Published: August 01, 2011
We are all aware that most companies are finding it more difficult to access credit from their banks, and that the cost of doing so has increased. Alternative financing, such as factoring and reverse factoring, formerly the domain of smaller companies, is now becoming an important element in the financing portfolio for companies of all sizes. Furthermore, with Basel III looming, with its more stringent capital requirements for banks, and continued economic uncertainty, this trend is set to continue.
For those in any doubt, ‘alternative’ financing is not the same at all as ‘alternative’ music. No long skirts, unwashed feet or dodgy drummers are involved; instead, ‘alternative’ financing refers to a wide range of techniques from receivables financing through to pre-shipment, supply chain and distributor financing (figure 1). This article does not discuss supply chain or distributor financing, which has been covered in other recent articles in TMI, but rather asset-based financing such as purchase order and receivables financing. However, these techniques are also enjoying considerable growth as larger companies in particular seek to increase the resilience of their supply chain and sales channels. Unlike bank credit lines, where a company can draw down as much as required within a facility limit, alternative, structured or asset-based financing has a direct relationship with a company’s financial assets, such as receivables. Neil Clinton, Head of Large Corporates, Barclays explains,
“Over the past few years, receivables financing has become a more and more attractive way of providing finance, especially in the SME space. However, during the financial crisis we have seen a greater interest in a wide range of asset-based lending solutions. We have therefore developed a comprehensive asset-based lending portfolio, and are increasingly using our knowledge of our clients’ business to structure a financing solution around their assets to meet their future financing requirements.”
He emphasises,
“Large corporates as well as smaller companies have become more cautious, leaner, and have a greater focus on managing their cash flow needs effectively.” [[[PAGE]]]
Asset-based financing brings significant benefits:
Firstly, alternative financing is typically used for working capital financing due to its short-term nature, so bank credit lines can then be used for more strategic purposes. It also diversifies a company’s funding base in the event that one or more of its bankers stops providing credit.
Secondly, in most countries, it is looked on favourably in terms of accounting treatment. Parvaiz Dalal, Managing Director, Head Structured Trade - ASEAN and Head Risk Distribution APAC, Global Transaction Services, Citi outlines,
"Solutions need to support companies’ balance sheet objectives with clarity in their accounting treatment. For example, while traditional balance-sheet lending is recorded as debt on the balance sheet, with a direct impact on debt ratios and gearing, structured trade solutions that are underpinned by specific transaction flows can result in these flows continuing to be treated as payables, or taking receivables off the balance sheet by recognising them as sales accordingly.”
This also typically means that alternative financing does not compromise the company’s credit rating as the debt/equity ratio is not affected.
Thirdly, there may be opportunities to source alternative forms of financing outside of a company’s regular jurisdictions. As Parvaiz Dalal, Citi continues,
“As many companies expand their international footprint, treasurers and finance managers are attracted to alternative financing techniques not only in order to reduce the cost of capital, but also to leverage financing opportunities through lower interest rate environments, such as RMB funding in Hong Kong or Singapore.”
Most companies will prefer to finance receivables rather than purchase orders, but this will depend on how urgent is the need for financing.
An obvious question for treasurers reviewing their funding options is the financial benefit of receivables financing over bank lending. Clearly, this will differ substantially according to the company’s credit rating and business, but Demica’s recent research report, A Receivable Advantage (May 2011) explains,
“It is not easy to quantify the level of saving as it varies on a case by case basis and is contingent on various factors including the companies (e.g., portfolio) circumstances (e.g., perception of risk on a company) as well as the complexity of the deals. Thus, it is almost impossible to generalise the potential savings. As an indication though, several of the respondents said that TR securitisation can be 25% cheaper than relationship lending in some cases. One of the banking professionals also outlined that if syndicated loans are charged at 125 basis points, then customers of securitisation could potentially get 75 - 90 basis points. For the really established bank customers, the range might even go down to 50 basis points.”
This report also illustrates the growth in these techniques,
“At least 25% of the bankers have seen ‘many more’ sub-investment grade companies embarking on TR securitisations over the past 18 months and even more deals are being evaluated at the moment. They are confident that the demand will continue moving forward. One said that the market was quite buoyant before 2007, went quiet in 2008 - 2009, but activities are coming back with debt restructurings or refinancing by companies who had to accept less advantageous rates during the financial markets crisis.”
The trend is not only for low-rated companies, as highly creditworthy companies also see the benefits of diversification and increased access to credit. Neil Clinton, Barclays explains that there are still regional and cultural differences in terms of alternative financing adoption,
“There are still some differences between countries. For example, in Spain, supplier finance is a much more widely used product than in the UK. However, this is beginning to change with many large corporates now looking at this form of finance as a benefit to themselves as well as their supplier base.”
Parvaiz Dalal, Citi continues,
“We are seeing Asian companies taking the lead in growth of cross-border business, both within Asia and into regions such as Europe and North America. As cross-border flows have increased, the range of trade financing options available to these companies, and their counterparties, have also developed. While the legal environment in many countries in Asia limits the variety of structures that can be deployed, many companies are taking advantage of their international presence to establish alternative financing solutions in less restricted locations such as Hong Kong, Singapore and other parts of the world.”
