IFG Asset Based Lending & Supply Chain Finance Conference An Overview of Asset Based Lending

IFG Asset Based Lending & Supply Chain Finance Conference

AN OVERVIEW OF ASSET BASED LENDING

Richard P. Palmieri23 October 2013Istanbul, Turkey

What is asset-based-lending?

Asset-Based-Lending (“ABL”) is a form of secured and monitored lending

ABL utilizes assets that can be valued and monitored as collateral (principally receivables and inventory)

ABL uses a formula-based lending approach against eligible trade receivables and inventory with strict monitoring criteria to ensure the loan remains “in formula”

Control over cash collections to pay down outstandings is a key building block of ABL

ABL matches loans to borrower’s cash conversion cycle, allowing borrowers to borrow only what they need and pay interest only on funds borrowed

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History and development of ABL

ABL started in the USA during the 1920’s At that time, the USA was experiencing strong economic

growth, with a lot of small and medium-size companies needing financing to support their growth

These companies did not have a strong capital base and needed a form of financing to fund their working capital growth

Lenders developed ABL as a way to lend to these companies on a well-secured and monitored basis

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History and development of ABL

As with any new financing product, ABL had to fit within the existing legal framework

This meant that much of the early lending resembled factoring and receivable discounting instead of the ABL that we know today

Early forms of ABL allowed lenders to provide critical working capital financing to growing SMEs on a monitored and secured basis

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The evolution of ABL From its beginnings, ABL adapted to a changing legal and

regulatory environment Changes in laws made it easier to take security in present

and future receivables and inventory, thus converting ABL into a secured loan product

New laws and regulations have: Reduced the number of unregistered priority

claimants Converted retention-of-title claims to security

interests requiring public notice Made possible non-judicial enforcement of liens

Insolvency laws have recognized the priority of secured loans and their collateral rights

Thus ABL, with its secured, monitored and valuation approach to lending has become a primary form of lending to under-capitalized companies

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The evolution of ABL

With improved laws and regulations and acceptance of ABL, the product offering of ABL has expanded to include: Receivable and inventory financing Commodity borrowing base lending Securitization Supply chain financing Purchase order financing

ABL’s growth has resulted in the expansion of service providers needed by ABL lenders in the review, valuation and monitoring of the collateral supporting ABL facilities

These service providers include legal, field examination, inventory valuation, and collateral realization firms and training services available for new lenders entering the field

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ABL today

ABL is a widely accepted and used form of financing in the U.S.

Many ABL sub-products have migrated to countries in Europe, South America and Asia

ABL use has expanded from only working capital financing to acquisition and restructuring financings

It is estimated that one of every three companies in the U.S. utilize some form of ABL

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ABL today

Due to secured and monitored aspects of ABL, this form of lending has had lower Loss Given Default (LGD) rates during the recent U.S. recession than other unsecured and secured forms of lending

This lower LGD is allows lenders to risk rate ABL facilities higher than other forms of loans for comparable borrowers and thus allocate lower capital against this form of lending

This lower LGD is a result of the pre-closing collateral analysis and valuation and post-closing collateral monitoring and collateral re-evaluation that are the hallmarks of ABL

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ABL industry size

Thousands of U.S. commercial banks are engaged in commercial and industrial lending, and the aggregate value of their Commercial & Industrial loans is well in excess of $1 trillion. Many of these loans are asset-based transactions

At least 50 hedge funds and private equity funds with assets under management exceeding $1 billion are active in direct lending, often of an asset-based nature. Also, an estimated 20% of all private equity funds are involved with some form of asset-based lending

Over 1500 credit unions now provide commercial loans, including asset-based loans

Captive finance companies often provide asset-based loans in the form of accounts receivable financing and floor planning to their distributors and dealers

A number of equipment leasing companies also have broadened their involvement in asset-based lending because of intensified competition and shrinking margins in their traditional business

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ABL industry size – US market

