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31 Dec 08

Anthony Harrington looks at the asset-based lending market, from invoice discounting to loans against machinery, and finds it is good for raising cash

by Anthony Harrington

With traditional bank credit drying up and overdrafts being withdrawn or cut, companies have had to get a lot more innovative about finding ways of generating cash for work in progress.

Somewhat surprisingly, given the time it has been available, asset-based lending (ABL) is still relatively lightly used by mid-sized corporates, particularly in Scotland.

The good news about this is that many organisations have an as yet untapped resource for raising funding that could see them through to the economic upturn, when it comes.

Moreover, there are several really good things about ABL.

First, it is available from a number of sources in addition to the leading clearing banks.

Second, it is extremely flexible and can grow with the company or scale back as demand falls.

Third, unlike an overdraft, it is not repayable on demand. Provided customers do not breach the terms of their ABL contract, it will run and run, through good times and bad.

Fourth, it generally costs about the same, sometimes a little more, sometimes a little less, than a conventional overdraft.

Then there is the fact that although the basic deal very often involves invoice discounting, once the customer has signed up, the provider is generally happy to lend against a range of other unencumbered assets, including property, stock and plant and machinery.

As a final point worth noting, as far as ABL from the major banks is concerned, the teams involved have an inside track when it comes to access to capital. Bank credit committees love them because they are lending against solid assets, so if the worst comes to the worst and the client falls over, the bank has something of real value to fall back on.

As a result, ABL is very low risk and makes little or no demand on the bank’s regulatory capital requirements under Basel II. What all this adds up to is that ABL teams are virtually all very much open for business, crunch or no crunch.

Mark Storey, managing director, invoice financing, with Lloyds TSB Scotland, reckons that there is no doubt that enquiries from corporates about ABL are going through the roof. His customer-facing team is set to go from two people to six in January to handle the additional activities and enquiries. “This is a combination of the impact of the credit crunch and our activities in going out into the market and talking about ABL,” he says.

In Storey’s view, the Scottish ABL market is still pretty much untapped. “The impression of many that we have spoken to was that ABL is a very expensive way of raising finance, whereas in fact, because ABL is so flexible, we can generally work out a deal to suit everyone’s circumstances,” he says.

All ABL deals, by their nature are bespoke.

HSBC Commercial Bank joined the ABL party in September, launching a UK-wide proposition backed by a lending team set up for the purpose.

HSBC’s offering is very much aimed at the higher end of the market, targeting businesses with a turnover in excess of £25m. The team forms part of HSBC’s invoice finance business but extends lending across the full portfolio of asset types.

As with Lloyds TSB, lending will depend on the bank getting the receivables business, but the team will be able to take balance sheets and stock, including plant and machinery, into account.

Ian Galbraith, head of retail and commercial businesses, at the Royal Bank of Scotland specialist leasing arm, Lombard Scotland, comes at the cash flow issue from a somewhat different stance.

Where ABL looks to borrow against assets the company already owns, asset financing aims to free cash by allowing the company to acquire chunky assets without having to pay large upfront prices. Lombard’s operating lease business takes the same approach to large assets that contract hire offers in with private cars, and it brings a number of advantages with it.

“One of the key elements for the customer, of course, is that they get the use of the asset without having to part with large sums of money. Also, through sale and lease back, customers who in the good times went ahead and paid up front for their assets, can turn those assets back into cash without forfeiting their ability to use them in the service of the business,” he comments.

Being able to get the full economic value from the use of the asset right from the start, at a small fraction of the purchase cost, more often than not, will create sufficient value to eclipse the additional interest charge the company will have to meet on the lease of the asset.

“The point we want to stress is that Lombard is very much open for business,” he says. “A lot of our competitors are retrenching but we are actively out there in the market looking to support our customers.”

One of the impacts of the credit crunch is that market volatility has made asset valuations into something of a guessing game. Today’s asset value is not necessarily tomorrow’s or next week’s. James Baird, Deloitte senior partner in Scotland, says that there is no doubt that lenders have a more challenging task when it comes to trying to estimate where future asset values are going.

However, he points out that normal banking prudence will apply and, for non-receivables ABL, lenders will always look at the robustness of the cash flows supporting the company’s ability to service the asset contract. For receivables lending, of course, banks will have recourse to the company if someone defaults on an invoice and they will always look very closely at the quality of the debtors’ book in making any lending decision.

“There has been a problem with over-gearing in the market during the boom times, as asset values pushed up and up. Many companies borrowed heavily against rising asset values and my impression is that this will be counteracted by lenders exercising a real degree of caution on the values they are prepared to place on assets for ABL deals,” he says.

Barbara Brown, head of corporate and commercial for invoice financing in Scotland at Royal Bank of Scotland, says that demand for invoice discounting is “increasing nicely”, with a surge in enquiries in recent months. Moreover, she says that RBS is certainly not “pegging back” the percentage it is prepared to lend against debtors books.

She says that a number of clients are asking for bad debt protection as part of an invoice discounting deal. RBS underwrites this protection itself.

“The current economy gives us an opportunity to work with clients to make sure they have a good, ongoing source of working capital,” she says. “We have

some clients with deteriorating positions, but we work very closely with them to ensure that both their and our risk is mitigated.”

John McNeill, director, business restructuring services at BDO Stoy Hayward, says that ABL is really proving its value as a cash-raising tool. “The only problem in invoice discounting is where the client’s client fails to pay and the debt gets reassigned back to the company benefiting from the ABL agreement.”

External credit insurance is possible for ABL debt, but it is expensive when provided by third parties. Moreover, specialist ABL debt insurers are very vigilant and will often pull the cover if they see that clients on the debtor’s book are running into difficulties.

Market watchers generally expect ABL to become more mainstream through the next two years. By the time we come out of the downturn, ABL should be much more entrenched right across the SME market. n

ANTHONY HARRINGTON is a freelance business journalist.

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