's helpful. But at the end of the day, track record and also scale is helpful.
Matt Edgar:And the reason those 2 are very much related to one another is every investor, lender, and even speaking from our perspective, every adviser is going to want to have enough information to audit performance and what that looks like. I think it's more important in very niche, very specialized asset classes because in that situation, the originator you're speaking to is probably one of a very small handful of folks in that space. But if it's a more broad asset class like equipment or ABL or factoring or any other or consumer lending. Yeah. I think it's a bit easier to look through to, those asset classes probably because if you're looking at a pool of consumer loans, everybody kind of understands, you know, what vintages perform better, what don't, what the sort of, you know, loss rates should shake out to generally speaking.
Matt Edgar:So I think that's very important. And I think the last, I guess, point to touch on for ourselves and a non bank lender, I guess, to get involved as a first facility is being able to size a day 1 draw. A lot of, credit funds in particular, banks too, but it's upmarket, so it's probably obvious. But with nonbanks, you do all this diligence. You do all this work.
Matt Edgar:The preference is always to get capital drawn on day 1 versus have a facility where you might commit 10,000,000 or $15,000,000, and who knows when that capital is actually going to be drawn and pay interest back to the lender. So I think being able to say say size for us probably a day one draw of a minimum of, call it, 15 to $20,000,000, is probably where we'd personally like to start engaging, which, again, is sort of, I guess, the output of what I mentioned before, track record scale and, also,
Andres Sandate:you
Matt Edgar:know, having enough auditable data where a informed decision can be made.
Andres Sandate:Yeah. Yeah. You have to be, underwritable as I say. I don't even know if that's a word, but I I use it. So let's talk about the different types of investors across the different structures that you that you just mentioned, that can be approached.
Andres Sandate:And, obviously, each of these investors has different mandates, different, risk appetites, different needs. They're gonna have a preference for different structures. So I know there's a lot of considerations when you look at these cohorts. So, again, this will probably be a longer answer, but something that's great about podcasts is folks can go back and listen to them again. So, feel free to take your time, but I'd love to just understand for our listeners.
Andres Sandate:Again, a family office, friends and family is gonna be very different in, it's underwriting and what they're looking for than, say, especially like, private credit fund. Right? That's that's deploying capital all day every day into these origination businesses. That's not to say any thing, negative about the family office space. It's, it's clear that there are families that that have a lot of depth and experience.
Andres Sandate:But broadly speaking, talk about the cohorts, talk about the differences. What are the things that we need to know kinda going in?
Matt Edgar:Yeah. And I I agree. And and and maybe just one point on on the family offices because I think they're becoming an increasingly important piece of of the pie, if you will. Family offices are a bit tougher than others because mandates tend to be, for better or for worse, all over the place. When you're managing a fund, LPs are giving you capital to manage those funds.
Matt Edgar:Typically, you have a pretty narrow strike zone of what you're looking to do. You know, a lot of credit managers will have credit opportunities funds, which can be I don't wanna say go anywhere funds, but be more opportunistic in what they're investing in. But with family offices, I think you find, you know, reduced, definition, I'd say, around their mandates. It's typically, you know, one family or, you know, several families' capital, which is different than managing, you know, a very broad base of of LPs. And not to mention, given they're not operating, I'd say, in the confines of a GPLP structure, you know, serving institutional investors in most cases, that also gives them, quite a lot of latitude and could be opportunistic in changing with the market.
Matt Edgar:So I feel like when we speak to family offices, we need to kinda check-in with them every 3 to 6 months just to understand if their mandate has sort of changed or the the the goalposts have shift. So that's one, I guess, you know, preluding comment I just wanted to address before I forget. But to answer the question, I mean, in general, I mean, it's obvious, but not all capital is the same, and, frankly, some capital is a lot friendlier than others. So we really seek to work with our clients for not only the best execution through, you know, pricing and structure advance rates, all those things, but also finding the best partner, hopefully, for the long term. So we kind of break down, I'd say, the capital provider universe, between, I'd say, banks, credit funds, insurance companies, family offices, and and hedge funds as I kinda mentioned before.
Matt Edgar:But I would caveat that there is a lot of gray space, between a lot of these categories. Some credit managers might have, you know, hedge fund strategies. You know, some family offices might look a little bit more like credit funds than others. So, like I said, I think each investor is unique, you know, as private markets continue to grow. And I'd say in terms of what I'll give a more broad answer.
