Well before the UK voted to exit the European Union, CFOs needed to monitor worldwide events constantly as they faced an increasingly complex set of global decisions. To grow revenues, manage risk and optimize supply chains, companies of all sizes have become increasingly international in scale. Every new jurisdiction has its own legal issues, and steps must be taken to minimize currency and tax exposure. The globalization of business also causes CFOs to need financing that facilitates their international strategies. These needs may challenge the structures of their traditional cash flow-based banking arrangements, especially for companies with non-investment grade ratings.
By contrast, the asset-based lending market has adapted to serve many such needs and can provide a flexible and cost-effective source of liquidity that takes advantage of investments in fixed and working capital assets across a growing range of countries.
While much has been written about globalization, its impact on financing decisions cannot be understated. According to Dealogic, global cross‐border M&A volume reached $1.56 trillion in 2015, representing 31% of total volume, a record level. U.S. cross‐border M&A reached $726.8 billion, also a record year and up 54% year-over-year. With the expansion of international M&A has come a growing need for cross-border acquisition financing.
Beyond acquisition financing, companies with global sales and operations increasingly find themselves with assets and financing needs in a multitude of jurisdictions. Traditional cash flow-based loans provided by U.S. banks can often address some of the offshore needs of domestic companies, but these structures are typically highly covenanted and are mostly available to companies with strong credit ratings. For below investment grade companies, financing structures frequently attempt to limit the availability of funds in offshore locations, and also restrict the ability to move funds among subsidiaries. These limitations often run counter to the financing objectives of the borrower.
Growth in the U.S. ABL Market
U.S. asset-based market liquidity has deepened over the past decade, with annual syndicated volume ranging between $80 and $100 billion. Transactions of $1 billion or more have become relatively common. According to Thomson Reuters, there were 22 such transactions in 2015, the largest of which exceeded $3 billion. In addition to an expansion of market capacity, there has also been an evolution in terms of structure and pricing. The covenant structures of asset-based loans today are highly compatible with those of other debt markets, including those for high yield bonds and institutional term loans. Most broadly syndicated asset-based transactions provide multi-year committed financing with no maintenance financial covenants if a borrower maintains a minimum level of liquidity.
Moreover, asset-based lenders are inherently more focused on asset valuations and liquidity. Cash flow is a secondary consideration. As a result, many asset-based structures provide borrower-friendly terms for items that can enhance shareholder value, such as acquisitions, distributions and share repurchases based only on liquidity metrics, with little to no reliance on maintenance financial covenants. Pricing for asset-based loans is also very attractive, particularly when compared to cash flow-based loans for companies rated below investment grade. According to Thomson Reuters, average pricing for asset-based loans over the past several years has averaged less than 2% over LIBOR, with pricing typically based on liquidity rather than ratings.
The flexibility and attractive pricing of the asset-based market has resulted in syndicated asset-based credit facilities being provided to companies in a wide range of industries, including many businesses with sales, operations and supply chains well beyond U.S. borders. Historically, these companies have looked to finance their offshore needs through intercompany loans, increased trade credit or local credit arrangements in the countries where they do business. Because these financing sources are often limited or restricted by existing corporate credit arrangements, borrowers have had to manage their liquidity and currency issues very carefully, often in ways that are sub-optimal for the business.
ABL Growth Outside the U.S.
The asset-based market outside of the U.S. has grown and evolved in recent years as it has adapted to the increasingly global needs of borrowers. Canadian secured lending laws are very similar to those in the U.S., and the asset-based market has been highly successful in Canada for many years. Beyond the U.S and Canada. there is a growing ABL market in several offshore jurisdictions, notably the UK, Ireland, Germany, the Netherlands, Belgium and Australia.
While the asset-based market in Europe and elsewhere has grown over the past few decades, it is still relatively small in both deal size and market capacity when compared to the U.S. and has been somewhat limited in jurisdictions. These markets have not evolved as rapidly as the U.S. in terms of structural flexibility and are therefore not as well suited to provide for large cross-border financings.
The efforts to expand asset-based-lending outside of the U.S. have been aided by the work of governments in many offshore jurisdictions looking to spur more bank lending by strengthening their secured lending laws. The United Nations has recognized the importance of this issue in economic development through the United Nations Commission on International Trade Law (UNCITRAL). According to Richard Kohn of Goldberg Kohn, who represents the Commercial Finance Association at UNCITRAL, “UNCITRAL has discovered the crucial role that asset-based lending and other forms of secured finance can play in helping businesses grow, creating jobs and improving standards of living. On July 1 of this year, after years of work, UNCITRAL adopted a Model Law on Secured Transactions that will enable countries to modernize their secured transactions laws in an efficient and cost-effective way, which in turn promises to expand the number of countries in which U.S. lenders will consider making cross-border loans.”
U.S. ABLs Expand Jurisdiction
The depth and flexibility of the U.S. asset-based market and the desire of the market participants to continue to service the needs of their borrowers as they grow, have led to an expansion of U.S.-based facilities to accommodate assets in a growing list of jurisdictions. The proven ability to perfect on security interests in assets domiciled offshore can give asset-based lenders greater comfort when lending outside the U.S. in comparison to a cash flow-based approach. This, in turn, has led to a growing number of U.S.-centered asset-based loans with substantial availability in non-U.S. jurisdictions. In these facilities, non-U.S. availability is based on collateral values in offshore jurisdictions, and all loans are made under a single credit agreement in which lenders participate ratably. Loans can be made in the currency chosen by the borrower, with a wide range of options. Several cross-border facilities have been in excess of $1 billion, and tenors mirror the typical U.S. asset-based five-year structure.
In addition to leveraging foreign investments in assets, cross-border financing structures can potentially reduce foreign exchange risk and work in conjunction with tax planning strategies to provide direct advances in local or multiple currencies from regional or affiliate offices against jurisdictional assets. By closely matching the loans to the location of the offshore assets, asset-based facilities can provide effective currency management.
An example of the growth and flexibility of the U.S. asset-based market is the $1.2 billion facility for Novelis, a provider of rolled aluminum products based in Atlanta. According to Steve Fisher, CEO, “Novelis was in the midst of a significant investment program involving major capacity expansions to meet growing demand worldwide. Over the past five years we have expanded our operations to meet aluminum growth in the marketplace. Today we’re on four continents. We entered into our current asset-based financing because we need a flexible financing solution that provides working capital in the U.S. and in Europe as well as provided for equipment financing as we build out recycling and automotive centers across the globe.”
The needs of borrowers for cross-border financings will only increase as their operations become more global in scale. The depth and flexibility of the U.S. asset-based market has enabled it to grow and adapt to address the increasingly international needs of its borrowers. The flexibility and attractive pricing of the underlying structures, efficiency with respect to tax and currency issues and growing list of potential jurisdictions make asset-based structures more attractive than cash flow structures available to the same borrowers. The continued evolution of the U.S. asset-based market makes this alternative a critical tool for CFOs as they evaluate their financing needs outside of the U.S.