A solution to the credit crunch?

A gloomy risk outlook and hesitant consumer spending has weighed heavy on the asset finance industry, but this type of borrowing could still be the best bet for cash-strapped companies, as Dan Matthews reports

Although it doesn’t sound like it, the term “asset finance” is actually very broad. It can refer to one of two actions: borrowing in order to buy an asset over time, such as a car or a piece of machinery, for example; or sweating an asset that you already own to release some of its value.

Then there is the definition of the “asset”, which could be machinery, property, motor vehicles or just about anything with a cash value. Even money – in the form of invoices sent to trusted payers – can be used to borrow money under factoring or invoice discounting.

The important common ground is that there is a “thing of value” upon which the loan is based, as opposed to a standard loan which is offered or withheld depending on the lender’s assessment of the borrower’s ability to pay it back.

Traditional wisdom dictates that this “thing” makes asset finance a good bet for lenders because they have a right to sell the asset should the borrower not be able to repay money owed. It also gives companies, like manufacturers and transport businesses, access to one-off chunks of cash if they find themselves falling behind on cash flow.

Borrowers have access to less cash than they did five years ago against the same class of asset

But with fewer buyers in the market, assets are harder to shift and prices are coming down. What was rated at one price ten years ago is almost certainly rated lower today.

As Patrick Wilkins, regional director at ABN Amro Commercial Finance, points out: “Assets like machinery and property are dropping in value, not because these figures are being plucked from the air by banks and lenders, but because there is a depressed demand from buyers.”

It means sale and lease-back agreements are harder to come by and deals that do happen cover a smaller proportion of assets’ true value. A consequence is that borrowers have access to less cash than they did five years ago against the same class of asset.

“Sale and lease-back lenders are a lot coyer than they were before the credit crunch,” explains Tracey Ewen, managing director of IGF Group, which specialises in factoring and invoice discounting. “In the recession values came down and some lenders realised they had over-lent for the new economic environment.

“Since then lenders are concerned about lending more than an asset is worth, so while you might have got £8,000 for something worth £10,000 then, now it would be more like £5,000 or £6,000. It’s the same thing that happened with 100 per cent mortgages, which are fine when the market is going up, but not when it’s coming down.”

Fred Crawley, editor of Leasing Life and Motor Finance publications, agrees that there has been “a fundamental shift in recent years”, even though the market is still strong. “Funders are focusing on the serviceability of the asset finance and so the underlying financial strength of the corporate, rather than the potential re-sale value on possession,” he says.

Since the credit crunch lenders have put a lot more thought into whether borrowers can pay back, even if there is an asset mitigating the risk of a loss. The tougher lending environment and dropping assets prices mean asset-backed products are looking more and more like standard loans in the way risk is calculated.

However, the news is not all bad. According to Tom MacDonald, financial services partner at Deloitte, the tightening of lending criteria is far from uniform and, both the likelihood of achieving a deal and the value of the deal, depend greatly on the asset at stake and the solidity of the business applying for the loan.

“Residual values tend to behave in cycles that are very much specific to the asset class,” he says. “For example from a vehicle finance perspective, the reduced number of new vehicle registrations during the earlier periods of the credit crunch has in some months constricted the supply of second-hand vehicles, which has limited the downside risk in terms of asset prices.”

For this and other reasons, the statistics show asset-secured lending is outpacing business banking. In 2011, business written by asset finance companies in the UK was up 10 per cent on the previous year to £19.5 billion, representing more than a quarter of all capital investment by UK firms. Commercial vehicle finance on its own was up 22 per cent to £4.4 billion.

Meanwhile, in the third quarter of 2011, members of the Asset Based Finance Association, advanced £16 billion, an annual rise of 9 per cent. In contrast, lending to private non-financial companies dropped 2.3 per cent in the 12 months to the end of September 2011, according to the Bank of England.

The industry agrees that this rise in popularity is because of, not in spite of, the credit crunch. Research by Leasing Life magazine last month revealed that 86 per cent of asset finance business leaders agreed that the current increase in new business volumes was the result of businesses needing an alternative to standard bank funding.

Elaine Shelley, who runs the valuation and advisory business development team at GoIndustry DoveBid, says asset based lending appears to be increasing partly because of its “product attractiveness”.