Matt Edgar:We can get, I guess, more into detail if needed. So without getting into any category specifically, I mean, all these cohorts operate, I'd say, very differently from one another as it relates to cost of capital, deal structure, and risk appetite, but also in terms of a process timing and expectation for how each party will behave and interact with one another post close. So we never want to sign our clients up to an overly cumbersome reporting process or other requirements that are needed post close that either they won't be able to deliver on on the timelines requested, or it's just going to become, you know, such a significant burden to operating the business that it won't make sense to, you know, partner with that, lender or investor down the road. And I think, you know, as as we're seeing, we kind of chatted about, you know, insurance companies having, you know, significant appetite. But I think across each of those, you know, different, categories, appetite for the space sort of oscillates up and down depending on where we're at in the market.
Matt Edgar:So, I gave the example of the insurance companies before, like I said, but for banks, for example, a lot of the institutions that were doing what we call lender finance, I e providing asset based facilities to other lending businesses, have really retreated, I'd say, post bank sector volatility that we saw last year. So a lot of the institutions, you know, doing under finance have retreated. I'd say, you know, the more tourists in the product have retreated, but a lot of the true players remain. That being said, with the true lender finance, banking practices that remain in market, I'd say there is a bit of a higher bar for securing a bank facility today than there was, say, you know, 12 or 18 months ago. And banks are really beginning to look at, the holistic relationship they have with a borrower, which means I will give you a facility, but I also expect you send all of your deposits to us and we manage that, treasury, corporate banking, and look at it on a, you know, total fees to the bank basis outside of this facility, which I think operationally just gives a lot of, folks pause.
Matt Edgar:And I use that example just, you know, to show how, different cohorts are more or less active at any given time. So we try to balance what, for lack of a better term, is is realistic for any given issuer, when taking on, you know, these sort of, of of mandates. So that's kind of my broad answer, but I'm happy to, you know, dig into anything, specific for for any of these categories, really.
Andres Sandate:Yeah. Well, I think there's a a couple of categories that I'd like to to drill into. One that I'd like to start with is, you know, private credit. And so, you know, when when people hear private credit, I think if you talked about private credit 5 years ago, the vast majority of private credit would be, you know, floating rates, senior secured, sponsor backed, sponsor driven sort of transactions. Obviously, private credit has has expanded considerably, and while many still do think of that, you know, corporate, you know, PE sponsored transaction market as sort of the core meat and potatoes of private credit, clearly, there's a lot of other areas.
Andres Sandate:So when thinking about these these private credit platforms that that just focus in asset based or asset backed, they finance financial assets among other assets. It's a broad market. I can think of just off the top 15 or 20 different platforms that a growing firm that's got good data, good track record, good loan origination history, a team with a lot of experience, and they've done all the right things. I can think of a lot of firms that they can go to. How do you think about that part of the market for, like, ABL facilities when it's their first, you know, $50,000,000 25, $50,000,000 facility, but before they can go to the bank market.
Andres Sandate:And and how would you characterize that, that group of of participants?
Matt Edgar:Yeah. So so growing, I'd say, is probably the, the the overarching term. Right? Yeah. And I think, I mean, you you set the question up well in sort of starting it at 50,000,000.
Matt Edgar:Yeah. When you get to a 50,000,000 deal size, which, look, that this is doesn't necessarily need to be all day 1, but if there is a near term expectation that 50,000,000 will be drawn on a facility, It's a very robust market. I mean, you mentioned 15 to 20. You know, there there there's probably north there's definitely north of, you know, 60, 70, probably close to a 100 firms that would look at transactions like this, and some are, you know, pure play firms that this is all they do, and there are others that are part of a larger platform that may have a number of different private credit or alternative credit strategies where asset backed or specialty finance lending is one area. So So they could
Andres Sandate:be sorry to interrupt you, Matt. But they so they could be running a half a $1,000,000,000 within a $5,000,000,000, you know, credit organization, and this particular team, they're specifically looking to deploy that, you know, half a $1,000,000,000. But they could also be in a way sort of internal teams that are competing for capital. And so you're out there as this team sort of trying to originate, whether it's equipment finance deals, financial assets, aviation, litigation finance. I mean, I'm just going off the top here, but I I'd love to spend some time helping educate the listeners around that universe of 70, call it up to a 100 firms, and some of the sort of markers because you talked about this earlier in the first response, which is the partnership and really helping the client, think about what is the partnership that you're gonna have.
Andres Sandate:It's it's important to get the right deal and to be structurally on market. But but it's it's not just about advanced rate, eligibility criteria, you know, rate. It's also about what are you gonna do when things don't go as you anticipate they were supposed to go. You know, how how much flexibility are you gonna have? Yep.
