When collateralizing a debt line, size is not all that matters. One has to be extremely aware of the particular assets being put as collateral and how they interact with each other and with the contractual restrictions.

Let’s say, for example, you are a lending company in need of financing. You then go ahead and manage to secure a structured debt facility with a big fund. They are most definitely going to require that the collateral follows certain guidelines, and even in the realm of eligible collateral, there are layers of considerations that determine their worth to the fund.

So first off, try to make sure that the eligibility criteria align as much as possible with your origination engine. This way, you will ensure that most loans would be eligible in case you need cash from the fund. Of course, you can still originate some non-eligible loans to adopt a more aggressive approach on your own, which is fine to a certain degree, just be aware that you’ll have to keep that risk to yourself.

Now, funds sometimes realize that they need to change those pre established eligibility criteria to better adapt their risk exposure, and as such, they may often propose amendments to the credit agreements. In this type of situation, we urge you to first analyze the immediate consequences of such amendments before signing off on the changes. We’ve witnessed first hand how borrowers suddenly see their eligible collateral balance significantly reduced after an amendment, putting their credit line at risk of default, and diminishing their ability to ask for cash for some time.

And what is more, amendments are not unidimensional, they are probably also changing the commitment amount and advance rates (probably even to your benefit) so don’t be blinded by the positive changes, put them all on on the scales and see if they make sense. For example, a sizable increase in advance rate may not be enough to counteract more restrictive eligibility criteria or concentration limits.

That said, the same applies to being careful with the concentration limits you are agreeing to. Try to agree to rules that fit your specific lending model, and the way you operate. If, for example, you operate solely in Mexico and Colombia, don’t accept a concentration limit that states that no single country can concentrate more than 50% of the portfolio.

Or in other cases, the issue rests on the fact that the concentration limits haven’t been tried out in the applicable collateral to see how much hypothetical excess concentration there would be. You might have a sizable eligible balance, but if excess is eating out a big chunk of it, then the assignment would’ve been for naught.

Also, to ease your operation, stay away from sophisticated limits and operations. The concentration limit might be appropriate in what it’s trying to accomplish, but try to minimize complex-to-calculate restrictions, such as weighted averages or dynamic/recursive rankings. We’ve seen in some cases that algebra itself is not enough to optimize the value of the collateral. Luckily, at Vaas, we’ve developed optimization models that support any number of scenarios, but we still recommend prioritizing simplicity.

Finally, for both eligibility criteria and concentration limits, we suggest analyzing how close you would be from breaching them. In a scenario where loans over 30 days past due are ineligible, having none of those in the portfolio is great, but having none in the proximity is even better. Yes, you might have a ton of loans that are eligible today, but if those are 27 days past due and in three days the majority of those remain unpaid, you are going to be in a lot of trouble. So wouldn’t it have been better to negotiate from the getgo 40/45 days instead of 30? You should always look beyond the current status of affairs: distributions, averages, medians, standard deviations, ineligibility conversion rate, etc.

At Vaas, we are here to help you sort out all these sorts of things and more.

By: Martin Strauss | Head of Capital Markets

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