Navigating today’s financing environment can seem like a daunting task for a specialty finance company in need of working capital. Post-recession, the perception of credit risk for nontraditional asset classes remains high, and viable financing options for specialty finance companies are harder to find. That perception can really harm certain industry segments, such as finance companies, because they are not well understood by lenders.

The availability of liquidity is tight right now for finance companies – especially smaller finance companies. Finance companies with less than $50 million in equity will find it harder than their larger counterparts to find credit facilities. From a lender’s perspective, credit risk trumps growth in an above average risk or troubled credit environment.

While we are seeing recovery, albeit slow, we are still in a very cautious period. During the recession, credit was not readily available for companies in any sector, including finance companies. Today, credit is more readily available, but there is still significant concern over what impact a European sovereign debt default and/or Eurozone recession would have on credit availability at a global level, and what the impact would be on credit availability in the United States.
 
As for specialty finance companies, the current lending environment has created a bifurcation in terms of traditional asset-based lending and financing for specialty finance companies. The cost of credit has been driven down significantly for borrowers and transactions that are traditional and more readily understood. Competition is fierce for transactions that meet the prevailing underwriting standards, but there is not enough demand for credit that meets those standards. For companies that don’t meet credit standards or are in asset classes that are not widely understood, pricing has been driven down from its peak during the recession, but because it is seen as a specialty situation, it hasn’t been commoditized.

Stability Among Uncertainty

But, it’s not all bad news. While this segment may not be well understood because lending to specialty finance companies is more complex than traditional leveraging of receivables, inventory, and/or fixed assets, there are lenders that have the expertise and resources available for this specific financing niche. Wells Fargo Capital Finance has been a steady source of capital to lenders and leasing companies for the past 12 years. In fact, in 2009, during the depths of the recession, the Lender Finance Division of Wells Fargo Capital Finance generated a record year in new business origination. Because Wells Fargo Capital Finance understands the countercyclical nature of specialty finance, we are well positioned to help companies succeed, even in times of uncertainty in the marketplace. And, because we are part of Wells Fargo & Company, we remain strong and stable even during unfavorable market conditions.

The Need to Fine Tune

Since the recession, we have fine tuned some of our lending practices. Specifically, we have become more selective within the asset classes we leverage because of differing default severities and the time required to liquidate some types of assets. For example, we are much more cautious when it comes to real estate. Prior to the recession, hard money lenders were often provided revolving lines of credit to finance short-term commercial mortgages. However, when commercial real estate values in certain markets fell by fifty percent or more and the borrowers were no longer viable, the time required to liquidate became significantly greater than the time that would have been required to liquidate more traditional lease or loan receivables.

Financing Considerations for Finance Companies

Before finance companies approach a lender for financing, they need to review their own financial statements, management team, systems and policies to determine if they would be an attractive credit. At Wells Fargo Capital Finance, we consider three different components of a company: intellectual capital, fiscal capital and systems. The intellectual capital refers to the management team. If the company is a start up, the management team needs to have a verifiable track record of success in the same asset class. Fiscal capital takes into consideration a company’s equity and its proposed debt to worth. As for systems, a finance company should evaluate both its technological systems and its documented policies and procedures to assess and manage the credit risk of its own obligors.

In addition, a finance company needs to have a minimum capitalization of $5 million, and the company needs to have the ability to originate $25 million annually or already have achieved that level of originations to be an attractive
prospective borrower. We also tend to focus more on lenders specializing in asset-based lending, factoring and equipment finance, in addition to some specialty asset classes such as merchant cash advance and insurance premium advance.

Finding the right credit facility that provides the right amount of debt capital and leverage is critical to a finance company’s success. Capital is key. Ultimately, it’s the specialty finance company’s raw material inventory which is converted to the “finished goods” of purchased accounts, asset-based loans, leases and other financial assets.

Reaching More Customers

In July 2011, Wells Fargo Capital Finance acquired Castle Pines Capital, which provides vendor programs for extended payment terms to value-added high technology equipment resellers (VARS). We have successfully integrated the business of Castle Pines Capital into that of Wells Fargo Capital Finance. The division formerly known as Castle Pines Capital will now be marketed as the Channel Finance Division of Wells Fargo Capital Finance.

The Castle Pines Capital acquisition is one of many former borrowing relationships where Lender Finance acted as an incubator for a specialty finance company. The size and flexibility of the credit facilities provided by Wells Fargo Capital Finance were the raw materials for the growth and success of our borrowers, that became attractive acquisition candidates for financial institutions (including Wells Fargo), strategic buyers and private equity sponsors.

Lessons Learned

Specialty finance companies have experienced a dramatic contraction of credit availability since 2007.  Although credit contracted in the 2001 recessionary cycle, the past four years have been much more difficult and prolonged. When looking back, three important factors differentiated the survivors: moderate leverage, stable underwriting parameters, and a knowledgeable lender with years of commitment to the specialty finance industry. For specialty finance, when times are tough, credit and cash are key.