Andres Sandate:You know? Can you pick up the phone and call the team? Like, talk to us about that universe of of participants because it sounds like it's grown a lot over the last 5 years and continues to expand.
Matt Edgar:Yeah. I think I think that's right. In in terms of other characteristics, I'd say that we look for on behalf of our clients outside of pricing, advance rate, the obvious economic terms, which are very important, but it's not the whole deal, are are a couple of things. So, you know, we put a premium on working with lenders on behalf of our clients that can grow with our clients. So whether that is accomplished through, you know, a $50,000,000 delay draw on day 1, but perhaps an accordion feature up to 1.50 or 200,000,000 down the road, we think that is, granted they're typically uncommitted, accordions at the end of the day, but we think that's a reasonable vote of confidence, in certain situations for for lenders to support, our clients, I'd say, over the long term.
Matt Edgar:And I think, you know, one positive of the nonbank market relative to the bank market is, you're you're dealing with investors, I'd say, rather than lenders, and I mean that because there there there's more flexibility, all things equal, of the nonbank market, and the bank market as it comes to amendments and just I'd say I I I don't wanna say being more commercial, but, being more realistic on how the business is actually expected to perform. So that being said, the, you know, bank market tends to be much more rigid as it relates to, you know, reporting and covenant compliance and amendments to the facility. Whereas, I think the nonbank market, you know, at times can actually be more structured and have more protections in place, but that can, you know, often lead to a better outcome for the borrower when there is, a downside protection. And I find that a lot of lenders will say, you know, everything in the credit agreement is important, but in practice, if there's a breach on this or if the borrowing base at close is a bit different than expectation, I think there's a greater degree of latitude to be commercial and find a solution for the borrower than there might be in the bank market.
Matt Edgar:So I think that's helpful, and that's part of the reason you're, paying up for a higher cost of capital with a nonbank relative to a bank. So I think that's one piece of it. And also just from a, you know, working style perspective, like, doing reverse due diligence is just as important.
Andres Sandate:I was getting ready to ask you about that. I mean, we we've spent so much time, and I know the emphasis is always on the preparation and the data room and the diligence on behalf of the lender to the originator. But I also think now that there's a proliferation of lenders to the specialty finance originator, let's talk about some of the things that the CEO and board, CFO should and you are thinking through and evaluating when it comes to, you know, getting different term sheets. Like, what kind of diligence, should you be doing?
Matt Edgar:Yeah. Yeah. And and and something we we tell our clients and, you know, some some shape or form is, at this part of the market, you you shouldn't be desperate for capital. So we almost like to phrase it as be reasonable, but a lender should be lucky to be in business with you guys. Right?
Matt Edgar:So it's not you're lucky to just get the term sheet. I think it's a a two two way street, and there's a mutual respect that needs to be established, which I think sets up for the strongest partnerships from from our perspective. And I think, you know, another big piece with so many entrants coming in and out of the space, you can pick it up pretty quickly with what even an initial term sheet looks like. Some folks are more sophisticated than others. As I mentioned, I think there's some, what I'll describe as, generalist private credit firms that are trying to get into the space that may not be as smart as some of the pure play, better known guys that have been doing some form of lender finance for many, many years.
Matt Edgar:So I think that's something that comes through, pretty early on in the process. And in most cases, again, all things equal, a more sophisticated, more experienced lender will be, you know, the the better route in most cases. And I'd say the other big topic is, you know, consistency or stability of capital. Large firms aren't always better. They can be because they have much more stable, capital basis and can, you know, be in market with numerous funds at once.
Matt Edgar:But for folks that are, you know, smaller, maybe managing 1 or 2 funds, not necessarily a bad thing, but we really like to understand what the trajectory of raising, future capital is, what is in their broader portfolio, and understand how they're really, I guess, navigating the LP environment because, you know, down the road, if we're truly looking for a lender that can grow with our clients, being able to raise more capital from the underside is, a critical input into that, obviously. So we like to, you know, diligence that out, as well. And, I'd say the third thing, which, I'll be short on it, but, lenders will typically offer, customer referrals of other borrowers that they've worked with, which typically are are fine. It's good to really dig into, hey. When something didn't go as planned, how did that lender react?
