Lenders open door to a new style of financing
Loans based on assets, not property, can enable businesses to expand, discovers Anthony Harrington
IT WAS inevitable that in the wake of the great 2008 global financial smash, regulators were going to demand that banks increase the amount of capital they hold in reserve. Since the risk is deemed to increase for certain kinds of lending, such as term loans and overdrafts, the banks have to hold even more capital in reserve for these kinds of loans.
This has created an incentive for banks to look for other lending products that carry less of a capital reserves penalty. For business, particularly for firms in the small to medium-sized enterprise category, the way this has played out has been to make traditional lending harder to come by.
However, this need not mean that lending is unavailable. It means, rather, that alternative sources of funding have come to the fore, namely lending that emphasises the role of any assets that the company can put up as collateral.
And, as Simon Wells, business development director, north, for GE Capital – one of the largest of the asset-based lending (ABL) houses – explains, there is now quite a broad range of assets that lenders will consider when putting together an ABL proposal for a business client.
These assets, such as the sales day book or invoices, also include items such as inventory, plant and machinery. Before this would either not have been considered by main- stream lenders, or else would have been marked down unrealistically as collateral, releasing only a fraction of their value to the business.
For some banks, property is also back on the table for consideration, though the banks still have so much second and third-tier property on their books, mostly at values that are inflated by comparison with current market prices, that property is not the most comfortable of assets for them to consider.
“We are finding that businesses are very open to the idea of ABL rather than term loans and overdrafts as a means of raising working capital,” Wells says. I n particular, ABL lenders such as GE Capital are proving attractive to SMEs, since companies have found, to their cost, that keeping all their eggs in one basket, by confining their relationship to just one major bank, has not played well for them – particularly now that banks are reconsidering their lending strategies.
Wells points out that ABL provides borrowers with a practical mix of funding. “A company can raise funding against its inventory and sales ledger (invoice discounting) on a revolving basis which mirrors its working capital requirements but can also borrow against unencumbered plant and machinery by way of a term loan which can smooth out peaks and troughs in trading performance. This has proved attractive for SME businesses over the last few years,” he comments.
With Scotland being dominated by the three major banks – Royal Bank of Scotland, Halifax Bank of Scotland and Clydesdale Bank – invoice discounting as a form of lending has been noticeably slower to take off here than in England. But, SMEs are now finding that ABL is a product that is ideally suited to their funding needs and is competitive against the traditional overdraft, Wells notes. There is a tremendous appeal in releasing capital that is tied up in existing plant and machinery.
This element of ABL has much in common with a conventional term loan in that it will be paid down over an ag reed period and the lender will look closely at the borrower’s cash flow to ensure they are comfortable servicing the debt.
But from the lender’s perspective it is attractive, since it is backed by solid collateral which has been professionally valued. “We would expect to advance up to 80% of the value of the equipment, so plant and machinery worth £1 million would raise £800,000 of funding,” Wells says.
KPMG partner Bruce Walker points out that there have been some fairly large ABL fund-raising
‘ABL ALLOWS YOU TO GROW, TO BUY NEW EQUIPMENT AND BORROW AGAINST IT IN TURN’
exercises already in 2013. In March the Glasgow-based GAP Group, the largest privately owned plant and tool hire business in the UK, shifted its banking from Clydesdale to the Royal Bank of Scotland Corporate because RBS was prepared to provide GAP with a three-year ABL deal worth £70 million, which was basically lending against GAP’s existing plant and equipment.
GAP management reckon that the working capital released by this deal will enable them to continue to open up at least three to four new sites a year.
“GAP had traditionally borrowed on term debt and overdraft, but using your balance sheet to finance plant is not a good way forward. When you still own the assets, amortising them is not a good way forward. What you need is a revolving credit facility.
“This allows you to grow much more rapidly and to buy new equipment and borrow against that equipment in turn,” Walker says.
He points out that the banks are now making a major move to try to transform as much of their term debt and overdraft business into ABL lending as possible. Smaller companies need to take advice as to how they can take advantage of this switch to ABL by funders.
Instead of a shut door they could well find that lenders are back in business, Walker says. As a result, we are likely to see a number of announcements of good-sized ABL deals through 2013 and beyond.
Simon Wells says that GE Capital will offer loans worth 80% of a company’s plant value