HEADLINES [click on headline to view story]:

Money matters

Snap Shots

Modern Medicine

Learn to Live to Learn

Heart to Heart with Hillary

Psychological Perspectives

Money matters: Asset-Backed Lending

Graham Macdonald
MBMG International Ltd.

Background

Asset-backed lending funds have enjoyed good returns in recent years, sparking the interest of investors and their advisors in the process. Over the five-year period from ’96 to 2000, for example, when most stock indices exhibited bi-polar behaviour with large gains being followed by sometimes larger gains being followed by sometimes larger falls, many asset-backed lending funds averaged over 12 percent annually, with few losing quarters and little market correlation. Not many investors are familiar with this part of the investment houses. This report introduces the subject and sets out to provide answers to the following questions:

1. What exactly is asset-backed lending?
2. What are the key risk factors and qualities required for investment success?
3. What investment performances can we anticipate?

Asset-Backed Lending

Where does a middle-sized business go when it urgently requires short-term liquidity? Not to a traditional lender such as a bank if it has already mortgaged its real estate and pledged its receivables (money owed by its customers). Traditional lenders typically prefer larger clients, while other asset classes generally fall below their radar. So the business approaches a recommended non-traditional lender who in turn will carry out the following tasks:

1. Major elements of the business will be analysed, its strengths and weaknesses determined and cash flow projections developed.
2. Each unpledged asset class will be identified, reviewed and conservatively valued.
3. Where necessary, industry experts will be consulted to confirm key conclusions.

If such investigation unearths assets which can provide ample collateral, the lender will then prepare, negotiate and close a loan offer secured by the assets. Typically such loans are short-term by design - about twelve months - coming with relatively high interest rates and up-front costs and little in the way of prepayment penalties.

In such a deal, both parties stand to benefit. The lender obtains a good annualised return - more than fully secured by conservatively valued assets. The business gets quick liquidity, the ability to capitalise on an opportunity or solve a problem, and the flexibility to re-finance with a traditional lender or restructure.

Clearly such deals do not make the front pages but they go on all the time. For example, a software development company was losing money, needed liquidity, and had a valuable if unconventional asset in the form of a customer list that included many Fortune 500 firms. The customer list presented value to its competitors should they acquire the company. Using the customer list as collateral for a loan, the company had time to approach competitors and finally negotiate to be acquired.

Risk Factors

These can fall into three categories:

Mild: In good economic times it is not unusual for an asset-backed lender to find it harder to place loans. While not exactly a risk, funds are not fully deployed.

Short-term: During times of financial crisis there is typically a capital flight to quality, such as occurred in 1998 after the problems in Russia. Here, interest rate spreads between ‘safe’ treasury securities and ‘less safe’ bonds widen. This causes a drop, albeit a temporary one, in the market value of asset-backed loans.

Severe: Here, companies become distressed and pledged assets are sold to repay associated loans. Should this occur during recessionary times and asset values drop significantly, losses can be incurred.

Success Factors

Successful asset-backed lending requires a strong set of skills and assets which include:

1. A good brand name or reputation (most businesses seek out the lender).
2. Good industry experience and analytical skills.
3. Strong negotiating skills (the costs of such loans to business are high, but typically so are the benefits).
4. Strong risk-management techniques which include:
- diversification of investments by company, industry and region;
- modest use of leverage;
- focus on short-term loans;

- strong collateralisation of loans where pledged assets substantially exceed the amount of the loan.

In summary, non-traditional lenders go where banks fear to tread. Those with superior reputations, skills, speed of response and risk management controls fare the best.

Future Returns

Asset-backed lending is classified as an “event-driven” investment strategy, as returns in this arena are driven more by the volume of loans, their pricing and the quality of their collateral than by the movement of equity prices. Market correlation is very low, although economic crises do cause a degree of temporary volatility. In recent years, banks and traditional lenders have moved away from this more complex sector. This suggests that the future could look even better than a very respectable past, where asset-backed funds achieved equity-like annual returns with minimal volatility or market correlation.

The above data and research was compiled from sources believed to be reliable. However, neither MBMG International Ltd nor its officers can accept any liability for any errors or omissions in the above article nor bear any responsibility for any losses achieved as a result of any actions taken or not taken as a consequence of reading the above article. For more information please contact Graham Macdonald on [email protected]

with Andrew Watson

At the time of writing, I am officially on holiday. Yes! Another school year has reached its natural close and the reliable and I suppose, reassuring routine, of the past ten months is about to be exchanged for what at first glance might seem like six weeks of relaxation, rest and recuperation.

“Holidays: what shall we do with the children (and wife)?

However, I am sure that the sensations are different for teachers, parents and students. As a parent, I look at the next month or so and wonder whether I should be benevolent and keep my children away from study for the duration. They have, after all, worked hard most of the year and have definitely earned a break.