Matt Edgar:Were they a reasonable partner? How was it resolved? But I think you can also do some independent research and find other portfolio companies that perhaps the lender didn't introduce you to just to get, you know, a better sense of, holistically and make sure you're not, speaking to the, you know, 2 most vanilla, well performing credits. I think it's key to sort of go broader than, you know, what's direct, assuming it's okay with the lender. So, those are a few points that we always spend a lot of time on, frankly.
Andres Sandate:Yeah. It it you know, we spend a lot of time, because I think it's an area where there is a lot of questions, those earlier stage originators. But I think we'd be remiss if we didn't also, allow you to talk about the the bank market, to the extent, you know, you want to, the insurance market, and then you also mentioned forward flow. And then there's also the corporate note market. So, you don't have to hit on all of them, but as you sort of move to these other structures and most importantly, like, the investors, lenders who are most attracted to those types of structures, Somebody that's active in forward flow is gonna be very different than somebody, right, that's allocating out of an insurance pool of capital.
Andres Sandate:So maybe we could start with the bank market. I know that banks have pulled back broadly. That's a broad term since some of the bank volatility that we saw, you know, over the last couple of years, but they haven't gone completely away. There are still banks active in the space. So but I'd love to have you touch on banks and then talk about forward flow as well because that's maybe a a, if if you're a seasoned lender who's done multiple platforms, you're familiar with forward flow.
Andres Sandate:But if you're a relatively new Fintech lender or new into the lending business, maybe haven't done a forward flow transaction. Maybe you could touch on that. And then lastly, I'd love to get your your thoughts on the growing, and and critically, important space, which which I think is gonna play a lot of, is gonna be a lot in a lot of conversations in the years ahead, and that's the insurance market.
Matt Edgar:Yeah. And I think that's right. And and just to, make make one comment on forward flow, I mean, we can hit that first, but as it relates to insurance capital allocating to forward flow, we actually think in certain situations, insurance companies are the, best partner as a forward flow provider, and I think that's the case for longer duration type of assets. For instance, we were recently looking at a forward flow for, a consumer lending business, student lending business in particular, that, you know, had 15 year plus duration. So I think for something like that, it's very difficult fit a 15 year asset into a 7, 8, or 10 year at most, year credit fund.
Matt Edgar:Right? So, we actually think that in those types of situations, insurance can be, an important player, and we've seen insurance companies increasingly play in rated forward flow. So I think there's a question. There's a broader ratings question to be addressed as part of those, but I would say we are seeing, investors wouldn't say crossover, but, I think that's an example of, you know, you wouldn't typically think of an insurance company participating in forward flow, but at the end of the day, they're just buying whole loans.
Andres Sandate:So That's encouraging. Yeah. That's encouraging
Matt Edgar:to hear. So so so just one caveat. So, just to, I guess, round out the the comments around, I guess, forward flow and what those or I guess, why would somebody do this? Right? Why would you start a lending business but not hold the loans you're making?
Matt Edgar:So we think forward flow is a helpful tool in a couple of different cases. 1 is scaling a platform. Being able to use solar flow to build a track record, we think is a a pretty viable playbook, which, you know, friends and family and non institutional capital can only go so far to build a loan tape, build a track record. So if you're able to, in effect, rent a balance sheet from somebody else to build some, you know, data and performance stats on your originations and also get paid to service the assets, perhaps get paid an origination fee, you know, is is a viable way to build a portfolio. So that's 1.
Matt Edgar:And I think 2 for more scaled players, it's really just diversification of, investor type and also of, revenue generation as well. As a forward flow provider, it's a more asset light fee based business model relative to a NIM or spread based business, for assets that you are balance sheeting. So I'm not gonna get into the philosophical question, you know, which one is better, but I think most folks will agree that, having diversity and having some business lines that are heavier fee driven and some business lines that are heavier NIM driven, can be powerful complements to one another. So we think it's a smart and important, diversification play, and I think the reason why a lot of, folks will folks that are more scaled will sort of pursue, both markets, if you will, in conjunction with one another.
Andres Sandate:Yeah. Yep. And and I also think it's important to note, if you're a founder, it's it's critical that you'd be thinking about, you know, which of these businesses. You mentioned the philosophical question, but it's also practical. Like, if you're taking equity from certain sources, there could be motivations to grow the business and scale quicker versus if you're taking capital from other alternative sources or maybe funding the business more off your own balance sheet.
Andres Sandate:Maybe you don't have that outside, I'm not saying pressure, but that outside motivation to to try to scale quickly and therefore, you know, the sources of capital that you can pursue and the sources of capital that are most attractive. That all comes into play because, ultimately, as a founder, you want flexibility. You wanna continue to drive down your cost of capital. You need to be thinking about who are the partners that can help you get to scale, right, beyond just providing you capital. Are there other things that they can do?
