While the rest of the banking industry runs from the credit crunch storm, asset-based lenders are basking in opportunities. Anthony Harrington finds out why.
Just to prove that every thunderingly oppressive black cloud has a silver lining, while the global banking industry has a bad case of the jitters over the credit crunch, the asset-based lending (ABL) fraternity is writing business like there's no tomorrow.
The reasons are obvious. There is quite a bit of anecdotal evidence to show that banks at present are trying to get to grips with their overall debt positions and are putting pressure on their larger corporate customers not to put in any requests for further borrowings, until at least after Christmas.
With that kind of cash flow pressure, corporates start to get innovative and ABL is an excellent and very flexible way of raising finance in a credit crunch.
Richard Mascall, a director at the Birmingham office of chartered surveyors SHM Smith Hodgkinson, is involved in valuing all kinds of non- property assets for lenders. Generally this means putting a value on plant and machinery, or stock. He reckons that the asset-based lending market is more aggressive and competitive right now than it has ever been.
"There are a lot more players in the market now and people are taking very sharp positions. In fact the competition in the market is one of the prime reasons we are seeing lenders being prepared to use stock as security for their loans," he says. "Traditionally, stock has been seen as a very risky asset to lend against. But today, most lenders will consider it as part of the mix."
Mascall thinks that there are at least two major drivers behind the current demand for ABL. There is no doubt, he says, the liquidity problem in the market, caused by the US sub prime mortgage crisis, has caused many traditional lenders to tighten their lending criteria.
This in turn has forced companies to look at alternative ways of funding their need for working capital.
When companies sign up contracts, they need working capital to fulfil those contracts, so people are looking to alternative funding, and asset based lending is a prime source," he says.
Another major driver is corporate transactions. A number of lenders are now interested in finding ways of enabling management buyouts (MBOs) or trade acquisitions to be made through a mix of debt and ABL, with no private equity input at all.
"The idea now is to borrow not just against the assets of the business that you want to acquire, but to borrow against your own assets as well," Mascall says.
Taking up this point, Simon Woodcock, director of business development at Lloyds TSB Commercial Finance in Birmingham, reckons his bank has been very active buy-in management buyout (BIMBO) market over the last year.
He says that the bank is increasingly seeing deals where the vendor has decided to enable the MBO by agreeing to take his/her money out of the company over time - in effect financing the deal themselves, in part, in return for a share of the upside in the company as it prospers under the new management team.
Asset based lending comes into play here as the MBO team look to raise as much financing as it can to give the vendor some down payment and to help the new look organisation fund its initial period under the new management team.
Woodcock points out that this is very much an external service that Lloyds TSB provides.
He says: "We don't insist on getting the company's banking as a prerequisite for us getting involved. It is nice if we can get it of course, but my role is actually to develop the bank's business in the external market."
So far this year Woodcock has completed two asset based lending corporate transactions out of the Birmingham office. He reckons that Lloyds TSB as a team will look to do around 15 such transactions over the year.
He adds: "Over the last three years we have done one in nine of all the buyout transactions in the UK. I have personally just completed my 37th transaction in seven years."
A key part of any ABL deal is for the lender to do due diligence on the asset classes involved. Woodcock points out that the bank will generally do its own due diligence on debtors and stock, and will look to have professional valuations done by suitable third parties on property, plant and machinery.
According to Woodcock, the bank has a very good pipeline of work on the go right now. One point he makes, though, is that the gestation period for asset- based deals has definitely lengthened in recent months.
"It now takes anything from three to nine months for this kind of deal to fly," he says.
Michael Lodge, partner and banking law specialist in the corporate group at East Midlands law firm Nelsons, reckons that, in his experience, asset based lending (in its many forms) has been used increasingly over the last few years for acquisitions and buyouts, as well as providing working capital and funding for the acquisition of specific assets.
"Initially, invoice discounting was used in a transaction to replace the working capital which would otherwise have been provided by the funding bank. Now it is often also used to help fund the acquisition itself.
"If a bank funding an acquisition can be fully secured against real assets, with additional funding being provided by an invoice discounter, whether as a replacement for a working capital facility or as part of the acquisition funding, it may be easier to get through credit and the bank funding may be cheaper than it would otherwise be," he says.
