whitepaper - asset based financing - gaining popularity in the middle east

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Asset Based Financing - Gaining Popularity in the Middle East Asset-based Financing provides a powerful financing solution for midsized and larger companies that seek to maximize the value of their assets, achieve greater liquidity and pursue new growth opportunities. Once considered financing of last resort, asset-based lending has become a popular choice for companies that do not have the credit rating or track record to qualify for more traditional types of financing. It has expanded its global reach from North America to include UK, Europe, Australia, South East Asia and Middle East. Sponsors have become increasingly aware that ABL offers significant benefits when compared to cash-flow financing, including lower cost and greater flexibility. Understanding Asset-based financing Asset-based financing is a form of secured lending that is based primarily on the quality, value and adequacy of the collateral that an issuer pledges. In general terms, asset-based lending is any kind of borrowing secured by an asset of the company. Asset-based lenders focus on the quality of collateral rather than on credit ratings. Broadly, the following categories of assets are pledged by the borrowers: Accounts Receivables Inventory Equipment (Plant & Machinery) Property / Real Estate Accounts receivable and inventory - assets that have a high degree of market liquidity and can be easily valued and monitored - head the list of qualifying assets. Long-term assets such as equipment and real estate are often used as additional collateral when the Asset Based Loan (ABL) is structured as a term loan with a fixed amortization schedule. Typical ABL credit facilities may include a revolving line of credit used to support working capital needs and possibly a term loan to provide availability against longer- term assets, such as machinery and real estate. It can also include capex facilities to provide financing for capital expenditures.

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Asset Based Financing - Gaining

Popularity in the Middle East

Asset-based Financing provides a powerful

financing solution for midsized and larger

companies that seek to maximize the value

of their assets, achieve greater liquidity and

pursue new growth opportunities.

Once considered financing of last resort,

asset-based lending has become a popular

choice for companies that do not have the

credit rating or track record to qualify for

more traditional types of financing. It has

expanded its global reach from North

America to include UK, Europe, Australia,

South East Asia and Middle East. Sponsors

have become increasingly aware that ABL

offers significant benefits when compared

to cash-flow financing, including lower cost

and greater flexibility.

Understanding Asset-based financing

Asset-based financing is a form of secured

lending that is based primarily on the

quality, value and adequacy of the collateral

that an issuer pledges. In general terms,

asset-based lending is any kind of

borrowing secured by an asset of the

company. Asset-based lenders focus on the

quality of collateral rather than on credit

ratings.

Broadly, the following categories of assets

are pledged by the borrowers:

Accounts Receivables

Inventory

Equipment (Plant & Machinery)

Property / Real Estate

Accounts receivable and inventory - assets

that have a high degree of market liquidity

and can be easily valued and monitored -

head the list of qualifying assets. Long-term

assets such as equipment and real estate

are often used as additional collateral when

the Asset Based Loan (ABL) is structured as

a term loan with a fixed amortization

schedule.

Typical ABL credit facilities may include a

revolving line of credit used to support

working capital needs and possibly a term

loan to provide availability against longer-

term assets, such as machinery and real

estate. It can also include capex facilities to

provide financing for capital expenditures.

Applications of ABL

ABLs can benefit both midsized and larger

companies. For higher quality, large-

corporate borrowers, ABLs are often used

simply for financing working capital. These

companies use ABLs to fund seasonal

changes in working capital, for shareholder

value-creating actions such as share

repurchase programs, dividends or

distributions, and for opportunistic

acquisitions.

For midsized companies, ABLs usually

comprise a larger proportion of overall

capital structure. Here, in addition to

providing working capital financing, ABLs

often incorporate term loans, which are

secured by longer-term assets such as

machinery and real estate, to provide

incremental credit capacity.

Acquisitive companies use ABLs as part of

their acquisition financing structures, which

may also incorporate other forms of junior

capital.

