Published: July 01, 2014
The demise of securitisation has often been mooted, and it is indeed true that many of the more exotic pre-financial-crisis instruments have disappeared, never to return. However, a number of securitisation types, based on solid, high-quality assets, have not only weathered the storm, but look set for a revival and growth; one such is trade receivables securitisation (TRS). This year has seen the Basel III rules on securitisations eased from their initial punitive levels,[1] a boost to all high quality asset securitisation classes. The evidence for a healthy interest in TRS can be found in a range of key analyses and initiatives in this area from the last 12 - 24 months[2].
Even though data from the ECB indicates a turning point for easing of commercial credit terms, and an uptick in demand, relationship lending across the regions remains lack-lustre, with indications of a shift in mindset towards alternative means of raising working capital, such as receivables finance.[3] Diversification of working capital sources seems to be the new flavour.
So, despite the bad press over securitisation as a whole during the financial turmoil, TRS has fared relatively well compared to other securitised asset classes, not least because of its self-liquidity nature, short maturities and its ability to provide sub-investment grade (SIG)/non-rated companies access to the capital markets. At the same time, TRS allows financial institutions to make the most efficient use of their capital and to provide broader financial support than they could in a conventional revolving credit facility. TRS also presents a less risky profile to banks than other forms of unsecured lending, making it a good, stable alternative product for banking organisations.
This qualitative research report seeks to provide an overview on the latest developments in the TRS market, informing securitisation market players about its current and future growth, opportunities and challenges and strategic importance for both corporates and banks. Input for the report has been gathered through an in-depth research project conducted amongst Europe’s largest 30 banks by assets, combined with a small selection of US-based global banks.
Judging from the aggregated responses, the TRS market has developed relatively positively over the course of the last 12 months.
Judging from the aggregated responses, the TRS market has developed relatively positively over the course of the last 12 months. More than 80% of the respondents confirmed growth of TRS at their banks, or at least an increase in customer enquiries about the facility. To give an idea of the range of experiences canvassed, a US banking behemoth registered a TRS growth rate of 10% in this period, similar to another Scandinavian bank. Growth was higher still at one continental bank – between 20% and 25% – and a UK-based bank saw up to 30%. According to a French financier, his bank has seen the number of deals rising to 60 last year from 50 in 2011. Contributing to this expansion was possibly a heightened level of interest in TRS originated from medium-sized corporates, opined the financier. This view is by no means an isolated observation; another respondent noted that growing demand from the mid-market has resulted in his bank working with more BB-rated companies on TRS deals. A similar comment was made by one financier, whose institution has witnessed a fair increase of interest from large corporates that have yet to tap the TRS market as well as SIG and medium-sized enterprises. A German respondent noted increased interest from factoring companies in particular as they look to transfer risks off their books.
There were, of course, a couple of dissenting voices. Contrary to the majority view of stable and positive TRS performance in the past 12 months, two commentators had expressed more measured sentiment against what they described as a “rather flat” development at their banks. One of them reasoned that achieving off-balance sheet treatment very much remains a main goal for companies using TRS. However, for those that do not regard this as their key priority, TRS might present a less compelling alternative than other available financing options such as high yield bonds.[[[PAGE]]]
The encouraging majority view of market development of TRS can be attributed to several factors, but the two most frequently cited drivers were: the requirement to diversify funding sources; and a recovering economy. For some companies, traditional methods of raising funds are now accompanied with much higher financing costs, making it an imperative to seek alternative funding channels. At the same time, medium-sized corporates are becoming more sophisticated in constructing their capital structure, partly manifested in their desire to explore financing options that warrant them a higher degree of independence from traditional bank lending, thereby widening the issuers base.
The improving global economic environment was also believed to have a positive effect on the TRS market. Signs of economic revival in the UK, the US and the Eurozone have helped remove uncertainty and restore confidence in the capital markets, giving companies who have been entertaining the thought of accessing capital in the market the assurance and a higher sense of security to make the move, remarked one commentator. Adding to this view, another financier believed that a less jittery market, combined with an improving perception of asset-based securities business, has encouraged more companies to consider TRS as an alternative financing method in their funding mix.
Other factors are at play too, such as the desire to raise funds at reduced cost, a sharper focus on working capital optimisation amongst companies, along with banks’ mounting interest in TRS business, are other stimulating forces for the TRS market. As one Dutch banker noted, optimisation of liquidity is a high priority on today’s business agenda. Businesses are recognising the extra value that effective management of their payables and receivables can add to their financial capacity. At the same time, companies are keen to deploy TRS to achieve off balance-sheet treatment and improve key balance sheet metrics such as return on equity, return on assets, or return on capital. The increased demand for TRS from the corporate constituency is equally matched by banks’ growing appetite for this credit facility because of its safer profile and lower consumption of capital compared to unsecured financing. The continuous growth of the market might have also been driven by the increasing number of bank players in the TRS market in Germany, the Nordics and Italy, added one respondent.
