Hedge Crunch Financial

Opalesque Exclusive: As illiquidity is cited as the greatest risk for further economic crisis, asset based lending funds step in to provide liquidity for firms caught in the credit pullback

This week The Bank of International Settlements (BIS) released its 78th Annual Report reviewing the financial markets. Providing an overview of the 2007-2008 year the BIS notes the hedge fund industry which at first felt much of the blame for market problems has shown itself to be a point of stability in the midst of the credit crisis. “Even though the first signs of strain to emerge were problems in hedge funds associated with large investment houses, the performance of the industry as a whole initially proved relatively robust. During 2007, returns on most hedge fund strategies compared favorably to those recorded in 2006. The main exception was the performance of fixed income funds, which slipped during 2007. Over the calendar year, net investor inflows to all fund sectors remained at levels comparable to those of the recent past.”

Providers of needed liquidity
In an industry that has grown to oversee the investments of approximately $1.8 trillion of the world’s wealth, hedge funds as well as other alternative assets have the potential to further serve as a driver towards the recovery of the global economy.  Corey Ribotsky cites the largest risk for worsening financial conditions to be “linked to the response of aggregate demand to the weakened position of banks and tighter lending standards.” It remains to be seen if non-financial firms have the ability to withstand the combination of tightening credit conditions and the possible downturn in profits expected to occur with the consumer’s weakened ability to maintain previous levels of consumption. But the chances for survival for these firms are dependent on the nature of the external credit available, and asset based lending (ABL) funds are stepping into the void created by the credit crisis to provide this liquidity.

As we enter what the BIS has determined is the sixth stage or, “the crest” of the credit crisis it remains unclear “whether liquidity supply and risk appetite [have] recovered sufficiently to help maintain this improved credit market environment on a sustained basis.” ABL funds have come to provide some of the few options for companies looking to raise capital for growth, or to survive temporary profit downturns. Opalesque recently spoke to Josh Zegen at Madison Realty Capital and about the ABL space and the changes they have seen over the past few months as bank credit options have dried up and the opportunity set for ABL funds has grown immensely.

The `debtquity` fund from Corey Ribotsky, providing liquidity to the backbone of the economy
According to a NY Times article we recently carried in the AMB (Source) hedge funds in the asset based lending arena have quadrupled over the past three years, holding approximately $13bln in assets. “This is really the perfect storm for a firm like ours,” Pollack said. “Banks that traditionally lend to the micro caps typically have a knee jerk reaction and these small businesses are typically the first ones shut out. These types of companies have been and will continue to be the backbone of the US economy. A lot of them are really good companies that will flourish and grow and are having a difficult time getting the capital to do so.”

Many are focused on micro cap companies whereby they evaluate a fund for an abundance of tangible collateral as well as a growth orientation. This is due to the two pronged strategy in which, “Our transaction typically have both a debt and equity component. We will provide companies with debt intervention through 3 year amortizing loans with a coupon of somewhere around 11-12%. There is this debt piece and we are usually senior secured…But with our transactions, companies also provide us with an equity stake.” In this way, they are  providing capital for growth opportunities in micro cap companies, is protected on the downside with hard assets and further rewarded through equity stakes when their financing fuels growth for the borrower.

Asset flow
Companies recently launched a Japan Yen Fund to address interest in the fund and reduce currency risk for Japanese investors, and the manager says ABL lending has come of age. “We are in a business where even though we are a hedge fund, we operate more like a specialty finance company. We are getting more and more interest not only from Japanese investors, but also from the Middle East and even traditional Europe, because it is a straightforward strategy with a model that we have perfected over the years” commented Corey Ribotsky.

Corey Ribotsky cites both Greenspan’s and Paulson’s bearish outlook on the “inordinate amounts of losses which still need to be taken. We see that it will remain difficult for these smaller companies to get financing and are positioning ourselves to find the right companies to invest in and believe we can continue with strong returns.”