Using all of your assets

Though historically frowned upon as a financing option, Asset Based Lending (ABL) has become increasingly popular in recent years. The Asset Based Finance Association (ABFA) – a trade association which represents all of the major high street lenders and plenty more besides – says in the quarter to September 2009 there were almost 45,000 ABL agreements in place – four times more than at the end of quarter one in 1995. Indeed, from the beginning of 1995 until mid 2008 the number of agreements in place rose in every quarter bar two.

Last year, against the backdrop of recession, Asset Based Lending understandably fell slightly but its share of the total commercial lending is expected to have grown nevertheless.

“Since the year 2000 the compound growth year on year in ABL agreements is around 13 per cent,” says John Bevan, head of sales finance at Barclays Commercial Bank. “So you can see its becoming more and more an acceptable means of financing businesses.” So what exactly is Asset Based Lending and why is it becoming more popular? ABL, from a business perspective, is the provision of a commercial loan that generally has something unusual as part of a package of securities against it. That something unusual could cover assets like accounts receivable, inventory – both finished goods and work in progress – plant and machinery (P&M), and even intellectual property rights. These are then put up along with traditional assets like property as securities for lending.

“ABL comprises a cocktail of facilities under one umbrella,” explains John Bevan’s colleague, Graeme Allinson, Barclay’s head of manufacturing, transport and logistics. “The lender takes the assets from the balance sheet of a business and provides lending values against each of them. Asset based lending tends to be primarily led by debtor facilities with a mixture of other facilities used after that.” ABL finance is typically utilised by mature businesses with multi million pound turnovers, though the banks can and will offer it as an option to asset rich smaller firms.

It works especially well as a funding option for growth because more money becomes available as sales, inventory and debtors rise. “It’s a virtuous circle,” says Chris Hawes, head of portfolio management and structuring at Royal Bank of Scotland Invoice Finance. “As your sales increase you can get into cash flow mode and receive something like 90 per cent of that money straight away. You then reinvest it and make more growth.” In terms of cost, there are no hard and fast and rules but you should expect to pay an arrangement fee, an annual service fee and a margin over base or LIBOR (London Interbank Offered Rate). The percentage of value that is made available differs from asset to asset. RBS provides up to 90 per cent of invoice value, around 60 per cent of finished goods in inventory, up to 80 per cent of the appraised value of machinery, and up to 80 per cent of property. Barclays meanwhile say debtors’ value could provide anywhere from 50 per cent right up to the full 100 per cent in some cases. Banks look at assets in terms of their realisable value, so, for example, finished goods would hold a better lending value to goods in progress.

Accounts receivables and inventory are generally used to create availability in a revolving credit facility where the initial loan value can continue to be drawn throughout the term of the agreement. Terms are typically one to three years.

John Bevan says manufacturing is one of the best suited industries for ABL because firms’ assets are “largely transparent and can therefore be valued effectively, as opposed to service based industries with intangible products”. Adds Chris Hawe: “Manufacturers often have a high degree of seasonality and ABL suits this as it is flexible with the movements in the working capital cycle.” ABFA’s figures endorse these points; with 30 per cent of the total number, there are more manufacturers with ABL agreements in place than any other type of firm.

Part of ABL’s bad press is based on similar but less favourable products. It has evolved so far from factoring – the sale of accounts receivables to a third party – that it is by now basically its own beast.

But it is those roots which gave ABL a persisting negative reputation, according to Chris Hawe.

“Factoring was once regarded as a way of cobbling some funds together only as a last resort,” he says. “This stigma was attached to ABL as a by product and still resides in some quarters. But essentially ABL monetises an asset like factoring did without the negative aspect of selling yourself short. With ABL you retain the asset and simply borrow against it, meaning the only way you miss out on the full value of the security, minus a bit of interest, is by defaulting on the loan. We are now seeing larger, very successful businesses using ABL to replace more conventional banking facilities. Our clients like the flexibility, the headroom and the close relationship which the ABL facility brings.” Mike Oxby, Director of Asset Finance at Santander Corporate Banking, says ABL has been invaluable to many firms since the recession began because of how quickly capital dried up when the downturn kicked in. Before the recession it wasn’t deemed necessary to keep large quantities of capital in reserve because, generally, suppliers were paying promptly “What has happened in the last eighteen months has been dramatic change in the business world, off the back of ten good years of trading for businesses and banks,” he says. “Perhaps businesses didn’t need to think too hard about how they preserve their capital before; now that has all changed.

“Some businesses bought assets in boom times and then thought ‘well I wish I hadn’t have done that now’ when the cash flow tightened up.

So they’ve had to explore things like Asset Based Lending sale and lease back options to free up some capital. Such financing options can provide valuable cash generation, whilst spreading the payments across the working life of the asset.” He points out that ABL “makes sense” from the lenders’ perspective, given the securities against the facility, and with available capital having been scarce recently it stands to reason that ABL agreements should seriously be considered.

One facet of ABL that could be construed as a downfall is that businesses must be prepared to accept that the bank will keep a closer eye on its collateral than they may have been used to under other commercial financing agreements. This is because securities could change on a daily basis – for instance when finished goods in hand become accounts receivable – and their value determine how much loan is available.

But John Bevan says this should be seen as a positive. “Asset based lending is about creating a partnership with the client,” he says. “We are very close to the day to day workings of the business, understanding the capital requirements of that business. It means we can make sure that a company has utilised all of its assets in the broadest sense to achieve the finance that it needs.

Ultimately, if the facilities don’t work for the client they won’t work for us either so it’s very important that the structure is right.” “The most important thing is that the money is used for something that is ultimately going to grow the business,” adds Graeme Allinson. “We wouldn’t advise an ABL agreement for a fleet of new directors’ cars!” All in all, there is no denying that credit remains tight, despite the likelihood that recession is technically now over in the UK and economists’ belief that the country will grow – albeit slowly – in 2010. But the message from the banks is that there is money to be had and Asset Based Lending might now be one of the best options – for banks and for businesses – in getting that cash lent out.