Setting the record straight

Asset-based lending is fast shaking off its “lender of last resort” status as European private equity finally comes round to the proposition. A table of experts discuss why it is now edging its way into the mainstream.

by . .

At the table

Martin Morrin, RBS Invoice Finance

Ben Slatter, Rutland Partners

Steven Chait, Burdale

Tim Hawkins, Centric Commercial Finance

Bob Henry, Matrix Private Equity Partners

Steve Merchant, Baker Tilly

Asset-based lending has been seen as a last resort in the past, yet has been hugely popular in the US for years. Do you think there’s a stigma in the UK and mainland Europe?

Morrin: There’s no real stigma but perhaps a lack of understanding of what it encompasses. You have three distinct propositions that sit within the Asset Based Finance Association (ABFA) marketplace: factoring, invoice discounting and asset-based lending. If you look at the history, life started with factoring, this evolved into invoice discounting and over the last five or six years this has evolved into ABL. ABL is very popular in the US and is less developed in the UK – nobody would dispute that. It’s a learning curve and it takes people time to get used to a new proposition. ABL is easily the fastest-growing element in our portfolio.

Our activity levels have doubled in the last 12 months. You need the capability, the right people with the right skills and experience and you need to be able to market that effectively. So there’s nothing holding it back or any reason why it should be seen as lender of last resort either. In any lending environment there are going to be some situations that are more difficult than others, and you will see the occasional failure. That’s not a feature of the product, it comes down to businesses and their management.

Hawkins: ABL has secured its place around the private equity table – it is providing much needed liquidity and has become a mainstream offering. A lot of it comes down to education. Until private equity has done a deal using ABL, it’s much easier to go the cash flow route because it’s familiar territory. It’s the route it has always taken until now. Once you can demonstrate that ABL works and once private equity firms try it, the proof is in the pudding. We’re also seeing much larger transactions coming through, which has a lot to do with momentum – the more you do, the more you see. People start sitting up and taking notice of ABL deal structures, particularly if they also include a cash flow strip.

We are seeing a combination of repeat business and newcomers. There are those firms with companies in their portfolios that have breached covenants set at a time when conditions were far better. Now these businesses want to move from cash flow to ABL because the business has changed. These aren’t necessarily bad businesses, they’ve just had trouble with cash flow covenants set when times were different.

You also have a lot of private equity houses that had to close deals purely with equity and are coming to us to put debt into the transaction post-deal. Additionally we have worked with a number of private equity firms who want to retire some loan notes and see ABL as a viable solution. Around 20 per cent of our business involves private equity, but we’d like to see that increase. Over the past three years that has grown because of the illiquid debt market. ABL has had a chance to make its mark because cash flow lending is expensive and has become difficult to obtain.

Why is ABL only now becoming more popular in Europe?

Chait: They’re much more comfortable in the US with comprehensive ABL, lending against stock, debtors, plants and machinery and real estate in one package. The size of the respective markets is very significant, but the laws are also very different and that makes a huge difference. In the US, they don’t have retention of title. It’s much easier to lend against stock because title passes on delivery, whereas in the UK, lenders need to reserve for balances due to suppliers. Also they don’t have the issue caused by the legal decision in the Brumark case in the US, whereas in the UK, to perfect your fixed charge, the lender needs to demonstrate control over the debtor proceeds.

In Europe other mechanisms are required, which differ from country to country, to ensure the requisite security is in place over the assets being financed. That all makes ABL more cumbersome in both the UK and Europe compared to the US. Across the Atlantic, lenders are now much more prepared to lend secured against stock and debtors in isolation (bifurcated facilities), which makes it more popular, and it works well alongside other providers of secured debt and equity in the capital structure. So it’s easier to put in place in America, it’s cheaper and it’s secured, but only against specific assets. This type of structure is best suited to those businesses that are profitable, good performers. If we can get towards that we’ll see much more growth over here.

As I said earlier, each country in Europe has different laws for taking and perfecting security, whereas the US doesn’t have those obstacles. The popularity of the product is definitely growing over here and private equity is starting to realise that it has its advantages. It may be more cumbersome to set up than a leveraged finance product, but in situations where earnings are not as high as they were historically, it’s a much better product for businesses because we’re not focused on massive growth – we’re focused on the assets that underpin our collateral.

Morrin: If you look at the ABFA statistics for Q4 2011, the stock security grew by ten per cent while plant, machinery and other assets grew by 95 per cent. So we’ll see one element of the security base growing at a much faster pace than some of the others. Part of this is down to recently completed deals, particularly Speedy Hire. Once you get traction and a deal like that done then you find more will follow. People are learning.

Merchant: There’s a growing understanding and fast-increasing level of collaboration between the private equity community and ABL providers. As an adviser it is clear the principal ABL players’ knowledge and expertise in working with private equity has developed tremendously in recent years in both the lower-mid and mid-markets.

Yes, the lack of liquidity in senior debt markets has played its part in encouraging private equity to work more closely and regularly with ABLs. At the same time, there are many more ABLs with the people and skills to make these collaborations effective.