Leverage: The return of warehoused debt

Avolon's warehouse facility marks the return of the type of lending that was last seen in 2007, prior to the credit crisis. The facility, led by UBS and backed by Crédit Agricole, Deutsche Bank and KfW Ipex-Bank, will see the banks warehouse Avolon's underlying aircraft leases into one pool. Warehousing is attractive to banks as they do not have to keep the risks of the assets on their balance sheets, but instead can securitise them into a diversified pool, which is then sliced up and sold into the market as tradable securities.

This type of structure helps companies to access bank finance, as they can use their underlying debt assets as collateral - which can range from credit cards, auto loans, and mortgage loans, to aircraft leases, royalty payments and movie revenues.
But, the market had ground to a halt following the credit meltdown, which started with US mortgage defaults. According to Caspar Berendse, partner at Cinven in London, the warehoused deal that supported the Avolon buyout signals a revival of the asset-backed, warehoused debt market.

"What the Avolon facility shows is that there are signs of life coming back to the warehoused asset-backed funding market," he says. "Part of our broader investment thesis is that we believe the broader funding market for asset-backed lending is likely to improve in both liquidity and attractiveness."

The deal comes shortly after the loan markets were bolstered by the resurgence of a number of collateralised primary loan deals, led by a $525m structure from Sullivan Fraser. But, it remains to be seen whether the loan markets will begin to win back the market share lost to the bond markets. According to some estimates, in the pre-crisis years, banks warehoused around 70% of corporate risk, with the bond markets taking up 30%. However, from mid-2008, the markets saw an acute shift, with bonds attracting 70% of debt. Roger Appleyard, head of credit research at RBC Capital Markets expects this trend to continue.

"The trend to raise debt through bonds as opposed to straight loans is something we expect to continue both from investment grade and high-yield issuers," he says. "In the future, we may even see smaller deal sizes and possibly some unrated bond issuers."

However, he cautions that, in the near-term, even these may struggle as credit spreads continue to widen because of eurozone sovereign concerns.