Lodge points out that it is important to realise that ABL is not always the junior partner in these transactions.
"Earlier in 2007, I was involved in a substantial buyout where the ABL element of the funding was nearly six times the bank loan. In addition, ABL has been used to replace existing equity funding and to fund buy backs and dividends.
"Banks and asset-based lenders are continually looking for new ways to structure the funding and getting the transaction done," he says.
According to Kate Sharp, chief executive of the Asset Based Finance Association (ABFA), now is the time for finance directors and managing directors of Midlands companies to review the amount of capital they have tied up in existing assets.
Freeing up this capital, she says, could provide the liquidity needed to sustain company growth at a time when traditional lending sources are tightening up on the amounts they are prepared to lend and increasing the cost of borrowing, she says.
In the wake of the Pre-Budget Report, and the credit crunch squeeze on corporate lending, ABFA has issued statistics showing that the asset based finance industry has released much needed liquidity into the economy by advancing a staggering £314.9bn to UK plcs and smaller businesses.
Increased demand for flexible funding has seen the number of companies using asset based finance grow to 48,172 in the first half of 2007. The greatest appetite has been shown by companies turning over more than £310m.
Clients within this bracket have increased by 56 per cent since 2006 and have been advanced £36bn.
Lending against the sales ledger continues to be the most preferred method of releasing working capital, but it is advances against other assets that is experiencing the fastest growth rate.
Companies are increasingly releasing the capital locked up in plant and machinery to fund growth, with this form of asset-based finance increasing by 123 per cent change since 2006.
The latest industry statistics also show movement in sector demand for products. The service industry is the sector with the highest client numbers, with an increase of 19 per cent from 2006.
The manufacturing sector is still buoyant as the second highest client number sector, but has only experienced a 1 per cent increase since 2006.
The construction sector has witnessed a substantial increase with a 123 per cent jump in the number of companies using ABL.
The retail sector still remains one of the smaller industries using the finance options, but is showing a steady increase with a 24 per cent increase since 2006.
The transport and distribution sectors have reported less of an appetite for asset based finance this quarter.
Interestingly, Sharp points out that ABFA members have reported a 200 percent increase in the number of clients using stock finance as an integral part of ABL.
Damon Walford, corporate director at Royal Bank of Scotland Invoice Finance, points out that there has been a marked increase in the number of companies willing to turn to ABL as a viable alternative to other forms of financing.
"It is appealing to finance directors who wish to have more control and flexibility. These are covenant light structures, which makes them very attractive to companies and they are very flexible forms of funding," he says.
Walford points out that ABL is a very proven concept in the US, where corporates take it for granted as a financing option. Its increasing popularity in the UK shows that lenders have become much more comfortable with the product.
"It enables them to structure the debt profile more aggressively, which can only benefit the client," he says.
Chris Jones, regional director, Barclays Commercial Finance says that Barclays has set up a dedicated asset finance team to support corporate transactions.
"If there is a requirement for funding against receivables as part of a transaction, then we are here to expedite a full ABL proposition, including lending against plant, machinery and stock," he says.
Barclays is very keen to use its ABL programme to fund management buyout transactions. The new ABL team was set up in February 2007 and has been open for deals since September 2007.
According to Jones, the proposition is drawing a lot of interest from corporate finance specialists across the Midlands.
Bibby Financial Services is very active in the ABL market, particularly with respect to invoice discounting. A spokesperson pointed out that invoice finance has become increasingly more sophisticated in recent years.
Bibby, among others, has developed a range of products and bespoke solutions for clients, with different solutions being tailored for different sectors, including the export and import sector and the construction and recruitment industries.
Rather than offering a one size fits all solution like banks, invoice financiers have invested in market experts and tasked them with developing a product that meets the particular nuances of the individual industries concerned, for example, the stage payment environment of the construction industry.
As a result of these advances, the number of businesses opting for invoice financing has increased considerably. In the UK and Ireland alone, members of the ABFA provide financing to roughly 46,000 businesses and process more than £3173bn of clients' invoices each year.