Even though the market for asset backed commercial paper has slumped after the credit crunch, the impact on TRS, said respondents, has been modest. The prevalent view was that the TRS market has not been significantly affected by the crisis. As a matter of fact, anecdotal evidence from a number of commentators suggests that banks are currently seeing a higher level of TRS business compared to the pre-crisis period. One respondent affirmed the current volume of TRS business at his bank has exceeded its pre-crisis level. A couple of financiers also pointed to a higher number of TRS transactions at their institutions than prior to the recession. According to one of them, the level of his bank’s TRS business has remained constant over the few years to 2013, but then underwent an increase in the last 12 months. Likewise, one respondent noted that while the number of deals at his bank has not risen much between 2007 and 2013, total volumes have increased.
Looking forward to the next 12 months, general consensus, with the exception of some isolated voices, points to a continuous growth in the TRS market. One British bank is anticipating its TRS business to grow by 5%-10%. Similarly, a German bank is expecting a growth rate of 10%. A slightly more optimistic forecast of between 10% and 15% came from a global bank who has already lined up a few large programmes in the pipeline. Having made a conscious effort in driving its TRS business in recent years, one continental bank is even expecting a growth rate of 10%-20%. As new capital regulatory requirements prompt weaker companies to seek alternative funding sources, one German financier believed that TRS will continue to profit from rising demand from SIG or non-rated companies.
From the risk perspective, TRS continues to represent an attractive business area for banks.
Looking at the external factors that will further stimulate TRS market growth, the most cited drivers are: an improving perception of the product and banks’ favourable stance towards TRS. While people in the past might have regarded asset-backed finance as the last resort for companies, that stigma is disappearing or indeed no longer exists, reckoned one financier. Furthermore, trade receivables have always been a staple asset class in securitisation as proven through the recession. Looking at it in the same light as a toxic subprime product would therefore be totally unjustified, cautioned two respondents. Investors are also becoming more discerning nowadays with regard to the underlying asset type of commercial paper. Since businesses are less likely to default on their trade debts due to the need to maintain their supply chains, trade receivables are less volatile than consumer receivables, making them an appealing and more secure asset class for investors, added a financier.
From the risk perspective, TRS continues to represent an attractive business area for banks. Since the new regulatory landscape has made traditional lending more expensive for banks, they are much keener to finance corporates through secured funding with low cost requirements. Within this context, TRS constitutes a useful means for financial institutions to mitigate credit risks, as well as to manage their own capital position.
Inevitably, with opportunities also come challenges: one financier was wary that the cash piles that many large corporates have been hoarding since the financial meltdown remove the incentive to securitise their trade receivables. Another commentator referred to the deal size as a possible constraint as TRS calls for a sufficient volume to justify the operational efforts and resources required to implement such a programme. Pricing could be a potential issue as well, especially since regulatory requirements have made it costlier for banks to run their businesses in general, making the provision of a competitive TRS offering more challenging than before.
Opinion divides into two distinct camps when it comes to the hot topic of regulation. For one body of commentators, regulation does not represent any major road blocks for the future development of TRS. They believed that after all, TRS provides companies with a good source of liquidity, and hence its appeal will not diminish even if the product becomes more highly priced. Other financiers, however, were more wary about the impact of regulation. One respondent, for example, argued that it would be unfair to subscribe TRS to increased risk rates because of their short maturities. He also saw the Liquidity Coverage Ratio (LCR) treatment of the conduits as a thorny issue as banks need to hold liquidity against undrawn positions. This echoed another commentator’s concern that an increase in price will make TRS less competitive, especially since it is permanently benchmarked against syndicated loan business. However, as banks are facing tough competition amongst themselves for clients and deals, pricing remains highly competitive. For the greatest client benefit, transferring the extra cost to those clients does not seem like a viable option either.
On investors’ appetite, nearly all respondents agreed that there is a very strong demand in the market. The short-dated nature of TRS was seen as a particularly attractive characteristic for investors. Eager to deploy their excess cash to achieve higher returns, many investors in the market are chasing assets at the moment, said one financier. Prior to the outbreak of the crisis, investors of the asset-backed commercial paper (ABCP) market were mainly money market funds and insurers. In the meantime though, many cash-rich corporates have become the major investor as they would like to employ the stable yields provided by the ABCP market, remarked another financier.[[[PAGE]]]
Compared with the TRS market in the US, the European market is still lagging in maturity, a widespread view amongst the respondents.
