February 2013 by Jim Leonard
As an arranger, structurer, administrator and reporting agent on trade receivables securitisations and other structured receivables finance products, we have been viewing the evolving trends and developments in this area of the market with particular interest. By way of background, I should point out that Finacity is not a lender nor an investor and so we partner with third party funding institutions – banks, asset-backed commercial paper conduits, funds and capital market participants. Our clients include corporations and financial institutions throughout the world and we currently handle the financing and administration of more than US$75bn of receivables each year.1 Our relationship with such a large and diverse universe of fund providers has yielded evidence of one trend in particular. Market feedback underlines the growing interest on the part of many mid-sized bank and non-bank financial institutions in expanding their reach in the receivables finance space.
The term “receivables finance” comprises a diverse set of products that has more traditionally been the domain of very large international banks. To the extent smaller banks have been active, it has mostly been as participants in larger banks’ supply chain finance credits, or as providers of relatively simple reverse factoring facilities (involving a minimal number of mostly well-rated obligors and small monthly volumes of typically large invoices) or simple borrowing base facilities (relying on self-reporting by the borrower). Most small and mid-sized banks do not have the dedicated trained operations staff or specialised technology platforms needed to administer the more structurally complex or operationally intensive accounts receivables (A/R) finance products. Meanwhile, the still sluggish global economy, together with a greatly increased regulatory burden and heightened pressure from bank equity investors for return on equity improvements, means that most mid-sized banks can’t afford the significant investment needed to acquire or develop infrastructure of this kind in-house. As a result, many are exploring possible outsourcing options. This article summarises some of the main sub-product areas in which we have observed the most interest from these midsized financial institutions.
Trade receivables securitisation
Trade receivables securitisation provides for efficient pre-funding of large, broadly diversified pools of accounts receivable on a revolving basis. Whereas factoring and asset-based lending methodologies produce a static or semi-static advance rate based on the underwriting or insurance of each individual credit obligor in a receivables portfolio, A/R securitisation provides a dynamic advance rate based on the realtime performance of the overall pool. This funding instrument is mainly used by large multinational corporations that often have many thousands of customers/obligors and potentially millions of monthly invoices.
Receivables securitisations are normally structured in accordance with established rating agency criteria to achieve high investment grade ratings. With proper structuring, onboarding, administration, reporting and – when required – back-up servicing, this funding methodology can produce a double- or triple-A rated financing instrument even on behalf of a low or unrated company that sells its products mainly to low or unrated buyers.
Moreover, when structured and managed by an experienced administrator, the securitisation architecture can accommodate quite complex financing situations. These can involve multiple selling subsidiaries in multiple countries using multiple enterprise resource planning platforms and multiple currencies, as well as enormous volumes of very small invoices. While, over the past few years, several banks have begun to book trade receivables securitisations directly on their own balance sheets, the vast majority of such paper is still held by bank-sponsored asset-backed commercial paper conduits (ABCPs). Meanwhile, public capital market placements account for only a small fraction of total outstandings. Thus, the total size and most other characteristics of the A/R securitisation market are quite opaque to outside observers. That being said, we estimate the global market for this instrument, including both public and private issuance, to be between US$50bn– US$60bn at present. As just 15 to 20 very large banks account for the lion’s share of investment in this product, and because transactions are typically structured to very high explicit or implicit rating levels that require minimal regulatory capital, the size of most A/R securitisations is quite large – usually at least US$100m (or equivalent) per transaction. Deals of up to US$200m are ordinarily funded by a single institution, with larger deals being structured as small clubs involving perhaps two to four participants.2 Wider syndications are unusual, and this means that smaller banks generally never even see these transactions. Moreover, given the big banks’ size preferences, potential corporate issuers with relatively small A/R portfolios (supporting deal sizes of under US$100m) often find themselves locked out of the market.
On the other hand, there is no fundamental reason why much smaller A/R securitisations could not be executed on still-acceptable terms to the issuer if interested funding parties could be found. In our experience, this market demand is very much in evidence – from the midsized financial institutions repeatedly asking why they were not shown transactions once these are made public. There has also been a growing number of unsolicited enquiries in recent years from various mid-sized western banks and western branches or subsidiaries of Middle East and Asian banks seeking assistance in structuring and administering new small trade receivable securitisations for their own corporate clients. Both these trends are, in my opinion, clear indications of the latent interest in this product among mid-sized financial institutions, which normally have smaller underwriting preferences than the large banks that currently dominate this market. From the issuer side, while there are indeed significant upfront and fixed costs that would tend to raise the effective all-in cost of relatively small securitisations, such transactions could still make economic sense for all parties involved. This is even for transaction amounts as low as US$25m–US$30m. For this reason, a number of mid-sized banks and other investors have expressed interest in a possible origination of a small securitisation product targeted especially at such investors. Given that most midsized banks do not have their own ABCPs, these transactions would be structured as bank balance sheet deals, and may indeed be “syndicated” for somewhat larger transaction amounts of, say, between US$50m and US$100m.