ABLs also tend to play a key role in the

financing of companies facing cyclical or

operating performance headwinds that

have caused their credit profile to

deteriorate. They need patient capital to

attempt to execute on their business

turnaround or restructuring plans, or just to

weather the current environment, including

the possibility of bankruptcy reorganization.

Often, an ABL is “transitional” capital for

these companies; for a time it provides

incremental liquidity and structural

flexibility characteristics that help owners

and managers reposition the company.

ABL Growth One of ABL’s key benefits in recent years

has been its competitive pricing. The

interest cost of an asset-based loan can be

significantly less than a traditional bank

loan. As lenders are advancing against a

company’s most liquid assets that have a

readily identifiable value, their ultimate

credit risk is lower.

ABL has long been a key feature of the US

loan landscape; however, Europe, including

UK, and the Middle East are catching up.

The ABL market in UK is growing rapidly as

awareness of ABL as a funding proposition

increases. The level of assets financed has

increased by 41% since 2009, to £18.8 bn in

2015.

At sector level, manufacturing is often cited

as an industry ideally placed to benefit from

ABL, alongside sectors such as distribution

and support services. According to the

latest ABFA figures, of the clients making

use of ABL, 12,915 were in the service

sector, 12,651 in manufacturing, and

10,742in distribution.

Underlying and supporting ABL growth is

greater understanding and acceptance

among corporates, private equity and

advisers. Asset-based lenders have

successfully targeted advisers and private

equity which has led to an increased

number of sponsor deals. This upward

trend is likely to continue as the market

further appreciates the benefits of ABL.

Popularity in Middle East Asset based finance is a popular method of

obtaining bank finance in the Middle East. It

is being offered by most local banks and is

particularly popular in the real estate

market. With increasing market prices and

reduced interest rates, ABL has become a

favored source for obtaining finance by

companies with substantial assets.

Manufacturers, wholesale distributors,

retailers, and some forms of service

companies are prime candidates for ABLs.

Suitable ABL candidates usually have

tangible asset-rich balance sheets, often

with at least half of their total assets in

working capital assets, such as accounts

receivable and inventory.

Recent fall in oil prices has tightened the

credit situation in the Middle East which

had not fully recovered from the Global

Crisis of 2008. This has resulted in an

increased interest in alternate financing

methods like ABL. Following are some of

the key requirements for which ME based

companies are looking at ABL as the

preferred method of generating finance.

Cash Flow Injection

In ABL transactions, the lender’s interest is

secured by the borrower’s assets, which

then forms the basis for determining how

much credit the borrower can access. In

contrast, the cash flow method of

determining credit capacity is principally

based on an analysis of the borrower’s

enterprise value.

Cash flow-based loans, while also usually a

secured form of financing, often use EBITDA

(or a company’s earnings before interest,

taxes, depreciation and amortization) along

with a multiplier to determine credit

capacity, rather than the value of the

underlying collateral assets. Both the level

of EBITDA and the multiplier applied can

change significantly during business and

economic cycles. During an economic

downturn, most companies will see their

EBITDA decline, both on a relative and

absolute basis. Often, the multiplier being

used by lenders will shrink at the same

time. This combination of declining EBITDA

and a shrinking multiplier can result in a

significant decline in available credit

capacity at what could be the exact time a

company needs access to capital the most.

This is the exact situation many companies

in ME face today in the wake of the oil price

crisis.

In contrast, the valuation of a borrower’s

assets is remarkably stable over a variety of

business and economic cycles. This makes

calculating a borrower’s credit capacity

based on asset values a highly predictable

way of providing capital to clients. For these

reasons, ABLs are the preferred of lending

for cash-strapped companies in ME, than

cash flow-based loans.

Increased Flexibility

Companies benefit from the limited use of

financial covenants and the embedded

broader flexibility built into negative

covenants. When a company moves from a

cash flow loan structure to an asset-based

loan structure, it sheds the restrictive

enterprise value-driven covenants under

the former. Often, it will see its liquidity

increase while being able to operate with

fewer (if any) financial covenants. This

provides significant flexibility to make

acquisitions, offer dividends and repurchase

shares.