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The size of the overall U.S. asset-based lending market in 2012 was estimated to be $620 billion in terms of loans outstanding. This estimate is based on extrapolations of data obtained from CFA members and other sources such as government agencies (e.g., FDIC) and trade publications (e.g., American Banker). The exhibit below shows market growth and how market size has been impacted by economic recessions:

Source: Commercial Finance Association

ABL and other forms of business finance

Supply Chain

Finance

Contract purchase

Multijurisdictional

financing

Purchase order

financingLogistics financing

Asset Based

Lending Vendor leasing

Factoring

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Vendors OEM END USERS

Cross Border Supply Chain

ABL philosophy

The success of ABL lending in the U.S. and in other countries is tied to ABL’s core processes and philosophy:

Detailed pre-closing collateral analysis and valuation Detailed review of borrower’s ability to report

collateral on a timely basis and in a form that the lender can use to easily track and re-value collateral on a regular basis

Frequent reporting and verification of the collateral Control of cash proceeds to repay outstanding loan

balances and thus keep the loan within the collateral limits

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Key elements of ABL The “exit strategy” is based on realization of the

collateral in the event of default, even in the borrower’s insolvency

Thus, the focus is on making certain that the loan never exceeds the collateral’s realizable value

This requires the lender to: Value the collateral with precision Address legal and business issues inherent in the

collateral Monitor the collateral Exercise control (dominion) over the proceeds of the

collateral Have immediate access to the collateral Know how to realize on the collateral

The lender must be an “expert” with respect to the collateral13

The keys to ABL’s success

As with any form of successful lending, limiting losses due to fraud, collateral value deterioration and business failures are key to being a successful lender

Although ABL structures can not prevent exposure to business failures and fraud, ABL’s basic structure and methodology can reduce losses when fraud, insolvency or asset value deterioration occurs

ABL limits losses through the principles of frequent collateral reporting, valuation and verification of collateral eligibility and control of collateral proceeds to pay down the outstanding loan so that the loan balance never exceeds the collateral’s realizable value

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The balance of this presentation will focus on ten key elements of a legal regime that supports ABL The legal elements are reflected in the UNCITRAL

Legislative Guide on Secured Transactions

1. Party Autonomy2. Creating a security interest in receivables and inventory3. Third party effectiveness of the security interest4. The registry system5. Clear priority rules6. Access to proceeds of receivables7. Access to inventory8. Insurance9. Enforcement10. The insolvency regime

ABL requires a supportive legal regime

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Party autonomy As in any credit facility, ABL requires comprehensive written

agreements Thus, the legal regime must recognize party autonomy

Subject to mandatory rules (such as consumer protection, usury, commercial reasonableness)

In ABL, the focus of documentation is on collateral-related matters:

Defining “Eligible Receivables” and “Eligible Inventory” Defining the “advance rate” Specifying the interest rate and fees Defining the conditions for making loans Granting a security interest in the collateral Defining the events of default Describing the lender’s remedies

Other relevant provisions (covenants, etc.) are also important

10 key legal elements of ABL loans

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Creating a security interest in receivables and inventory The security interest should be easy to create

No excessive formalities (such as notarization or translation)

No required notice to account debtors The security interest in inventory should be non-possessory The security interest should extend to both existing and

future receivables and inventory without additional documentation or action

The security interest should secure existing and future advances

The security interest should automatically extend to proceeds of collateral

Prohibitions or restrictions on the assignment or pledge of receivables should be unenforceable


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Third-party effectiveness of the security interest

There should be a simple way to make the security interest effective against third parties (including the borrower’s insolvency administrator)

The security interest should have first priority over competing secured claims Preferential claims (wages, taxes) should be limited Carve-outs for unsecured creditors should be

avoided


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The registry system The registry should be accessible to all prospective

creditors The registry should be easily accessible and fast (Internet-

based) The registry should be searchable to enable the lender to

identify competing secured claims The registry should use a “notice filing” (as opposed to a