Andres Sandate:And most of the more successful platforms are gonna have a pretty sophisticated approach over time where they're gonna be looking at multiple sources of capital and multiple funding relationships. And I think there's plenty of examples and horror stories of of Fintechs that sort of went all in maybe with one big shiny name, only to find out when the seas change, right, that capital can quickly go away, and, and it can severely impact the business. So that's for another podcast episode, but, talk a little bit about about the bank market if you would. And, you know, it's characterized as maybe slower now, but obviously, you know, banks still a meaningful part of this conversation. Non banks may wanna stay in some of these deals, so maybe you can sort of have your cake and eat it too, if you will.
Matt Edgar:Yeah.
Andres Sandate:But love to hear what you're what you're seeing there.
Matt Edgar:Yeah. Yes. So so by no means is the the bank market gone or, you know, significantly, less active, I'd say. I mean, the the the number of players seriously in the lender finance business have, been reduced over the past, call it, 12 to 18 months. But for those folks that are have been active in the space, it's it's it's business as usual.
Matt Edgar:Maybe there's a, you know, slightly higher bar for bank capital as I mentioned before, and there's looking through to that, you know, holistic relationship. But for Sure. Bank credits, deals are still getting done and banks will move quick to execute on those types of deals. So it can still be a, you know, a very, realistic aspiration to secure a bank facility. We're helping many borrowers do just that right now.
Matt Edgar:But I do think it is less common to see a business have their first financing as a bank facility, which gets to your point. You know, being able to and this gets back to the flexibility of the non banks. I think one smart question to ask as a borrower is, a, as we evolve down the road, would you guys be comfortable slipping into a second or mezz position? Have you successfully done that before? Because that sort of gets in front of, you know, the the the point where maybe you're borrowing for 2 years.
Matt Edgar:You start, you know, blowing it out on originations, great performance, scaling the business. You're becoming more attractive of as a borrower to a bank. If you're able to it makes a lot more sense to, you know, secure the bank facility and subordinate your nonbank lender to that NEST position versus waiting 3, 4, 5 years to pay off in full or refinance the existing nonbaked facility and then start migrating the cost of capital down. So we think that's a a a a pretty viable, I keep using the word playbook, but I think it is the right way to, think about it, in sort of combining and bridging to a bank only solution as an interim step.
Andres Sandate:And I think there's a lot to be said for having the right advisers, partners, could also include, you know, folks looking at compliance matters. Obviously, legal is a huge consideration here. Right? You can spend a lot of time mired in, documentation to get one of these facilities in place only to find out that you have do it again, potentially, if not done the right way or if you don't choose the right path when you go to the bank market. So there's there's different methods and approaches that savvy experienced, deal attorneys with knowledge of this space can assist around saving money, doing this efficiently, and preparing you for the ability to go to the bank market, and not have to completely start from scratch.
Andres Sandate:Right? So
Matt Edgar:Yep.
Andres Sandate:So I I think it is critical to to really have the right advice on the front end. So, lastly, talk about insurance. It seems like every time we we open up, you know, the journal these days, there's a a platform acquiring an insurance business or an insurance business, executive that's, you know, on a podcast talking about, you know, the the increased appetite for non correlated, you know, assets, diversifying their income sources, looking for longer duration, esoteric niche assets. Like, it all seems to point to, you know, that this is a important pool of capital. So I'd love for you to spend a minute on it before we get to our last, piece of part 2.
Matt Edgar:Yeah. Happy to. I mean, all of the, I mean, the the proliferation of insurance capital and asset based finance, like, it it it it makes sense. Right? When you think about a diversification play out of, you know, down the fairway private credit, There's a lot of very attractive features of asset based finance, particularly in the specialty finance space relative to cash flow lending.
Matt Edgar:So I think insurance companies have warmed up to the idea. And to be clear, they've insurance companies have participated in the securitization market for years years. Right? So I think this proliferation of private asset based finance, has really, you know, coming to the forefront for a number of reasons. I think insurance companies, like I said, have warmed up to, what I say, financing Main Street, getting access to student loans, consumer loans versus just,
Andres Sandate:you know,
Matt Edgar:auto corporate type of exposures, which is diversification play. But also being able to structure exposures to typically shorter duration self amortizing pools of diversified assets, which is a very data driven underwrite, is one could argue, better risk to be taking versus corporate credit risk, which, you know, is typically asset light. You're dependent on cash flows continuing to perform on the business. I think as, you know, private credit, generally speaking, has gotten a lot more competitive, returns are going to get bid down in cash flow lending where you partner with, you know, private credit managers or other BDCs that in most cases are kind of chasing around the same group of sponsors. And as competition increases, leverage levels are gonna go up, pricing's gonna go down, which I think is a pretty dangerous combination when you're looking to get exposure to private credit.
