What is specialty lending?

Specialty lending encompasses a range of financing options outside traditional corporate lending, focusing on both tangible and intangible assets to back loans.

About specialty lending

Primary goal: Diversify investment portfolios and manage risk by securing loans against specific assets.

Portfolio role: Specialty lending in portfolios can enhance returns through higher yields while providing diversification by exposing investors to niche sectors and non-traditional borrowers. However, this segment requires robust collateral and active monitoring to help manage risk, while the lender's expertise in niche markets adds strategic value.

Tangible asset-based lending primarily involves loans secured by real estate and physical assets like machinery and inventory, emphasizing the assets' liquidation value over the borrower's financial health.

When properly underwritten, these tangible assets can offer recession resilience, as the lender’s risk is more closely tied to the asset’s value than the borrower’s operating performance. Success in this strategy hinges on the lender’s ability to efficiently seize and liquidate the collateral in the event of default.

Coffee

Tangible asset

Case study: U.S. coffee roaster

Corporate term loan

 

The company

  • U.S. coffee roaster selling coffee, accessories and brand apparel
  • Largest direct-to-consumer online coffee subscription platform

 

Why they required a non-bank lender

  • Existing regional bank lender not in a position to upsize
  • Company had negative earnings in the recent period due to heavy marketing spend to grow revenue

S+8.5%

Coupon

2%

Origination fee

3/2/1*

Prepay fees

5 years

Term to maturity

Intangible asset-based lending are loans secured by non-physical assets such as intellectual property, financial assets, and royalties. For instance, it could include lending against brand names or licensing agreements, where the value lies in future revenue streams rather than physical goods.

This form of lending requires a deep understanding of the underlying asset’s value and revenue potential, demanding expertise in fields like intellectual property law and financial asset management. Intangible asset-based lending offers investors diversification beyond traditional corporate loans, tapping into revenue streams that are less directly tied to economic cycles.

Clothing

Intangible asset

Case study: Celebrity retail consumer apparel brand

First lien asset-backed loan

 

Background

In 2015, a celebrity sold a 62.5% stake in an eponymous retail consumer apparel brand to a corporate buyer retaining 37.5% ownership. In 2021, the buyer comes under financial pressure and goes into bankruptcy looking to sell assets. The celebrity then agrees to repurchase the 67.5% stake for $65 million. The fund manager arranges $58 million of financing in the form of an asset-backed loan bifurcated into First Out/Last Out tranches with another lender taking the Last Out Tranche.

 

The deal

  • Structure: First lien asset-backed loan
  • Deal size: $58 million (36.5m first out, 21.5m last out)
  • Collateral: Intellectual property
  • Loan-To-Value: 73%, based on minimum royalty contracts

LIBOR+650

Coupon

2.8%

Origination fee

4 years

Maturity

103/102/101

Prepay schedule

Source: Confidential manager, Russell Investments. For illustrative purposes only. Information as of June 2023. The scenarios presented are an estimate of future performance based on evidence from the past on how the value of this investment varies, and/or current market conditions are not an exact indicator. What you will get will vary depending on how the market performs and how long you keep the investment/product.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.

The value of investments and the income from them can fall as well as rise and is not guaranteed. You may not get back the amount originally invested.

Private Credit is considered a high-risk investment. Investing in a private credit involves considerable risks, you should make sure you understand the risks before investing.

Private Credit debt instruments are subject to the risk that a borrower will default on the payment of principal, interest or other amounts owed. The financial strength and solvency of the issuer, including the lack or inadequacy of any collateral securing repayment affect credit risk.

In general, rising interest rates in the market will negatively affect the price of the debt instruments. Sensitivity to a change in interest rates is more pronounced and less predictable in instruments with uncertain payment (or prepayment) schedules.

Investments in private credit should be regarded as illiquid. Private credit is not listed on an exchange, traded in the secondary market and are generally not transferable.

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