In theory, any financial asset can be used as the basis of financing; however, the proportion of total assets that can be financed will inevitably depend on probability of collection (which increases from purchase order through to approved invoice) and whether the amounts in question have been insured. Consequently, most companies will prefer to finance receivables rather than purchase orders, but this will depend on how urgent is the need for financing. [[[PAGE]]]
There a variety of factors that will influence the success of a receivables, or other form of asset-based financing programme. Working with a bank(s) with the ability to provide sufficient levels of financing, together with a robust platform that can be integrated with a company’s internal systems are clearly important. However, as Parvaiz Dalal also suggests, the flexibility in the design of a programme is also crucial,
“Once a structure has been put in place, which can take time and resources, treasury and trade finance departments do not then want to make frequent changes in order to maintain balance-sheet efficiency, to reflect cyclical changes in their business or to address an increase in the value of financing. To ensure the ongoing stability and consistency of solutions requires a strong financing partner with deep financing capabilities and experience at syndication. This is one of the risk factors that many companies considering alternative financing solutions will include when choosing a partner bank and putting together a financing programme.”
Demica’s A Receivable Advantage report illustrates that complexity and time for setup of the programme remain one of the greatest perceived challenges,
“Over 80% of the respondents see the complexity and the time required to implement securitisation programmes as the biggest challenges. The next two most cited hindrances are higher fixed costs and operational disruption in the set-up phase.”
Neil Clinton, Barclays argues that banks best positioned to provide financing programmes are those that spend time understanding the client’s needs,
“By spending time understanding our customers’ business we can structure the right financing programme to meet senior managers’ strategic objectives. At Barclays, we invest significantly in this process on an ongoing basis, so we can be a true business partner. This is an important factor in the longevity of our customer relationships.
Companies need to be sure that their provider of asset-based financing programmes has a detailed knowledge of their business, and the wider industry of which they are a part, so they are equipped to provide advice and just as importantly, to support the business during troubled times.”
In some cases, this requires an independent view of what can be achieved, as Neil continues,
“More and more forward-looking companies are using third-party advisers to offer an independent view of their assets and how they could best be leveraged. In addition, treasurers and finance managers are also looking to their bankers as a trusted advisor relying on their industry expertise and experience gained from working with other companies with similar needs.”
In today and tomorrow's economic and regulatory environment, asset-based financing has a growing role to play.
Receivables financing brings wider advantages to the banks providing these programmes too. According to Demica’s report, trade receivables securitisation is an important means by which banks can both support their clients and repackage the debt. Providing credit to low-rated or sub-investment grade companies is becoming increasingly difficult; however, as the report explains,
“Trade Receivables (TR) securitisation appears to be one of the great survivors of the financial markets meltdown of 2007 - 2009.This has been especially true for financiers of sub-investment grade companies, looking to find the optimal set of funding structures for their clients in a time when TR securitisation separates outstanding debt from the creditor company. It means that the debt can be rated on the basis of the collection of debtors, rather than predicated on the creditor company’s rating which, in the case of a sub-investment grade company, will be low.”
There are also demands from investors,
“Top European banks are seeing increased demand for accounts receivables securitisation as other sources of distribution and risk-offloading have disappeared.” [[[PAGE]]]
Receivables and similar forms of financing is just one of the ways in which corporates of all sizes and credit quality are diversifying their funding base. However, with Basel III looming, the cost and availability of bank credit is likely to reduce further, although the true implications of this are still uncertain. According to the IMF Working Paper, Bank Behaviour in Response to Basel III: A Cross-Country Analysis (Thomas F. Cosimano and Dalia S. Hakura, May 2011)
“Large banks would on average need to increase their equity-to-asset ratio by 1.3 percentage points under the Basel III framework. GMM estimations indicate that this would lead large banks to increase their lending rates by 16 basis points, causing loan growth to decline by 1.3 percent in the long run. The results also suggest that banks’ responses to the new regulations will vary considerably from one advanced economy to another (e.g., a relatively large impact on loan growth in Japan and Denmark and a relatively lower impact in the U.S.) depending on cross-country variations in banks’ net cost of raising equity and the elasticity of loan demand with respect to changes in loan rates.”
The banks themselves mirror this view. As Neil Clinton, Barclays suggests,
“New financial regulations such as Basel III will have an impact on financing in the future. As such asset-based lending will become an even more important product that the banks can offer. As both customers and suppliers in emerging markets become increasingly important, end-to-end trade and working capital solutions are essential tools for multinational companies.”
Neil continues by emphasising that as these techniques become more ubiquitous amongst larger companies, the more tightly squeezed SMEs should not be forgotten,
“Larger multinationals are frequently highly sophisticated with a good understanding of how to leverage their assets successfully for financing purposes. The challenge for banks will be how to deliver similarly advantageous solutions to SME customers that require similar levels of financial and operating efficiency, but perhaps may lack some of the resources enjoyed by larger organisations.”
In today and tomorrow’s economic and regulatory environment, asset-based financing has a growing role to play, and for many companies, this will be the only feasible funding option, while for others it will be an important element in a diversified funding portfolio. Such techniques are also beneficial for the banks as they can securitise these portfolios and sell them to a keen investor base, without having to lend their own balance sheet. Programmes with global reach, an efficient technology platform and closely integrated processes are likely to prove most successful, and that have been designed specifically around the needs of each company.
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