A warehouse facility is a type of revolving credit facility used to finance assets originated by a company before they are sold or securitized. The assets, often consumer or commercial loans or trade receivables, are originated by the company and then pledged as collateral to the warehouse facility to obtain financing. The proceeds from the sales or securitizations are then used to pay down the warehouse facility balance.
During the life of the warehouse facility, there is an established priority of payments that dictates how the cash flows generated from the collateral assets are allocated on an ongoing basis. Understanding this waterfall is critical for any company utilizing a warehouse facility.
What does Priority of Payments mean?
The priority of payments establishes the order and priority in which the various fees, expenses, and debt obligations owed to the different transaction parties will be paid on a periodic basis. This waterfall determines how cash flows from the collateral assets pledged to the warehouse facility are allocated as they come in.
Most warehouse facilities have settlement dates, often monthly, where the priority of payments is assessed and the allocated funds are distributed. The priority ranking establishes which party and obligations get paid first before funds trickle down to the next level. So those parties and fees ranked higher in priority get paid before those lower down the waterfall.
Most warehouse facilities are structured as revolving facilities that have defined revolving and amortization periods. During the revolving period, the priority of payments focuses on paying the ongoing fees and interest expenses to keep the facility revolving. After an amortization event occurs, the priority shifts with an increased focus on paying down the outstanding facility balances.
Key Parties in a Warehouse Facility
Before diving into a detailed priority of payments example, it is important to understand the various parties involved in a warehouse facility:
Borrower
This is a special purpose entity (SPE) that borrows under the warehouse line to finance the collateral assets originated by its affiliated companies.
Originator
This is the lending platform company that originates the loans or assets to be collateralized. The Originator sells the assets to the Borrower SPE.
Servicer
The party that services the loans – sends statements and collects payments from the underlying borrowers. Usually the Originator plays this role.
Agent
Typically the lead lender that serves as the administrative agent, collateral agent, and paying agent on behalf of the lending group.
Lenders
The Agent leads a group of lenders that provides the financing under the warehouse line.
There are also various other parties like independent directors, backup servicers, trustees, etc. that may have a role with certain structural protections. For simplicity, the priority analysis below will focus on the key ones listed above.
Below is an example priority of payments clause from a warehouse facility term sheet. We’ll use this to walk through what gets paid when according to the prescribed priority ranking.
Priority of Payments Example
Below is an priority of payments example from a Stilt warehouse facility. Depending on the lender, the priority of payments could be different. Generally, lenders want all the required expenses like fees, agent fees, backup servicer expenses, servicer expenses, etc to be paid first, then lender gets paid interest, principal, and finally the originator gets the residual.
Below is an example:
On each Settlement Date (generally last day of every month), Available Funds shall be withdrawn from the Collection Account and distributed by the Borrower with direction from the Paying Agent as follows:
- to Agent, all accrued but unpaid fees and other amounts owed to it under any Facility loan document
- to Servicer, an amount equal to the Servicing Fee with respect to the preceding Collection Period (and any unpaid Servicing Fee from any prior Collection Period)
- to the Back-up Servicer
- (a) to the Agent, for the benefit of the Lenders, all accrued and unpaid interest due to each Lender, then (b) any unpaid Minimum Revenue Requirement amounts
- to the Agent, for the benefit of the Lenders, proceeds sufficient to reduce the Aggregate Advanced Amount by an amount sufficient cure any Borrowing Base Deficiency
- after the Revolving Period Termination Date, all remaining proceeds to the to the Agent, for the benefit of the Lenders, until the Aggregate Advanced Amount is reduced to zero
- to the Reserve Account
- pro rata, to any Secured Party, all other obligations of Borrower until all obligations have been paid in full; and
- so long as no Default or Event of Default, any remaining Available Funds shall be distributed to the Borrower, otherwise, held in the Collection Account until resolved.
In the above case, Agent is appointed by the Lender for monthly reconciliation, calculations, and furnishing payments.
Now let’s walk through what each level of priority entails:
First Priority – Agent Fees
The administrative agent has top priority on the payment waterfall. It takes significant resources for the agent to manage the warehouse facility across areas like valuations, collateral reporting, distributions, compliance, etc.
Most agents earn between 10-25bps of the total facility size annually. This comes out to around $200-500k+ per year for large facilities. The agents want to get paid before anyone else. First priority agent fees often include:
- Structuring Fees: Flat fee paid upfront for putting the facility together.
- Administrative Fees: Ongoing annual fee for ongoing administrative services.
- Legal Fees: Expenses incurred by lawyers reviewing changes to the facility.
- Amendment Fees: Fees to consent and implement facility amendments.
Second Priority – Servicer Fees
The party servicing the loans collateralized in the facility also gets paid towards the top. The servicer handles collecting payments and managing the borrower accounts. This takes significant manpower and infrastructure.
Servicers usually earn around 100bps (1%) annually on the outstanding balance serviced. For a $100 million facility, this would be $1 million per year or ~$83k per month required to service the loans. This servicing fee gets paid directly via the priority waterfall, with unpaid amounts accruing.