The power of asset-based approach to

lending is its ability to look beyond the

current circumstances facing a company,

particularly if those circumstances have

made the business unprofitable, and to find

value in the investments the company

makes in the ordinary course of conducting

its business.

Speed

Asset based financing is a relatively quick

method of accessing cash in cases of

emergency or as a method to fund

expansion. Companies which are planning

major strategic changes, like expansion into

overseas markets, product R&D and

innovation, upscaling payrolls or structured

M&A activity, can resort to the ‘quick

money’ influx method of Asset Refinancing.

With refinancing, the business can continue

to use the asset without any interruption in

operation. The company sells an asset to

the leasing company for the current value,

which then leases it back.

Limitations and mitigation

The assets owned by a business change

daily. New sales are recorded as new

accounts receivable and existing accounts

receivable (old sales) are collected in cash.

Inventory is both purchased and sold. Some

inventory is converted from one state to

another, such as from raw materials to

work-in-process, or to multiple states within

a day. The composition, quality and value

can change quickly, and these changes are

not always reflected in the periodic financial

statements a company may publish.

Since an ABL is based on these kinds of

assets, lenders need a different kind of

information to be able to adequately

monitor and gauge these changes in the

collateral base. They require periodic

reporting, such as accounts receivable

aging, and inventory composition and

valuation reports. ABL borrowers provide

this kind of reporting along with their

periodic borrowing base certificates —

which recognizes the changes in these asset

classes from period to period — in addition

to the usual and customary financial

statement reporting. The frequency with

which a borrower has to provide this

information is usually a function of its credit

profile and the amount of unused loan

availability. Stronger credit profiles with

abundant liquidity generally report

monthly. As credit profiles decline and/or as

liquidity becomes more constrained, the

frequency of reporting would be increased

to weekly. In extreme situations, borrowers

can be required to report changes in

accounts receivable and inventories on a

daily basis.

To reduce the reporting burden on

borrowers, Asset based lenders need to

invest in software and processes for

reporting, determining ineligible collateral

and uploading information. These

technological advances substantially

mitigate the one significant drawback of

ABL.

Nucleus Software offers solutions and

services that help financial institutions

manage ABLs reducing the overheads for

the institution and easing the pain for the

borrowers.

Conclusion Asset based financing boosts business cash

flow by releasing cash against the value of a

company’s existing assets. It provides a

convenient form of cash supply as assets

are used to free up the capital a company

already owns. The cash that asset refinance

generates can be reinvested into further

asset growth. A structured refinance plan

can help the company grow, take advantage

of a situation or simply help survival.

The growth of ABL in Middle East has been

impressive in recent years and this growth

only appears to be accelerating. ABL

facilities have been used in Middle East

across a broad number of industries

including retail, construction and shipping

and have proven to benefit both mid-sized

and larger companies. The flexibility of the

ABL product and its unique ability to

operate across borders makes it very

attractive in today’s global business world

of where corporate borrowers have

business interests across many different

jurisdictions and where the world is their

marketplace.

Authors

Arup Das

Lending Product Head (P&L Management), Nucleus Software

Arup is the Vice President and Lending Product Head (P&L

Management) at Nucleus Software where he is responsible to lead the

flagship product to the next level of global leadership. Before joining

Nucleus, he has played various roles in strategy and product

management with leading companies like CISCO, IPValue and Mphasis.

Author e-mail id: [email protected]

Vaibhav Gupta

Senior Product Manager, Nucleus Software

Vaibhav is a Product Manager at Nucleus Software where he is

responsible for managing P&L for FinnOne Neo for Cloud and Middle

East. He has previously worked on Cisco Solutions and was responsible

for product strategy, go-to-market initiatives and licensing operations

within the Unified Communications offerings.

Author e-mail id: [email protected]