In the wake of the global financial crisis and the ensuing disappearance of low-cost credit, corporations large and small are eagerly seeking alternative, less costly lines of working capital finance in order to remain competitive and, in some cases, survive. There are several options open to firms looking for alternative sources of finance, including factoring, securitisation of trade receivables (TR), leasing, renting, outsourcing and virtual staffing. The overall deterioration of asset quality over the past year has unmasked several weak areas of finance that relied on impaired assets, and has shifted the focus to asset quality. The beginnings of a drop in asset quality first became evident in 2007 and led to a surge in the number of delinquencies, as well as making it increasingly difficult for those firms seeking to raise finance secured against what are now considered volatile assets.
Another area that has found itself under similar pressures is that of securitisation. With asset quality deterioration in central and eastern Europe set to continue until at least mid-2010, firms have no other option but to raise finance against the security of more robust, creditworthy assets such as future flows, whole of business and TR. These lines of finance have the added advantage of being less complex than other transactions and although they remain somewhat complicated, they are relatively easy to monitor, therefore incurring less risk. The European Securitisation Forum (ECF) forecast overall securitisation issuance to fall to €272bn in 2008, the lowest level since 2004. However, the decline in overall securitisation activity is thought to be a direct result of problems caused by low quality assets – although solid assets such as TR have not experienced the same negative impact.
Rise of TR
Among the most solid asset types, finance raised against the security of TR seems to be emerging as an increasingly popular tool. The overall factoring share of the total financial market stands between 3% and 10% across European geographies. This only gives a partial indication as to the uptake of TR finance, however, since the popularity of other forms of TR finance such as TR securitisation and asset-based lending techniques is also on the rise. In order to gauge market interest and uptake of such techniques since the financial markets crisis, we commissioned a research project amongst 1,500 finance directors at UK, French and German corporations. The research was focused on four key areas: what proportion of European companies were already raising finance against the security of their TR, what percentage expect to make use of this financing method during the next 12-18 months, how the scarcity of bank credit has impacted uptake and banking sector attitudes to lending.
Structural changes in the banking system have made it imperative that banks lend at economic and more precisely risk-weighted rates. Recent figures show that banks may fail to meet around US$2 trillion of demand for credit origination globally over the next three years in the absence of well-functioning securitisation markets. In response to tightened credit conditions, corporate enthusiasm for alternative sources of finance based on robust asset categories has been mounting. Our research demonstrated that 56% of European firms believe the scarcity of standard bank credit will see large firms choosing to raise a greater proportion of their finance on the basis of TR securitisations. A similar proportion of firms in the UK and France shared the view, as did a marginally higher proportion of firms in Germany (61%). The positive news is that while finance departments urgently seek lines of working capital, firms appear to be finding ways around the scarcity of bank credit through the securitisation of their TR.
Furthermore, finance raised on this asset category is set to grow substantially over the next 12-18 months. Evidently, corporate financial managers are overcoming their uncertainties and discovering trade receivable solutions/models that are not so burdensome, as just under half of respondents (44%) said they planned to increase their levels of finance raised against the security of TR. The UK and Germany showed the most interest in developing this technique, suggesting that they will soon match already elevated levels of uptake in France. The rise may also be explained by gradually increasing awareness – since the millennium – of TR as a viable asset category, as finance leveraged on TR had not previously been possible in civil code jurisdictions in continental Europe. This was due to the fact that is was difficult to prove the legal separation of invoice debt purchased from a third party from the company that originally issued those invoices. Over the last five years, however, the stringent reporting requirements of a securitisation (combined with technology that facilitates the reporting process for the issuing company) have been accepted as legally robust proof of ownership of an invoice pool in Germany, France, Italy, Spain and other European countries. As a result, finance based on TR has now been an available working capital finance product in continental Europe, and its growth has steadily been rising.
A Robust Asset Category
Our study seems to confirm that in light of the recent exposure of firms to volatile assets, Europe is experiencing a steady retrenchment to the robust asset category of TR, considered one of the most liquid and creditworthy assets on the balance sheet. Current use of finance leveraged against the security of TR was revealed to be well past the ‘pioneer’ stage, with very substantial potential for future take-up. To date, some 36% of European companies said they had already raised finance against the security of their TR. French firms are significantly ahead of their UK and German counterparts, with 43% (as opposed to 31% and 34% respectively) already implementing such techniques. A possible explanation for this is the historically proactive approach taken by France in securitising its TR on a cross-border basis . Many French firms have subsidiaries throughout Germany, UK, Belgium, Luxembourg, Italy, Spain, Netherlands and other European geographies. With the urgent need to generate working capital amidst the scarcity of bank credit, an increasing number of firms in all three countries thus seem to have embraced the largest single asset category on their balance sheets – their TR.
Commentators have noted that the European market is set apart from the US market in being less standardised and that recovery will be very dependent on the banking sector’s ability to overcome the shortage of credit. The latest European Central Bank (ECB) lending survey suggests that although recovery will be a lengthy process, the market has already improved significantly and “access to wholesale funding in money markets and debt securities markets was less impaired in the third quarter of 2009 than in the previous quarter” and that “access to securitisation also improved, but the share of banks reporting hampered access remained at elevated levels.” The difficulties banks have been experiencing has helped to shift corporate focus to raising finance secured on robust asset categories, including TR. These will undoubtedly play a central role in shaping the development of the securitisation market.
A factor that has become increasingly evident over the last year is the rising demand for greater levels of security from banks’ clients to avoid facing caps on their credit limits. Our research showed that 61% of European firms had experienced this, claiming that certain banks are unwilling to extend credit unless businesses can offer stable assets such as TR as security. All three countries were similarly affected, although when combined with companies linking this to the scarcity of bank credit, Germany was worst hit. This may be due to the country being heavily overbanked and inefficient when compared with its international peers, doubling the pressure on lending criteria that the current slow economic state of the country has produced.
In conclusion, European companies are now turning to finance raised on the basis of TR to improve access to credit. Forty-one per cent of European firms shared the view that the key to healthy working capital management in 2010 was TR finance. Banks are becoming increasingly keen on firms offering this asset category, as this solution offers access to lending without taking on unacceptable risk. Invoice debt is seen to be a high quality security, while TR are seen as the most liquid and creditworthy assets on the balance sheet.
Finally, and perhaps even more fundamentally, 46% of European companies are of the opinion that any stigma formerly associated with selling TR to a factoring company has now largely disappeared. This is a positive sign that firms are beginning to regain confidence in securitisation, and are now proactively seeking stable and creditworthy assets to securitise. Indeed, with current credit constraints, many banks seem unwilling to lend without the security of such assets.
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