Compared with the TRS market in the US, the European market is still lagging in maturity, a widespread view amongst the respondents. According to one commentator, the US is the most accepting market for any type of securitisation, followed by the UK, then possibly France and Germany. The multiple jurisdictions and multiple currencies in Europe make the implementation of a TRS programme inherently more difficult in Europe than in the US – a challenge highlighted by several financiers. Because of its geographical boundaries and separate legal frameworks, the one-size-fits-all mentality to the structuring of TRS programmes in the US is simply not applicable in Europe. To support the claim some respondents referred to the higher number of smaller transactions in Europe in contrast to the bigger, more standardised transactions seen in the US. In addition, compared to the highly sophisticated legislation on TRS in the US, the legal systems in many smaller European countries have not been very well tested, although encouraging signs are coming. Many jurisdictions in Europe are now either creating or clarifying securitisation laws, observed one financier, which should help drive usage and popularity of TRS.
In contrast to Europe, US corporates tend to be funded by the capital market rather than the banking market, reasoned a commentator from a major US bank. This is likely to be caused by a number of factors, with the greater willingness of European banks to extend their balance sheets being one. US corporates are also able to perform weighted issuances. This financier believed that European companies will gradually adopt a more capital markets oriented mentality in their working capital management, including the employment of TRS structures. There has already been a noticeable shift from the main buyers of European ABCP.
Collective responses of the research show that the top three motivations for corporates to perform trade receivables securitisations are: 1) cheaper financing rates, 2) off-balance sheet treatment and 3) diversification of funding sources. More than two-thirds of the banks have a TRS customer portfolio that is more or less equally split between SIG and investment-grade companies. Some banks are clearly serving more SIG companies though, as is the case of two commentators who noted that more than 65% of their clients are SIG corporates. It is expected that the share of SIG companies in banks’ TRS portfolio will further increase as such corporates take advantage of the facility to raise funds at a lower cost.
Helping to fuel the demand are also highly leveraged companies, with more than half of the financiers expecting very high demand coming from this client segment and a further 30% predicting at least moderate demand. As noted by one respondent, given that such companies nearly always finance themselves through a combination of unsecured debt at high yields, securitisation is a much more attractive financing option. Interestingly though, amid all these predictions of higher demand from less than top-grade companies, a couple of financiers have also been seeing more well-rated corporates strategically employing TRS.
It seems apparent that there is healthy market demand for TRS, but exactly what role does it play in corporates’ financing mix? There is no straightforward answer to this question, which is dependent on a variety of parameters, including business sector, company size and credit rating, amongst others. A German financier believed that TRS provides more than 10% of its clients’ financing requirements. However, TRS could represent up to 20%-30% of a company’s financing portfolio, noted two other respondents. For highly leveraged companies, the proportion could even rise to 50%, added a UK banker. As for large multinational corporates with a good and balanced capital structure, TRS may provide 10%-30% of their capital needs. Putting his estimate at between 15% and 20%, one Dutch banker was convinced that the proportion of TRS in working capital finance is likely to increase further.
All respondents affirmed their banks’ conscious efforts in promoting TRS to their clients, with the majority of them offering this facility to both existing and new customers. More than 65% of the banks saw TRS as “very important” while the rest considered it as “somewhat important”. The facility is also regarded as a particularly useful tool for banks to develop new client relationships and to do cross-selling.
As one respondent emphasised, while banks might not always be prepared to offer incremental relationship credit to customers, TRS allows them to incrementally lend to companies without increasing risk. The facility also has a lower incidence of loss and gives banks the ability to leverage a client that may not necessarily have the level of net worth to secure traditional borrowing levels, commented a respondent.
Almost all banks interviewed confirmed their ambitions to further expand their TRS business in the next 12-24 months. One financier believed that many companies are currently exploring options to diversify funding channels and to obtain off-balance sheet financing, a belief that seems well substantiated by the business development at his bank. While its TRS transaction volume was €1.4 bn last year, the bank has already passed the mark of €1.2 bn so far this year, well on track to reach its 2014 target of €2 bn. Another financier highlighted the additional balance sheet capacities of his institution and asserted its goal to further expand its TRS business within the next two years.
The majority of respondents believed that syndication amongst banks plays a relatively important role for TRS.
Based on the collective responses of the research, the average volume of banks’ TRS programmes is approximately €200 m, with most banks operating within the volume bracket of between €50 m and €300 m. A few banking institutions are particularly active in large-scale transactions, such as one US bank whose deal size averages €450 m. Another French bank, that normally works on transactions with a volume of between €400 m and €700 m, is currently constructing a programme especially tailored for smaller-sized transactions owing to an increasing number of company enquiries. A German bank which focuses primarily on TRS for the Mittelstand has an average deal size of between €50 m and €100 m.