“document filing”) system There should be no formalities (such as notarization) There should be nominal filing and search fees The should be no requirement to disclose the maximum

indebtedness on the public notice All competing claims should be subject to registration

No “secret liens” (including retention-of-title claims)


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Clear priority rules There should be clear priority rules to resolve

conflicts among competing secured claims Priority among competing consensual security

interests should be awarded to “first to file or achieve third-party effectiveness”


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Access to proceeds of receivables Dominion over proceeds

Lock box (post office box) Borrower notifies customers to pay directly into the

account Blocked account agreements (also known as control

agreements) Depository bank agrees to honor lender’s

instructions and waive set-off (except for administrative fees)

Two types of dominion over proceeds: “Full” dominion “Springing” dominion (dominion only on Event

of Default or other triggering event) No-offset letters with customers Waivers of restrictions on assignment/pledge


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Access to inventory Waivers (for access and waiving liens)

Landlords To store or sell inventory on premises To convert raw materials to finished goods

Processors Warehouses Mortgagee’s waivers

In-transit goods Negotiable/non-negotiable bills of lading Agreements with port processors and other

bailees


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Insurance Casualty insurance on inventory

Lender as loss payee Must be in place at closing

Credit insurance Covers risk of customer insolvency Can also cover political risk Problems with credit insurance

Reporting requirements Customer and country limitations Not a substitute for a security interest


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10 key legal elements of ABL loansEnforcement There must be efficient and predictable enforcement mechanisms Receivables

The lender must have the ability to obtain the books and records relating to the accounts

The lender must have the ability to notify account debtors Inventory

The lender must be able to obtain access to the inventory to safeguard, sell or convert to finished goods

Intellectual property considerations Insuring the ability to sell trademarked inventory and the

“exhaustion” principle There should be non-judicial enforcement procedures, providing for

public or private sale with: Safeguards for the borrower and third parties (commercial

reasonableness standard) Court supervision if necessary

Courts must be predictable and efficient

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The Insolvency Regime A security interest has no value to a lender unless it

is recognized and enforceable in the borrower’s insolvency proceeding

The insolvency regime should: Recognize the existence and priority of validly

created security rights Allow the lender to receive the economic

equivalent of its collateral subject to (1) appropriate delays and (2) avoidance proceedings required for the administration of the insolvency proceeding


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The future of ABL ABL is expanding globally due to its flexibility and

success in providing borrowers with liquidity while reducing the lender’s cost of credit and fraud in lending to under-capitalized entities

ABL has expanded beyond trade receivables and inventory to other assets including equipment and intangible assets where the legal and regulatory regimes permit

ABL is receiving increased recognition as an important lending technique for SME’s: U.N. Receivable Convention (2001) UNCITRAL Legislative Guide on Secured Transactions

(2007) Current UNCITRAL Registry Project Most European countries participated in all three

projects Copies available at www.uncitral.org

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Richard P. Palmieri

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Richard P. Palmieri, Managing Director, ANR Partners, LLC has served in a variety of senior roles and employs a strong analytical approach to business issues. Richard developed his expertise working in a variety of financial service sectors including; factoring, asset based lending, consumer financing, investment banking, supply chain financing and vendor leasing. He currently focuses on enterprise business transformation, mergers & acquisitions, interim executive services and business performance improvement.

Mr. Palmieri is a past Chairman of the Commercial Finance Association, a member of the Experts Advisory Panel of the United Nations Commission on International Trade Law, a

member of the Turnaround Management Association and a member of the Association for Corporate Growth.

Richard P. Palmieri, Managing DirectorANR Partners, LLCTel: 917-863-9661

[email protected]

http://www.linkedin.com/pub/richard-palmieri/2/72/2bb/

mailto:[email protected]

http://www.anrpartnersinc.com/

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ThankYou

Documents

IFG Asset Based Lending & Supply Chain Finance Conference An Overview of Asset Based Lending