But then again, I know perfectly well that if what can be regarded as a rather artificial and extensive hiatus in the learning cycle is not utilized to stimulate my children intellectually, socially and physically, reinforce what has been learned and redress what has been (for a variety of reasons) forgotten or remains unlearned, then the time will represent a massive wasted opportunity. So, as a parent, it would appear that I have little option, morally. My responsibility towards my children demands that they (and of course, my wife – important to get that part in) remain the top priority.

Suddenly, one of the great and (often) hidden benefits of schools becomes obvious by its absence. The social framework, the network of friends and organized usage of time by others (teachers) is removed and in its place, there remains nothing – unless you put it there. When I was forced to briefly ‘home school’ my children for a short time a year and a half ago, the social dynamic was undoubtedly that which they missed the most. Thank God for loyal friends!

For families who have two working parents or perhaps an organized daily routine which for the rest of the year does not need to consider children – notwithstanding dropping off and picking up times from school – the absence of a social construct in the holidays can create quite a lot of anxiety and even conflict. “What are we going to do with the kids?” is a question which all parents have wrestled with and many struggle to find an answer to. It’s as if we are surprised that the holidays have actually arrived!

So what are the solutions? Clearly, this depends on age, but the enormous popularity and success of, for example, Spencer Bragg’s St Andrews Sports Camp, can be attributed in no small measure to the demand which exists to keep children gainfully occupied for most of the day for at least part of the vacation. If they can learn something along the way, so much the better.

I suppose the nightmare scenario is to have to leave the children to their own devices, locked up in a house with only computers, crisps, DVD and MSN for company. Sometimes, we should remember, the home environment might not be conducive to a child’s happiness or welfare.

Many parents have to work incredibly hard to fund their child’s education, their day to day existence. It’s easy to forget this, cushioned by luxury, as many of you reading this column (with respect) probably are. For many years as a student and before I started making enough money to make a living solely by exhibiting paintings, I worked in Community Centres in places like Peckham, New Cross and Bermondsey, in London. It was just about the hardest work I’ve ever done (until I looked after a reception class for three hours a week last year!) and was often dangerous, usually scary, sometimes uplifting and occasionally, very sad.

I shall never forget the three young children, aged four, six and ten, who every day of the six-week holiday, traipsed across London from Tooting to Peckham on public transport, to spend the entire day with us, whilst their mother toiled for fourteen hours a day to put food on their plate. Anybody who knows London will recognise that this particular journey is tedious in the extreme. The ten year-old was in charge. They were there before we arrived in the morning and were the last to leave in the evening. They had their bus and tube fare and a pound each day to spend on lunch, which was unvaryingly, chips and coke. This was the reality of their condition. Of course, they were incredibly resilient, street wise children, who really enjoyed spending the day as part of a community, but they were so tired by the time they had to go home, it was enough to make you cry.

I have found that holidays can be absolutely exhausting, the more so if they involve significant travel. Quite apart from the distances involved in travelling to places we might need to visit to see family, in Israel, Italy and the UK, our arrival (and I know expats will recognise this sensation) prompts a mad scramble for our company and inevitably leaves too many people unseen for another year, others unhappy at being squeezed out of our schedule. But it’s really bizarre – in my experience, friends and family seem to expect us to do all the visiting – and are reluctant to come to us. So there we are, exhausted after a long year and longer flight, being asked to negotiate London transport and London prices in order to say, “hello”.

Now, please don’t misunderstand me, we want to say “hello”, but it’s just so tiring. Almost always, when it’s time to leave for Thailand again, we’re more exhausted than when we arrived. I suppose we are constantly emptying and refilling our emotional tank, learning as we go that in our hearts, there can be no goodbyes. A ‘farewell’ is merely the prelude to the next ‘hello’.

If you’re on holiday – enjoy and be safe.

On the London bombings

I’m writing this as the news of the bombing outrages in London is breaking, so I hope you don’t mind if I express my dismay at the attacks and my sense of great concern for the city of my birth, where the great majority of my friends and family live and work. I witnessed some of the IRA bombs in London in the 80’s and 90’s and seeing pictures of the bus in Russell Square just reminds me of Jerusalem. Just like then, (we’re travelling) we won’t know until we arrive home if those whom we hold precious are still alive. Once, in Israel, they weren’t. So, I hope whatever you are doing, you might find a minute or so to just to stop and think about the victims. I believe, in one way or another, this includes us all. As Donne wrote, “Any man’s death diminishes me.” Further, I would like to echo former British Foreign Secretary Robin Cook’s sentiments in the Guardian newspaper. He writes that “the war on terror cannot be won by military means”. By education, then, I hope. By education.

[email protected]
Next week: Perceptions