The majority of respondents believed that syndication amongst banks plays a relatively important role for TRS. One financier opined that 15% of his bank’s TRS transactions are syndicated. Another commentator regarded syndication as almost indispensable for large transactions. However, there are also a few qualifying voices arguing that TRS is not a huge syndication market, especially in Europe where average transaction size tends to be smaller than that in the US.
The success of a TRS programme depends on a variety of factors, but the two most crucial ones highlighted by respondents are: accurate reporting and quality of banking partner. Indeed, more than 65% of the financiers considered frequent asset performance reporting as a crucial contributory factor to the success of a TRS programme. One commentator described reporting as a vital pillar for effective management because of the influential role it plays in managing operational and credit risk. Reporting also holds the key to ensuring transparency, especially since rated European TRS require regular receivables audits conducted by third-party auditors.
Given the importance of accurate reporting, the role of third-party technology specialists in helping companies track and report on the performance of the receivables was highlighted by a number of respondents, making the choice of the right service provider ever more crucial. Less sophisticated companies might lack the IT infrastructure and reporting systems to segregate and manage the receivables. Even if they do, their infrastructure might not necessarily be able to generate receivables reports as frequently as desired by the bank, especially when daily reporting is required, commented a financier. This is where an external specialist application tends to be leveraged to provide an easy means of entering ledgers, managing acceptances and then outputting standardised, current receivables reporting on a regular basis.[[[PAGE]]]
Ensuring the smooth operation of a multi-jurisdictional TRS programme can prove very challenging. This is particularly the case when the country subsidiaries of the business have different internal reporting structures and systems. To illustrate the complexities in such a scenario, a respondent referred to a transaction that he had recently worked on involving receivables denominated in four currencies originated from 29 branch offices across seven countries. Real-time and in-depth reporting proves critical for TRS programmes with such diverse dimensions. It must be noted that a couple of financiers also emphasised the absolute importance of ensuring a sound and robust structuring of the programme in the first place. Once the structure is in place, easy, accurate reporting and auditability are central to the viability of the programme.
Finding the right banking partner is another key dimension in ensuring success of a TRS programme. As highlighted by several commentators, the financing bank must command comprehensive knowledge of the customer’s businesses and have the flexibility to adapt to client’s evolving requirements and needs on a long term basis. Adjustments to the programme may be needed, for example, when the client has acquired a new business or would like to include a new jurisdiction. Furthermore, it is important to choose a strong bank partner that can provide stable lines of liquidity and professional project management skills.
Addressing the topic of key challenges of implementing TRS programmes, in addition to reporting issues and the collection of quality data, legal and contractual risk were regarded as a delicate matter. Trade receivables are often originated under diverse terms to debtors located in different jurisdictions, hence understanding the specific true sale requirements of different countries is a crucial exercise. Furthermore, contractual prohibitions on sale or transfer of receivables also have to be carefully examined. Expert legal opinion is therefore required to determine the transferability of the receivables in respect of each jurisdiction where the debtors are located.
As achieving off-balance sheet treatment has become more difficult under International Financial Reporting Standards (IFRS), initiatives to streamline the balance sheet might become more challenging these days, noted one commentator. In addition, since receivables are fast turn-over assets in a TRS programme, banks need to be vigilant about cash control.
As the European economy returns to sustainable growth, the significance of TRS in corporates’ working capital finance is expected to increase further.
The results gathered from this qualitative research show that TRS is an increasingly relevant and helpful financing technique for a growing number of companies. As the European economy returns to sustainable growth, the significance of TRS in corporates’ working capital finance is expected to increase further as businesses seek reliable sources of cheap funding to finance corporate projects and investments. Particularly for mid-market companies that normally have to pay a premium to access credit markets owing to their lack of investment grade credit rating, TRS allows them to raise funding at a very attractive cost without utilising existing funding lines. Contributing to the further development of the TRS market is also banks’ favourable attitude towards this credit facility as well as investors’ eagerness for higher risk-adjusted returns. Even though the implementation of a TRS programme calls for sufficient planning and professional project management, and there might well be operational and legal challenges to be overcome, TRS can provide companies with convincing economic rationale in the long run. In light of businesses’ continuous pursuit of higher operating and capital efficiencies, TRS, with its ability to help companies unlock the value of their debt assets, may soon become a standard funding technique rather than merely a viable option for many businesses.
Independent organisation MindMetre Research was commissioned to conduct survey amongst Europe’s biggest 30 banks by assets (compiled using information from SNL Financial), along with a few selected US-based financial institutions. Qualified respondents were interviewed about the position and growth of trade receivables securitisation. Respondents were asked to give their opinions on the market in terms of recent growth; projected growth; drivers and challenges; usage and significance for companies; strategic importance for banks and implementation issues.
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