Matt Edgar:So I think asset based finance offers a real differentiator and diversifier away from that, which folks, I think, have, you know, warmed up to. Not to mention my prior point on the forward flow, in certain asset classes, you have much longer duration assets, whether it's student lending, whether it's mortgage. So insurance companies, by nature of how they're capitalized, tend to be much longer term, stickier capital where you can match the long duration assets with long dated liabilities, which credit funds and even banks, as we all know, have struggled with historically. So I think that, in many cases, makes them the ideal partner for a lot of specialty finance, platforms out there.
Andres Sandate:Yeah. Yeah. That's that's critical and something that I think we'll continue to cover here on the Asset Back podcast. I wanna spend the last few minutes giving you an opportunity to talk through some of the important structural features of these ABL facilities. So I I think if, you know, we tell listeners to sort of go back to part and we spent some time talking about I call it the sort of big the big 2 or 3.
Andres Sandate:Right? Pricing is always the headline. You know, that's what it seems like a lot of the the folks are really focused and preoccupied on is, you know, rate rate rate. But I think we also spent a good amount of time talking about things like the borrowing base and and how that's defined is super important. Advanced rates, against the borrowing base we talked about.
Andres Sandate:There's other important considerations, though, when setting up, one of these facilities. And I'll go through a handful of them, and I'd love for you to talk about them, and and what they are, number 1. And as the originator and from the lender's perspective, some of the issues, some of the considerations that are gonna come up, so not in any particular order, but let's talk about eligibility criteria. So if we're a lender, eligibility criteria is gonna come up in the conversation around the term sheet. What does it mean?
Andres Sandate:What are the implications? What do we need to be thinking about?
Matt Edgar:Yeah. It's a good one to start with because it's, typically one of the more time intensive ones to negotiate, admittedly. So one zero one level, these are this is the list that governs what can and can't be contributed to a portfolio or an SPV. For instance, if you're a consumer lender and your average FICO score is just making it up, you know, 650, you'd maybe set a minimum FICO for an eligibility criteria's sake at 550 or 600, provided that if you are below 550 or 600, the loan would not be eligible extending credit against, will be a similar or better quality than what has historically been underwritten and what can be audited when looking at your track record, underwriting, I guess, similar type or similar similar quality of assets.
Andres Sandate:Yep. So that that I think you said it it, you know, it's it's great if you have a graded it's good if you get a attractive advance rate, but if your eligibility criteria, blow that out of the water. Right? Because everything is deemed ineligible. It you know?
Andres Sandate:Therefore, you can't actually borrow against the pool of assets that you thought you had created, then you're not gonna be able to draw on the facility. So now we run into a problem. So let's talk about concentration. You know, you as an originator out there, you're getting traction. You find a seam of origination.
Andres Sandate:What is excess concentration? And why why would a lender put guardrails around concentration? What are what are they trying to protect against?
Matt Edgar:Yeah. So so I think it's protecting against the same, you know, it it it's almost an identical concept to eligibility criteria, but instead of looking at a single asset, you're looking at it on a portfolio, portfolio basis. So, again, just to use an example, no more than 10% of the portfolio can have a FICO score less than 625, or the average duration of the underlying assets in the books need to be inside of, you know, 24 months, and then the other tests. And I think the idea for this is that, you know, should you breach any of these categories, then there would be some sort of adjustment either to the, advance rate or borrowing base to exclude certain assets so that on a portfolio wide basis, the lender is still underwriting risk that is, I guess, the the the targeted risk that they're looking to take.
Andres Sandate:Yeah. So that they're they're getting an exposure that, you know, ultimately, they they are paying for, and that they want and that their LPs expect them to deliver. Let's talk about utilization. You you you gave this scenario of a 15, $20,000,000 draw, sort of day 1 that these lenders want capital to be utilized. So so if we run across minimum utilization and then you also brought up the idea of an accordion.
Andres Sandate:Right? You may start with a 50 or a $100,000,000 facility. What is an accordion? How does it benefit, the the borrower, and and what what's an accordion? Is there a typical number that we should be looking at relative to the sort of original facility?
