Why Intercreditor Agreements Will Matter More with Alternative Business Finance

Given the rise of alternative business assets to finance by non banks, one area that is important to understand is the area of intercreditor arrangements.  Simply put, an intercreditor agreement exists where more than one lender has a claim again a borrower and some or all of the lenders have a claim as secured creditors. The key is secured, as opposed to unsecured.

As non bank lenders raise capital to fill the void left by banks given their reduction in leverage lending, capital constraints by Basel, and asset reductions, it’s important to understand intercreditor agreements.  According to a survey on alternative finance conducted by Allen & Overy recently, bank lending is top, but by far isn’t the only source of funding. Corporates are making use of a diverse funding mix.   The survey found Bank lending accounts for 48% of all lending, alternative finance is 30% and the capital markets account for 22%. Furthermore, only 2% of corporates get 100% of their funding from one source.

The rise of Specialty Finance Businesses, defined as non bank companies who use a balance sheet to either buy  assets or originate and put them on their balance sheet, is on the rise.

A recent article in the Secured Lender by Katherine Bell, Jennifer Hilderbrand and Jennifer Yount gave five predictions for Intercreditor Agreements in 2016:

  • Second Lien/Junior creditors will press for more favorable intercreditor terms – Their reasoning is very rationale. As more non banks enter the field with lower capital costs and greater risk tolerance they will press for more  privately negotiated second lien term loans.
  • There will be an increase in split collateral intercreditor arrangements and more focus on valuation methods. Their point in the article is that more parties to divide up collateral invite potential disputes on the value of that collateral
  • There will be increased sophistication around access, use and license rights related to intellectual property in split collateral deals. Point three really is a subset of the point above, and relates to the fact that so much around finance has to do with intellectual property.
  • Intercreditor Arrangements will evolve to address cross-border considerations. I talked about this in my 11 Fearless predictions post.  Essentially, as there are more innovative cross border receivable lending solutions developed by both bank-owned asset-based lenders and other lenders who adapt their credit policies to the fact that more and more companies have offshore receivables, intercreditor agreements must evolve to handle multiple jurisdictions.
  • In light of recent case law, senior lenders will negotiate for broader and clearer Chapter 11 protections: The authors cite court cases on how junior lenders are having more say in bankruptcy despite clear restrictions on that in their intercreditor agreements.

As any that are involved in credit underwriting know, this stuff matters a lot when problems arise.  And they do arise.  And with forecasts of slowing economic growth and potentially more rate rises in the U.S., it is important to understand the documentation and how it is interpreted in practice.

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