"We had already taken the view back in 2006 that we were not comfortable with the CDO market, and so we had short exposure"
Specialist investment group Arch Financial Products has witnessed the increasing interest in the financing strategy. In just over 12 months, the group has built up its assets under management from $100 million to $1.3 billion. Its core funds follow a private finance strategy, focusing on asset-based lending, including structured and specialist credit. In 2007, the firms private finance funds produced between 14% and 19% net of fees with zero monthly drawdowns for any fund.
Stephen Decani, senior partner at Arch, says that the credit crunch has created more asset-based lending opportunities. Even companies with a decent credit rating are finding it more difficult to access funds from traditional banks or commercial lenders because of the enormous strains on their balance sheets from a combination of liabilities, excess leverage and increased interbank funding costs. As a result, those in need of financing are prepared to accept higher repayment costs to reliable sources of capital such as Arch and its partner firms.
"We expect at least 100 to 200 basis points of uplift over historical asset-based lending returns for the next couple of years and an increased credit and collateral quality. For example, a facility provided to a financial services firm against captive fee receivables last year might have cost 11% to 14%; now it is likely to be more like 13% to 16%. Many quality enterprises, including the likes of GE, have had to raise their credit requirements in response to internal policy and other constraints, which gives us the opportunity to lend against better-quality assets," says Decani. That there are a lot of low-risk assets floating around at good premiums because of illiquidity issues is encouraging more asset-based lenders to set up. "There are teams setting up by spinning out of banks or similar organizations, and we are seeing increasing competition. But we should benefit from an early-mover advantage and diversified strategy capabilities," says Decani.
Arch provides asset-based lending in the shipping, infrastructure, and financials sectors, securing finance against trade goods and receivables, and offering specialist bridge lending. Decani highlights financials as a sector that will provide good opportunities in 2008. "Numerous firms are still doing well, cashflows are very visible and transferable, and we can happily lend to them to provide for their expansion plans or similar." Emerging markets will be a source of regional diversification. "There is a lot of money that is already tied up in certain markets, and a lot of value embedded within assets that can be borrowed against. In specific markets, political and financial risk is low and any risk is well paid." In addition to Archs 45 staff in London, the firm is expanding to Hong Kong and China, and is finalizing a joint venture that covers the Middle East and Asia.
Arch participates in asset-based lending deals, and as such relies on networking and contacts for deal flows. Decani was global head of distribution for the international arm of the FirstRand banking group before joining Arch. Founder and chief executive Robin Farrell was previously a consultant to Goldman Sachs and head of the alternative investment group at Dresdner Kleinwort Benson.
In structured credit and ABS, Decani says the funds are focusing more on opportunities in distressed assets. "We had already taken the view back in 2006 that we were not comfortable with the CDO market, and so we had short exposure. That has not really changed for us but we are seeing more value opportunities. We dont traditionally take direct market risk and each security is analysed for the value of the physical assets." Decani says some asset-based lending funds that had veered away from investing with physical assets in mind, and that moved too far into CDOs and direct ABS pools, suffered last year. "In a pure ABL fund, drawdowns just should not happen, due to the strength of collateral and what should be substantial risk buffers," he says.
Arch is expecting returns over 2008 to be higher than 2007s as credit continues to be scarce. Valuations will be crucial to making successful investments, however, says Decani. "Recent experience has shed more of a light on where valuations should be. Once you have the right infrastructure and methodology in place, regular ABL is fairly straightforward, but in the case of semi-distressed opportunities, that is tougher to work out. Are valuations good now? Or should we wait another six months? It is an interesting period."