ABFJ: The asset-based lending industry built its solid reputation around the ability to structure a credit facility around both current and long-term assets to ensure a successful exit in almost any circumstance. In a film financing, how is a typical deal structured to minimize risk and maximize return? Can you please comment on some of the more common characteristics that go into the structure of a film financing that make it unique?
JW: Film finance can involve a number of different structures, including facilities for the purpose of producing a film (supported by short-term assets) or facilities collateralized by films that have already been completed and theatrically released (supported by long-term assets).
Film Production Loans
Before a bank will consider financing a film, a producer must assemble a package that includes a detailed cash-flow budget and timeline to produce the film and a collateral pool known as “pre-sales” to support the financing. (Before film production has begun, producers will typically “pre-sell” or license distribution rights to the film to third-party distributors from around the world.) These licenses call for what are effectively advances or “minimum guarantees,” which are contracted receivables whereby after the film has been completed and delivered to a distributor, the distributor has the obligation to pay the producer a specific amount for its right to exploit the film. These receivables serve as the basis upon which the bank makes the loan.
What is unique to film finance is that each receivable is individually discounted based on the risk of the specific counter party, rather than one advance rate applied to an entire pool as is typically found in traditional ABL deals. This unique aspect requires expertise and knowledge of global distributors, their payment history and/or reputation in the market. Each receivable may also have varying payment terms, based on the distributor’s risk profile, including progress payments or contract support through a bank-issued letter of credit. Similar to construction finance, facility draws are used to fund detailed approved cash-flows to produce the film. And, a third-party bond company will monitor the production and budget to ensure that the project is completed on time, on budget and delivered to the distributors in accordance with the technical specifications needed to trigger the contracted payments due. All collections of receivables are directed to a bank-controlled lockbox until the facility is fully repaid.
Facilities Supported by Completed and Released Films
Banks will also provide financing collateralized by completed films which have been theatrically released. In this instance, after a film has been released, the value of the future cash-flows for a film in other distribution windows such as home video, video on demand, free TV, etc. (referred to as “ultimates”) can be reasonably forecasted. banks will lend against these future cash-flows (discounted to net present value) under a borrowing base with applicable advance rates. The ultimates value is either calculated by a major studio (e.g., Universal, Disney, Sony, etc.), the producer and/or a third-party valuation firm. Under this type of structure, actual cash-flows are monitored and compared against the original forecasted cash-flows. Net remaining future cash-flows may be further discounted under the borrowing base based on the historical accuracy of the original forecast.
ABFJ: Today’s market environment, where investors and banks are seemingly flush with cash with only limited opportunities to invest and/or lend, would seem to be ideal for a capital markets unit in a financial institution with recognized expertise, to exploit this opportunity. Do you believe this is true or false? If true, is the investment yield or return high enough to offset the real or perceived risk?
JW: I believe that is generally true, although just because you have the requisite expertise does not insulate you from the basic laws of supply and demand. Even in the specialized world of film finance, we have seen new entrants come into the market over the last 18 months, which has had the effect of reducing margins and putting pressure on structure. It is our prior experience in the market — developed over many years and many loans — that allows us to differentiate between the real versus perceived risk.
ABFJ: What are some of the real or perceived risks and how are they mitigated by those who lead and manage a syndicate of lenders and/or investors in a film deal? Are there certain structures that are uniquely employed and could you briefly describe a typical scenario?
JW: A common misperception is that banks take box office performance risk, which is not the case. Film finance involves contracted receivables or discounted future cash-flows based on well-established valuation models. In the case of financing a film that has already been released, banks will typically wait a period of six to eight weeks after a film’s initial theatrical release in order to reasonably estimate the “ultimates” value.
ABFJ: One of the major reasons ABL lenders survive in a distressed situation is because of the high level of regular monitoring that goes on. In a film or production financing, is there a similar process that is used to “manage” the outcome in accordance with, say, a budget? With the former, if you maintain asset liquidation coverage you’re OK; however, with the latter, I’m not sure how the downside risk is mitigated or covered. Can you please comment?
JW: The key risks with film production loans are that a film has cost overruns, doesn’t get completed on schedule or — in very rare instances — gets abandoned completely. As I mentioned earlier, distributors’ payment obligations are triggered once a completed film is delivered to them. In order to mitigate this risk, banks will engage a third-party completion bond company that monitors the production and cash-flows to ensure the project is completed on time and on budget. If the film is not completed or delivered in accordance with the agreed-upon timeline and budget, the bank is covered under the bond, which is underwritten by insurance.
ABFJ: Longer term, what would you describe as some of the risks and opportunities for the film industry going forward?
JW: I think the single largest risk facing the industry today is the structural shift and transition to delivering digital products to the consumer instead of just physical products. A related risk is the ongoing threat from piracy.
ABFJ: If there was any one metric that you would monitor that would give you an indication of the health and vitality of the film industry, what would it be and why?
JW: I would say the performance of the theatrical box office, which is the first interaction of the industry’s product with the consumer. It is also the bellwether for all the downstream markets, such as home video and pay and free television.
ABFJ: Can you provide some background on your career? What interested you in film and entertainment financing?
JW: I started my banking career in New York and had the opportunity to come to Los Angeles in the late 1980s. I started in film finance in the early 1990s with a Japanese bank just as the film industry was starting its international expansion resulting from the deregulation and resultant growth of the terrestrial broadcasters and the advent of satellite television and quickly realized this was a unique and exciting area of finance. Over the subsequent 20-plus years, I’ve had the opportunity to build media and entertainment groups from scratch and to work in a variety of banking and investment capacities focusing on the media and entertainment industries, including investment banking and private equity.
ABFJ: You joined OneWest Bank in 2011. What differentiates OneWest from others in the film financing industry?
JW: OneWest Bank has a terrific slogan — “One Person at a Time” — which underscores our dedication and commitment to our clients. We are highly focused on servicing the needs of our customers and using our knowledge and expertise to come up with creative solutions for them to be better.
ABFJ: I read that you’ve arranged and structured the financing of more than 130 individual films. Can you provide any highlights or fond memories of your time in the industry?
JW: I love the film business for how it is a uniquely American industry and is still the gold standard around the world. I am also proud of the fact that it is home grown here in southern California. For me, the biggest highlight over my career has been the wide variety of interesting people from all over the world with whom I have had the pleasure to be able to work.
ABFJ: Is there anything that you would like to add that’s not covered above that you think would be of interest to our readers?
JW: Thanks for the opportunity to talk to you about what we do!
Joseph Woolf is executive vice president and head of Media and Entertainment Finance for OneWest Bank, which with total assets of $27 billion is the largest southern California-based bank. Woolf has nearly 25 years of banking and investing experience and over that time has underwritten or arranged several billions of dollars of capital commitments to a broad range of entertainment and media companies. He is a frequent speaker on entertainment finance and has done so before numerous conferences and organizations on four different continents.