Matt Edgar:Yeah. So so yeah. I mean, starting with, I guess, the, minimum utilization and and maybe taking a step back, we kind of define utilization in in 3 categories. So the the day 1 draw, as we mentioned intuitively, that's, what what is drawn on day 1 upon closing the transaction. And then, the initial commitment size is typically larger than the day 1 draw.
Matt Edgar:Like I said, there might be, you know, 35,000,000 out the door on day 1 with $50,000,000 on, on on the cover as the commitment. And then beyond the commitment is typically an accordion, which is uncommitted, typically executed based on mutual agreement from both sides, but that allows you to, increase the facility to a larger size and get more runway. So, I guess fit fitting this into, the concept of an unused or standby fee, I think, is important because Mhmm. As you think about the rate, the spread to SOFR is not the cost of the facility. You need to factor in, really all fees that are included, which may sound obvious, but we always find that clients' natural, inclination will be just to look at the spread.
Matt Edgar:But that being said, I think sizing the, initial draw and the commitment size, typically, the difference of the 2 is what a commitment fee would be charged on. And commitment fees seem de minimis or typically, you know, anywhere from 25 bps to a 100 bps from what, what we typically see, but that can add up. And I think being able to be smart around how you size the, total commitment size relative to the day 1 draw, is an important concept because you may think it's better to have a larger day 1 draw. But if it's a $50,000,000 commitment and a, you know, 5 or $10,000,000 draw, you're gonna be paying a significantly higher standby fee if if the facility was $20,000,000 or $30,000,000. So I think that's, you know, a key consideration.
Matt Edgar:And then, the accordion is another piece. As I mentioned, like, understanding how committed that is, I think, is important. By definition, they're generally uncommitted, but understanding, and it's this gets back to the reverse diligence concept of understanding how your lender has raised capital in the past, how successful have they been, when we wanna execute the accordion, will the capital actually be there? So those are the important questions I'd say to ask. And, I mean, no specific, I'd say number or level necessarily come to mind.
Matt Edgar:Like, we've seen accordions as much as, you know, one and a half to 2 times 2 times, committed. But we've actually thinking about it now, I've seen, then even higher than that where you have a $50,000,000 facility with an up to 200,000,000 accordion. But, typically, we probably see it in, you know, 2 times commitment, all in with, with the accordion exercise.
Andres Sandate:Yeah. You you remind me of a transaction I was involved in where I felt like a really important, sticking point. Ultimately, the the parties came to an agreement, but the the ROFR, right, where, you know, the the lender was effectively saying, look. We're doing a lot of underwriting. We're we're gonna reserve capacity in this vehicle and in the future vehicle.
Andres Sandate:We we prefer to grow with this platform versus having to go find 2 or 3 others. Right? So talk about ROFR language, as it relates to, you know, competitive markets, getting attractive pricing. I don't wanna jump ahead because there's some other pieces, but when you were talking about accordion, it made me really think about that transaction.
Matt Edgar:Yeah. ROFR and ROFO are actually two points that are, they they they're definitely, a focal point of, you know, borrowers and lenders in the market. And, I mean, you're kind of alluding to it. It's in a lender's best interest to double down and upsize for a credit that they've been with for a couple of years. And Yeah.
Matt Edgar:They've done the work on, frankly, versus trying to drum up a a new opportunity, getting it through investment committee, and spending months months to diligence and close the transaction. So it's a great return on time to actually be able to, execute these. So I think ROFRs are I hate to use the term, our market, but they generally are market terms and should be expected. But, you know, lenders typically can be reasonable around brokers. I think in certain situations where, you know, you can secure much cheaper financing relative to what your existing partner can provide, is a very, you know, common carve out, I'd say, that we see in these types of, in these types of terms.
Matt Edgar:And I think also Yeah.
Andres Sandate:At least they get a chance to maybe match it or or
Matt Edgar:Exactly. Exactly. And I think the other point is, the type of capital. For instance, one transaction we're working on right now, it's a forward it's a loan sale and forward flow facility. So our ROFR only relates to forward sale and and forward flow, opportunities because the company is securing a bank facility, and it wouldn't make sense to have a ROFR on debt financing, holistically going forward.
Matt Edgar:So I think those are sort of the main points, which, again, most lenders are reasonable and understand that's expected. You don't wanna put your borrower in an adverse situation just to, you know, draw on a line that is not gonna be as accretive to their other options, but, there needs to be some protection for the lender again to have that opportunity to upsize, for the reasons I, you know, sort of mentioned.