Portfolio factoring is a product that varies greatly in form, substance and market perception from country to country. While a few big banks offer nominally “multi-local” factoring solutions across several European countries at once, most progammes like this are (in contrast to the above-described securitisation model) still essentially composed of individual country-level facilities in terms of legal documentation, obligor notification mechanics and various other features. Furthermore, while many big European banks offer quite aggressively priced with and without-recourse factoring/invoice discounting facilities tailored to meet the needs of even the biggest multinational companies, in other parts of the world – including North America – the landscape is dominated by small independent factors that cater largely to small or “unbankable” companies at very high effective interest rates. In the US, there are only a handful of large banks that are really active in this market and that can offer all-in funding rates competitive with those obtainable on other types of bank facilities. That is not to say that large domestic or foreign companies operating in North America would not have a need or desire for such facilities. Indeed, there are many European companies that would happily avail themselves of attractively priced, European-style “agency” factoring (wherein servicing is retained by the seller) if such facilities were more widely available in North America. Especially useful would be non-recourse factoring facilities, though these are more the exception than the rule in the US and Canada. When carefully structured, non-recourse factoring can also be used to provide off-balance sheet treatment to the selling company under both the US GAAP and IFRS accounting regimes. Unfortunately, many potential bank entrants into this space currently find themselves constrained from making the necessary investments by the abovementioned profitability and cost pressures. An effective factoring operation requires specialised processing and accounting technology, as well as trained marketing and operations staff, to be successful. Though the continuing pressure on banks to reduce their cost structures has inhibited many from venturing into this product space, there has been, over the past couple of years, a growing number of mid-sized banks and specialist finance companies seeking a partner to help them offer an efficient factoring product to their corporate clients. The main function of an outsourcing partner is to provide the onboarding, administration and reporting, while the financial institution brings the client and the funding. Structuring is typically done collaboratively. By deploying this type of arrangement, the main barrier to entry – which is the initial set-up and ongoing administrative expense – is eliminated. Furthermore, for banks concerned that they may not generate enough new factoring business on their own, arrangements of this kind do introduce them to the provider’s own clients – and further business development opportunities.
Reverse factoring/supply chain finance
Like receivables securitisation, supply chain finance (SCF) has also traditionally been mostly the domain of very large banks. Because this product naturally generates sizeable amounts of concentrated credit risk on each specific bank client being supported (in other words the buyer or invoice payer), many mid-sized banks have been able to participate in this market only indirectly as buyers of participations from the big banks that administer those programmes for their large, well-rated clients. On the other hand, onerous upfront development costs make it prohibitive for many midsized banks to develop and run their own SCF programmes in house. Thus, to better service their own corporate clients and to more effectively compete against their bigger rivals, many mid-sized and even some quite large banks have found it more efficient to partner with an experienced third-party platform provider than try to reinvent the wheel themselves. What do banks look for when choosing a third-party service provider? The following paragraphs summarise the main requirements..
Provider requirements Full back office solution
Most importantly, many aspiring mid-sized SCF banks say that they want a partner that brings more to the table than just an off-the-shelf, one-size-fits-all softwareor technology-based product. Instead, they require a service provider that offers a full back office solution – including onboarding, programme administration, discrepancy reconciliation and timely customer service – in addition to a high-quality, easily adaptable technology platform. They complain that some mainly technology-based platforms in the market are wholly dependent on the quality of the data being fed into the system. This is because there is no human supervision to ensure that the data and outputs make commercial sense (i.e. the “garbage in, garbage out” problem), and because some platforms cannot be flexibly adapted to efficiently handle non-standard inputs or business models. Accordingly, it is important to many bank users of such products that their service partner is led by experienced finance and business professionals who speak the same language as them, and not only by programmers and “techies”.
Many mid-sized banks also prefer a provider that can deliver insightful, easyto- understand structuring advice to ensure that each new client facility they establish is structured as efficiently as possible given whatever unique circumstances apply to that client. And this is while reflecting the bank’s own goals and drivers in relation to the client. Others look for a platform that can be used on either a disclosed or undisclosed (i.e. white label) basis, and that the latter can accommodate either bank-funded programmes or self-funded ‘reverse auction’ type programmes.
Sharing the business
Finally, some institutions that consider entering the SCF/reverse factoring field worry whether they will able to generate enough new business from their existing client base to justify the effort. Such banks often prefer a service provider that has a robust corporate calling effort of its own, and willing to share new business leads with its established SCF funding partners. In our experience, many attractive new transaction opportunities emerge during the course of A/R securitisation services discussions. These include ancillary products such as factoring, asset-based lending, SCF and reverse factoring. A non-balance sheet provider is in a strong position to introduce these opportunities to funding partners with an interest in those products. Likewise, it is not uncommon that certain A/R securitisation and asset-based loan facilities impose caps on the advance amounts available against certain large obligor concentrations. When this has occurred, we have structured a hybrid funding solution that pulls those obligor concentrations out of the facility collateral pool and, instead, funds them separately through one or more of our SCF partner banks on a reverse factoring basis. This additional asset origination capability is another source of incremental income for our partners.
Not just for the big guys
To conclude, there is ample room for small and mid-sized bank and non-bank financial institutions to compete effectively in the broader receivables finance space against much larger institutions. However, in most cases, they will need the help of a trusted third-party service provider for origination, structuring, administration, reconciliation, reporting and distribution capabilities.