“Facilities granted on the basis of historic information will not necessarily prove flexible enough to meet the future financing needs of a business as it expands, at least without a potentially disruptive round of renegotiation,” says Ms Shelley. “Overdraft facilities can also be withdrawn at any time, which can be of concern in the current environment, when business confidence is at a premium.”

David Grier, a partner at financial consultancy Duff & Phelps, says: “In many situations asset based lending is one of the few solutions to managing growth and planning for the future.” However, he warns: “Any transaction involving asset based lenders is likely to include a deep dive into the longevity of the organisation, the individuals who are in control of the sector and increasingly important exit routes for the lender.”

And there’s the rub. Although asset finance seems to be an industry in rude health, standard lending rules apply. If you are planning to apply for this form of funding for your business, be prepared for due diligence that mirrors any other loan application.

“Some lenders will accept riskier clients since they underwrite based primarily on the strength of the asset’s value,” says Mr Crawley. “But these will probably charge a higher rate of interest to cover default risk.

“Others, especially those lending against ‘soft’ assets with weak resale values such as small-ticket IT or catering equipment, will underwrite based entirely on the strength of the customer’s balance sheet.”

His advice is to be flexible and find a provider who can offer expert advice in the asset class you are buying into. The chances are, especially with a lender that is prepared to put time into a deal, that a solution can be found, he says.

ABN Amro’s Mr Wilkins says only businesses with certain, easy to sell on, assets need to apply: “In order for businesses to increase their chances of securing asset finance, I’d recommend that they carefully consider the value of those assets,” he says. “For example, a bespoke piece of machinery, which can only be operated by a handful of trained experts, is going to raise much less than a more common piece of machinery because there will be fewer buyers looking to purchase it.”

Mr MacDonald at Deloitte agrees that the asset is everything. “It’s an unfortunate reality that some assets devalue over time,” he says. “Anyone who has every bought a new car knows this all too well. Businesses should consider the saleability of their assets before trying to secure finance against them.

“In theory, renting higher quality assets should require the lender to place less reliance on the quality of the borrowers own credit profile. Obviously a good track record of consistent payments is also helpful.”

For certain businesses, in particular those needing to buy or finance expensive kit on a regular basis, few forms of borrowing can match the asset-based variety. But whether you are able to conclude a deal or not depends on your needs, your business’s financial strength and, not least, your powers of persuasion.


Focusing on using assets for growth

Imaging specialist Harman Technology employs 260 workers in Mobberley, Cheshire, and has an annual turnover of £26 million. It chose asset-based lending to fund its plans to diversify into new applications and increase overseas sales, securing a £4.95-million facility against its inventory from ABN Amro Commercial Finance.

The firm is the largest dedicated manufacturer of black and white paper and film in the world, and incorporates three major brands; Ilford Photo, Harman Photo and Kentmere Photographic which produce a wide range of renowned photographic products.

Since the funding it has been able to focus on other aspects of its business, including thin-layer film and paper coating for the medical sector, and innovative sports products.

The company’s 132-year experience in the applications of silver, a key component in the photographic process, led to the exploration of this material’s anti-microbial properties for use in products such as sportswear, plasters and medical diagnostics.

“While our core business centres around photographic products, our expertise has developed over the last century into a robust proposition for other markets where silver has commercial applications,” says chairman Howard Hopwood.

“We wanted a specialist that could take the time to understand our business and create a solution which allows us to leverage against our assets, enabling us to invest in our existing offer as well as expand into this exciting new product stream.”

Since sealing the deal last year, Harman has introduced a new range of holographic glass plates, created black and white “negatives” from digital pictures, and introduced new pinhole photography technology.

The business recently announced the sale of its one-thousandth unit of its high-performance Ilford pinhole photography kit, which is popular with professional photographers and photography students.

It has also stepped up its marketing efforts by launching a competition for photography students with a £1,000 first prize and made its debut at the Focus on Imaging Exhibition at the Birmingham NEC in February.

Peadar O’Reilly, regional director at ABN Amro Commercial Finance, says: “Easy access to flexible finance is a vital part of this and will help build financial confidence for stronger growth as well as wider economic recovery. As the UK economy recovers, we expect to see many more progressive refinancing deals as businesses refocus on growth.”