Andres Sandate:Yeah. You've alluded to, and and it goes back to partnership too. Right? That's gonna be important part of this this process. The last couple that I wanna talk about are, covenants.
Andres Sandate:Financial covenants. I've I've heard covenants, you know, coming into play depending on the stage of the company. Right? If if it's an earlier stage company, they may have a minimum, cash on hand type of covenant or they wanna see days of runway covenant. Later stage companies, maybe it's more traditional financial covenants.
Andres Sandate:Can you just speak to those?
Matt Edgar:Yeah. Quick. I mean, the the purpose of financial covenants are to ensure that the servicer is is a going concern. Right? Yeah.
Matt Edgar:You wanna make sure that I am lending to a litigation finance platform. We are in part underwriting the platform's ability to service these loans, so we wanna ensure that as long as our facility is in place, they're a going concern. They're gonna continue to service the loans. We can talk about backup servicers and all of those things, but in spirit, that's what financial covenants are seeking to protect. And we see these in in in every deal.
Matt Edgar:I think the the form and substance of them obviously differs by stage of company, but most common that we see are, you you know, some degree of minimum liquidity like you mentioned, some maximum, you know, debt to net worth tests, perhaps interest coverage and some other, metrics that, again, are just seeking to, ensure that, you know, the servicer will, will will be around to to manage the loan book.
Andres Sandate:Right. And then collateral quality tests and and triggers. Again, this is all sort of building to towards avoiding default, avoiding events of default. So those are maybe 1 in the same.
Matt Edgar:Yeah. I think of them different financial covenants are typically struck at on a consolidated basis or at the servicer level. And I view the collateral quality tests are typically struck at at the SPV.
Andres Sandate:At the essence?
Matt Edgar:The correct. And, you know, the these really dictate, I guess, in summary, how the facility, primarily the advance rate will behave as performance changes, typically, to the negative. So, for example, if delinquencies spike to 10%, the events rate is reduced by 5%. If they spike to 20%, the events rate is reduced by 15%. So in this example, as the portfolio quality deteriorates, lenders hold the right to proactively adjust their exposure down.
Matt Edgar:And keep in mind as part of this, depending on utilization, this can likely cause forced amortization or pay downs of the facility, which creates natural liquidity issues. So that's another consideration of just managing an ABL facility. But, hopefully, that example is helpful in at least highlighting and, you know, shows why lenders introduce these these concepts at an asset level.
Andres Sandate:Yeah. And and what I was alluding to was that, ultimately, unlike, let's just say, an equity investor, a venture investor where there's theoretically unlimited upside for a lender. Right? They know their upside. Right?
Andres Sandate:And get paid back the principal plus interest, maybe some fees. So the the the things they can put in place are the covenants, and different tests, and then have different triggers and mechanisms where they can protect their principal ultimately. Because 1 or 2 bad deals, you know, can severely impact the outcome of a fund. Whereas in venture, 1 or 2 good deals is really what the fund manager is expected to identify. All the others are probably gonna be zeroes.
Andres Sandate:So That's right. Just a completely different, sort of underwriting process. Well, that wraps up part 2. I know we went longer. You gave a great deal of information.
Andres Sandate:Part 3 of our 3 part series, Matt and I are gonna talk about, the closing and funding process, different providers that the that the, the borrower can put in place, around these asset based financing facilities to sort of manage and help govern, all of the different, criteria and covenants and tests. You're gonna talk about some of the biggest mistakes you see borrowers make when raising capital, and then also some of the biggest struggles, you know, you see when working with investors. And then we're gonna talk about, you know, the types of advisers typically required for these types of facilities. Some of the key key considerations as specialty finance originators evolve and seek to tap into the bank market and the broader capital markets, cost of capital, how that differs by stage, what can sort of borrowers expect today. Things are very dynamic.
Andres Sandate:And then lastly, you know, what do you sort of expect? I'd like to get Matt's views on what he expects to see out of the private asset backed finance market over the next year or 2. So a lot to come in part 3, but we'll leave it there. Matt Edgar of Edgar Matthews. I wanna thank you for joining me, on the asset backed podcast for this master class, for specialty finance originators and Fintech lenders.
Andres Sandate:Thank you for joining me today.
Matt Edgar:Yeah. Likewise. Thanks for, thanks for having me. I'm looking forward to, the next conversation. Appreciate it.
Andres Sandate:We'll get it on the calendar soon. Take care.
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