Third Priority – Backup Servicer and Other Priority Fees
Good structuring practice is to have a backup or alternative servicer enlisted to take over servicing if the primary servicer can no longer perform the duties. While lower in priority than the primary servicer, backup servicer fees still get priority over interest and principal payments.
Any other fees that are structurally important to other third parties may also sit at this level, like trustee or management fees.
Fourth Priority – Interest Payments to Lenders
Next in line comes the payments to the lending group that provided the money under the warehouse facility. This includes all accrued and unpaid interest owed on the balances drawn.
In addition, this section sometimes includes “minimum revenue requirements” that obligate the borrower to pay the amount of interest that the lenders would have earned if balances were maintained at certain levels. This protects against low usage.
Fifth Priority – Paydowns for Borrowing Base Deficiencies
If the value of the collateral assets pledged to the facility decline, it can trigger a “borrowing base deficiency”. This means the facility is over-advanced relative to the available borrowing base.
When deficiencies occur, the priority of payments requires diverting cash flows to quickly reduce balances and get the LTV back in line. This protects lenders against collateral value erosion.
Sixth Priority – Amortization Period Paydowns
After the revolving period ends due to an amortization trigger event, the priority shifts with the next available cash used to repay principal amounts owed to lenders. The goal here is to payoff the facility over the defined amortization period.
Seventh Priority – Reserve Account Funding
Properly structured facilities have reserve accounts that provide liquidity cushions in case cashflows slow. Often these reserves must be kept funded at a set percentage of the outstanding balances.
The seventh priority level directs incoming funds to replenish reserve accounts to their required levels before allowing anything else to get paid via lower levels.
Eighth Priority – Pay Other Facility Obligations
Any amounts still owed under the facility documents to third parties sit here next in line. Examples may include indemnities, excess expenses, damages claims, etc.
Ninth Priority – Repay Borrower
Last in line on the payment waterfall comes any remaining funds eligible to be paid back to the borrower. Because the borrower is supposed to be a bankruptcy-remote SPE, any distributions up to the borrower outside of the prescribed waterfall are closely monitored.
Generally, funds cannot flow up to the borrower if there are any defaults or triggers under the facility docs. Any amounts held while sorting out issues would sit in reserve accounts.
Waterfall Summary Recap
In summary, the detailed priority of payments schedule outlines the priority ranking of how cash flows generated from the collateral gets allocated as it comes in. Key parties and obligations are prioritized higher than others. For example:
- Agent Fees
- Servicer Fees
- Backup Servicer
- Interest Payments
- Paydowns for Overadvances
- Amortization Paydowns
- Reserve Funding
- Other Obligations
- Repay Borrower
Structural Variations by Facility Type
While the overarching logic and priority ranking tends to be similar across facilities, there can also be some unique structural considerations that warrant tweaks for different asset types:
Consumer Loan Warehouses
The warehouse structure described above is most similar to what you see in consumer loan warehouse facilities. Online lenders funding unsecured consumer loans want to finance originations before selling to investors. The priority categories are all highly relevant.
Because the assets are unsecured consumer obligations, these facilities also tend to have tighter triggers around collateral performance, elevated structural protections, and restricted cash movements up to equity during defaults.
Commercial ABL Warehouses
Commercial asset-based lending warehouses function similarly but the assets are secured small business loan obligations. There is more variability here in structures tailored to the underlying assets and borrowers.
The facilities themselves also tend to be more conservative with lower LTVs compared to consumer warehouses. The added protections, security, and structuring result in less restrictive cash movement clauses during defaults.
Trade Receivables Facilities
In trade receivables finance warehouses, companies pledge unpaid invoices as collateral. Payment streams as customers pay invoices flow down the waterfall to covered facility obligations.
One unique consideration is priority allocations specific to credit insurance premiums and claims. Trade credit insurance is common and diction provisions allocate cash to facilities with and without insurance separately.
Real Estate Warehouses
For interim real estate finance loans, the assets are secured by commercial or residential properties. Cash flows come from property sales, development projects, or transitional uses.
Waterfall provisions account for cost reimbursements, foreclosure procedures, and potential deed-in-lieu of foreclosure cash consideration payments to lenders as part of the allocations.
Summary
A detailed priority of payments schedule is a key structural protection governing cash movements in any warehouse finance facility. The waterfall establishes the ranking of which parties and obligations get paid before others as money flows in from the collateralized assets.
While specifics vary across facilities backing different asset types, the overarching priority logic follows a similar hierarchy. Agents, servicers, and critical structural costs get paid first, followed by interest payments to lenders and paydowns once amortization is triggered. The remaining funds can be allocated to reserves, other expenses, or paid back up to the borrowing entity.
Understanding these waterfall mechanics is important for any platform utilizing a warehouse facility as part of its funding capital structure. The stages dictate both how cash can flow during normal times and how protections engage during periods of collateral performance stress.