Cash release: what is this creature we talk so much about

Cash release is what ultimately will allow you to break even and, if things go as expected, also be the source of your returns, of your yield. Zero cash release means your efforts went for naught profitability wise, because either the cost of debt ate out all gross returns or defaults turned out to be more destructive than anticipated. It’s true, however, that in some cases a slim cash release is acceptable, provided that the goal is first growing and then worrying about profitability, but never allowing this state to prolong for long.

Asset backed facilities are almost always structured around a Trust vehicle, where the assets are parked away from the originator’s balance sheet, and into which collections flow directly. A neutral third party with fiduciary responsibility oversees that no one withdraws assets that are not their rightful belonging.

Now, let’s imagine a lender and a borrower’s relationship as that of a partnership in a joint business. Say they agree on a 75/25 ownership split on a vehicle that will be acquiring a 1M USD credit portfolio. Like all businesses, ownership stake is based on either tangible or intangible capital being contributed to the business, so the lender’s aforementioned 75% stake is a product of a 750k capital deployment. The borrower commits the remaining 250k.

Now, since this partnership is not actually pari-passu, the lender is indeed a debt partner, and has seniority over the assets. Meaning that if the portfolio was fully paid out at 800k (considering 200k defaults), then its claim is not actually divided 75/25 between both parties, but rather the lender is entitled to at least their financing contribution which was 750k, even though this is now more than 75% of the assets the Trust holds (93,75%). The borrower gets to keep the remaining 150k, which is of course less than the 250k they chipped in. So, in the world of private debt this is what we call taking the first loss in the relationship and, as you can see, it acts very similarly to the equity portion of a business. If not for the lender’s participation/financing, though, the entire portfolio would be susceptible to their first loss risk, so this way it’s extremely reduced.

Now, leaving that aside for the time being, let’s dive into a growth scenario. A month after kicking off the relationship, the original 1M portfolio has been performing as expected, low defaults and pretty good interest returns. Of the 1M portfolio, 300k has been collected as principal payments (reducing the portfolio itself to 700k), and an additional 100k was collected as interest payments. Now the vehicle holding all the assets of the relationship, the Trust, holds 700k worth of credit and 400k in plain cash.

Would be nice to get ahold of those idle 400k cash wouldn’t it? But how much of that cash can be distributed? And how much to the borrower in particular?

This is where it gets interesting. So in this scenario, the 700k portfolio is worth 75 pennies on the dollar for the lender, meaning 525k. Now, this is not enough collateral to cover their 750k financing, so the borrower should ideally assign an extra 300k worth of portfolio to the Trust, which at a 75% advance rate, would mean the extra 225k needed to cover the lender’s stake. So now that this first step is resolved, we can talk about distributing the 400k cash. Say, 50k must go to the lender as interest payments, while another 50k towards other structure fees. The borrower can now rightfully request a 300k cash release. This release is what gradually makes the borrower whole and more so even, if the default-adjusted loan returns are higher than the overall cost of funding.

Another scenario would have been not to assign that extra 300k worth of credit, but rather to reserve 225k as cash in the trust (or better yet, to prepay the lender). That way the lender is also covered with a mix of portfolio and cash, and there would still be a remaining 175k cash to distribute (400k – 225k). Of those, as mentioned before, 100k are destined towards interests and fees, whereas 75k are free to go straight to the borrower.

You owe it to yourself and to your business to repeat this cash release process as frequently as possible, so as to not drag it out. The sooner you can count on those recycled funds, the sooner you can deploy or lend them out again. Let cash drag be a thing of the past, let Vaas help lead the way.

By: Martin Strauss | Head of Capital Markets

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Martin Strauss

Capital Markets








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