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Collateral Salvage

The collateralization of intellectual property has emerged as a new credit-enhancement tool for asset-based lenders. Will it catch on with corporate finance chiefs?
Marie Leone, CFO.com | US
June 2, 2005

Asset-based lenders are in a tight spot, and CFOs looking for bigger loans for their employers are in a position to benefit from the lenders' predicament.

With corporate cash balances bulging, a general oversupply of capital-market liquidity, and hedge funds and other new entrants taking bites out of the asset-based lending (ABL) business, traditional lenders are competing fiercely for the attention of finance chiefs.

Lenders are groping for ways to stand out. One way for ABLs to distinguish themselves is to boost "borrowing-base availability," says David Peress, an ABL expert and principal at XRoads Solutions Group, a turnaround firm. Borrowing-base availability is the amount of money a lender determines it can make available to a company based on the value of the borrower's collateral and its risk profile. If lenders offer more money at the same borrowing rates, they'll win business, adds Peress.

And one way of stretching availability is by using intellectual property (IP) as collateral for a piece of the loan. Although it's a relatively new idea, IP collateralization has already increased available credit in a few cases over the last several years.

Typically, asset-based loans are secured with hard assets, including such collateral as inventory, receivables, real estate, and equipment. In an IP collateralization deal, however, the borrower pledges its intangible assets — such as patents, trademarks, and copyrights — along with its tangibles. As a result, the value of the collateral pool is increased. A more valuable collateral pool means greater availability and thus the potential for a bigger loan.

The problem, however, is that lenders tend to be wary of using intangibles as collateral because of the difficulty in placing a value on such assets. The trick in some of the new deals has been to treat intellectual property as a "credit enhancer," rather than the bulk of the collateral.

Consider last year's deal between Wise Foods Inc. and GMAC Commercial Finance. In October 2004, Wise, the maker of Wise Potato Chips and Cheez Doodles, closed a five-year, $43 million asset-based facility underwritten by GMAC. Included in that amount was $7 million in credit-enhancement backing by IP Innovations Financial Services Inc.

The deal separated the loan into two tranches: $36 million collateralized by the hard assets and $7 million using the IP as backing. The borrowing rates were the same for both tranches.

Charlotte-based IP Innovations, a four-year-old spin-off of the Principal Financial Group, worked with GMAC and Wise to increase the value of the snack company's collateral pool by adding IP assets to the mix, without forcing GMAC to take on more risk then it was comfortable underwriting.

For its $7 million guarantee, IP Innovations accepted a portion of Wise's IP as collateral. In general, IP Innovations takes a small percentage of the interest payments to the lender. Wise officials declined to discuss what percentage of the company's IP collateral was used in the deal.

In the event of a bankruptcy, IP Innovations would pay GMAC what's owed on the $7 million tranche and could foreclose on the IP collateral Wise pledged in the deal. Once IP Innovations foreclosed on the IP, it could liquidate the intangible assets to recoup its investments. Currently, none of the borrowers involved in the IP Innovations deals have filed for bankruptcy.

IP Innovations maintains a conservative loan-to-value ratio on each deal, says company CEO Keith Bergelt. He considers the ratio conservative because the company bases IP valuations on forced-liquidation value, rather than a market appraisal. That means that the IP's value is based on what interested buyers would pay if Wise were forced to liquidate assets immediately, which would likely be lower than what the market would pay in a non-distressed situation.

Relying on ABL for liquidity is typical for Wise, as is the case with many consumer-products companies steeped in hard assets, according to Kevin Reymond, CFO of Palladium Equity Partners, the majority owner of privately held Wise. But the finance chief was attracted to this particular ABL deal by the IP credit enhancement because it provided Wise with the levels of finance that it was seeking. The IP collateralization "allowed GMAC greater flexibility to get the deal done," says Reymond.

Reymond declined to talk about specific loan costs. But IP Innovation's Bergelt describes a typical deal as one in which an ABL lender provides a loan based on up to 85 percent of the total collateral pool, and charges between 50 and 250 basis points of the loan as interest, depending on bank policy and such risk factors as a company’s credit rating. In contrast, he says, mezzanine financing and other second-lien loans, which are considered alternatives to ABL, generally start with a 200-basis-point markup.

Wise president Ed Lambert points out another advantage of IP collateralization: transaction speed. Because it was a single-lender deal — the loan was made by GMAC, with IP Innovations acting only as a credit enhancer for the lender — the Wise deal took about two to three months to complete. That's much quicker than it would be if a number of lenders were involved, he says. Further, while ABL agreements require periodic reports on the status of all the collateral used in the deal, the IP collateral did not require any special documentation.


Perhaps more important, IP Innovations provides the snack-food maker with brand management and development advice as part of the deal, adds Lambert.

Reymond notes that GMAC introduced Wise to the idea of IP collateralization, a concept that was new to him. Indeed, with so few deals in the market, it's a wonder that any CFO has heard of it. IP Innovations, for example, has only inked four deals over the past year, with that handful of transactions making it the apparent industry leader.

The company's completed deals include a $53 million IP securitization for apparel designer and retailer BCBG Max Azria Group, which involved a $12 million IP-collateralization credit enhancement. The note was underwritten by New York Life Investment Management LLC and UCC Capital. Lloyd TSB completed a more plain-vanilla IP collateralization for UK-based Cambridge Display Technology. In that transaction, a $15 million revolving credit facility was enhanced with IP collateral.

Not all IP-based lending involves credit enhancement. In fact, as early as 2001, Levi Strauss & Co. and its bankers, led by Bank of America acting as administrative agency and collateral agent, directly arranged for $1.05 billion asset-based loan that used "a package of trademarks" as well as hard assets, says company spokesman Jeff Beckman. The financing included a $700 million revolver and a $350 million term loan. By the end of fiscal 2001, the company had no outstanding borrowing under the revolver.

Then in 2003, the clothing maker replaced the older facility with a newer one, again including IP in its collateral pool for a $650 million revolving credit facility.

Although few companies have used IP as a credit enhancer, the idea is creating some buzz. Bruce Bingham, a senior managing director with investment bank Trenwith Securities, says that he's starting to see "buy-in" among lenders about using IP as collateral. And Peress says he's noticed that increasingly, IP "is coming into play" in ABL deals.

Still, ABLs could have a long way to go in persuading more finance chiefs to take them up on such deals. After all, putting up IP assets as collateral would put a company's trademark at risk if it went into bankruptcy. In such a scenario, the loss of those assets to creditors could squelch a significant piece of future cash flow and threaten the company's ability to emerge from Chapter 11. For the low-margin companies that tend to seek asset-based loans, using intangibles to back them up might thus be too tangible a risk to bank on.




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