The outcome of the US presidential election took everyone by surprise across all business sectors. As a result, contrary to widespread consensus of market commentators, capital markets defied all expectations as fund flows from emerging markets returned to developed economies. And we’re on course to see a shift in policy, as throughout the election campaign and since taking office, one pro-business proposition of the Trump administration has been the promise of looser regulation, infrastructure investment and a more pro-UK stance in trade relations.
The plan to foster a looser financial policy augurs well for the banking industry generally and, in particular, the asset-based lending (ABL) market. Dodd-Frank has impacted the US ABL market somewhat in that it requires banks to originate “bankable assets”. These are essentially loans that must be paid by cash flow rather than by liquidation of secured assets. A well collateralised ABL does not tick all the boxes of the regulators. A loosening of Dodd-Frank may help to liberate this regulatory hurdle.
With the onset of Brexit, we continue to see the contrarian effect play out in the market, with the FTSE in excess of 7,000 points and continental European markets seeing all-time highs reached in France and Germany. The weakening of the pound has seen the FTSE 100 reach new heights as a large proportion of the constituents are multinational corporates who make the bulk of their earnings outside of the UK.
However, the weakening of the pound has also made UK companies vulnerable and attractive to opportunistic takeovers by foreign predators. Since the Brexit referendum, we have seen takeovers launched by Japanese company Softbank for ARM Holdings, Financial Times owned by Pearson being swallowed by Nikkei and France’s Renault planned acquisition of GM Europe, which owns the Vauxhall and Opel car brands.
So, how does this relate to ABL? ABL can be an alternative funding solution for strategic business decisions in mergers and acquisitions. Large corporates traditionally rely on capital markets to raise capital for funding takeovers either via an equity, bond issuance or a syndicated credit facility. Its prevalence is dependent on the current state of the capital and loan markets, which may be volatile. By contrast, ABL is a more consistent option and available if needed, playing its part in acquisition financing by diversifying funding to reduce risk, providing a supplementary or alternative source of funding independent of the markets.
In ABL transactions, the lender’s interest is secured by the borrower’s assets, and it unlocks the potential of the borrower’s debt-free assets on its balance sheet. These assets include accounts receivable, inventory, plant and machinery, real estate and even intellectual property. As such, the borrowers may have access to more stable and better credit terms relative to cash flow-based credit facilities in which the credit capacity is determined by the borrower’s enterprise value, which may be volatile during business and economic cycles.
ABL can be used to generate acquisition funding as well as providing working capital post transaction. It can be perceived as having the competitive advantage of being a more consistent source of liquidity to cushion market volatility, as seen from the immediate aftermath of Brexit, the US elections, and the UK snap election in June. Given its favourable capital treatment, ABL also represents a materially cheaper source of debt.
This period of uncertainty will continue to exist whilst the UK embarks on a hugely complex negotiation with the EU. This has, in part, motivated companies to consider the wider spectrum of potential sources of debt. Debt advisors have also recognised the need to be conversant on all product options and not solely on traditional loans or unitranche. Businesses of all types and sizes may not want to rely on a single source of funding and are therefore increasingly open to new lenders and products. This is particularly so for non-investment grade companies who are more vulnerable to the credit markets for term loans. If markets freeze again, these companies will be severely impacted.
Since ABL is ever-present, its relevance and importance to the market may come into sharper focus. The alternative finance market continues to grow with ABL breaking the £20bn funds out barrier for the first time in the UK in 2016, according to the Asset Based Finance Association. In the quarter ending 2016, the figure stood at £22bn, a rise of 13% year-on-year. This presents an opportunity for CFOs, FDs and group treasurers to consider ABL as an alternative source of funding as the product continues to take market share in the current Brexit era.
Every period of uncertainty presents an opportunity. Against the backdrop of optimism of de-regulation, the impact of UK M&A and the uncertainties of Brexit, now – more than ever – is the time for corporates – SMEs, mid-size, and large – to take stock of their capital requirements by considering ABL as an alternative or supplementary source of funding to maximise working capital efficiency in their capital structure.
Alex Dell is a partner at Mayer Brown.