Written by finance experts Stuart Fitzsimmons and Chris Dun, Senior Associate and partner Respectively in the banking and finance team at Maclay Murray & Spens LLP
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The financial crisis has resulted in a radical change to the easy availability of finance to corporates across the UK. For the banks, while balance sheet management is a continuing focus, there is also an increasing desire to consider a wider range of lending products, which can meet the requirements for the alternative funding options badly needed by businesses. What is clear is that manufacturing remains a key target sector for banks and that these institutions are considering more innovative ways of lending.
One of the recent trends in the UK market is an increasing number of transactions funded by banks to manufacturers, through asset-based lending or by combining asset-based lending with traditional secured lending. This type of funding has always been popular in the US and some parts of Europe. They are attractive to banks, as the loans are generally fully secured by a clearly identifiable asset pool of the borrower.
A key reason why asset-based lending ticks the boxes for banks in the current market is that the bank debt is seen to be more closely connected to the secured assets than might be the case with a plain ‘vanilla’ secured bank loan. Typically, an asset-based loan will operate by using a formula to determine the maximum amount of the loan, which the borrower can drawdown against an agreed percentage of the value of the specified assets pool.
While this will quite often be receivables, multiple asset classes could often be involved, including inventory, machinery and equipment and, in some cases, real estate. Normally, the more liquid the assets, in terms of the speed with which they can be converted to cash, both as part of the borrower's general business or upon an enforcement by the bank, the higher the percentage of the asset value that the bank will be prepared to advance.
A number of asset-based lending transactions have recently been completed across the manufacturing sector, ranging from pharmaceuticals to engineering businesses. The substantial inventory and receivables books commonly held by such asset-rich businesses, often works particularly well for this form of financing.
Businesses must, however, bear in mind that the asset base used to determine the amounts that can be advanced under the loan is not the same as the assets used to secure the loan. These are two different issues. Quite often the assets used as security for the loan will extend beyond those assets used in the formula to determine advances under the loan. In some cases, these may even extend to all of the assets of the borrower, which offers an additional security cushion for the banks in an enforcement scenario.
The fundamental importance of the specified asset pool to the mechanics of the loan means that banks will often require greater visibility of the asset position, compared to ordinary secured banks loans. As a result, there is likely to be some negotiation about how frequently the bank will expect the borrower to provide information on the value of the assets held. In reality, there can be an operational impact for borrowers in having to monitor the fluctuations in the asset pool and satisfy the diligence requirements. As a result, asset-based lending may not be appropriate for all organisations.
However, manufacturing businesses with efficient inventory controls already in place offer an attractive scenario for banks that may have a greater focus on the asset pool and liquidity, than cash flows. In turn, such businesses could find that asset-based lending facilities may provide greater facility headroom. The good news is that this approach can also help reduce the financial covenants required in the loan documentation.
In a market where access to finance remains difficult and demand is subdued, new and specialised forms of lending are coming to the fore. What makes the increasing popularity of asset-based lending particularly encouraging is the evidence of banks’ appetite to lend. This is to be welcomed in the current market and manufacturing businesses should be considering whether asset-based funding of this nature can provide the access to finance needed for increasing cashflow, raising working capital, funding acquisitions or restructuring. In reality, it is an opportunity for some manufacturing businesses to make their assets work much harder in a difficult market.