Summary

With a little more than a month to go until the UK is due to leave the EU, a number of leading retailers and wholesalers have announced that they are building up stock in case Britain exits without a deal. Companies such as Unilever, which makes a number of products well-known to British consumers, and Dixons Carphone have announced plans to stockpile goods in order to mitigate any potential disruption at the border.  While it is anticipated that more and more businesses will follow their lead if Parliament doesn’t find a resolution to the deal impasse soon and notwithstanding the uncertainty created by the threat of a no-deal Brexit,  there is a real concern among British businesses that the possible disruption in their supply chain will not outweigh the significant risk in holding extra stock.   Apart from obvious tangible costs of overstocking, such as those resulting from having to expand warehousing space or increase insurance, a big issue for CFOs of these firms is whether it is in an effective use of their capital.

Possible Solution

In order to reduce the cash impact of stockpiling goods, businesses may want to consider whether they could benefit from an asset based loan facility (ABL).  ABL is a form of secured lending where the amount of credit a borrower can access is principally based on the value of its assets. It typically utilises assets that are most liquid, such as receivables and goods.  As the amount a company can borrower is tied to the value of those assets, it can be a handy tool for unlocking cash tied up in goods being stockpiled ahead of Brexit.

How does ABL work?

Asset based lending has been an established form of financing across the globe for decades and uses a formula-based approach to lending.  At its simplest, the amount of the financing is based on the company’s “borrowing base” which is typically equal to:

                Discount TIMES value of eligible assets MINUS reserves.

The discount is effectively the percentage of the assets (e.g. 85%) that the lender is willing to lend money against in order to ensure the value of the loan never exceeds the realisable value of those assets.

The reserves are amounts deducted from the loan to reflect any anticipated impediments to the realisation of that value.  For example, retention of title clauses in supply contracts and warehouseman`s liens for goods stored in third-party facilities are factors which may reduce the market value of a company’s goods. 

Asset based loans can provide a number of benefits for companies, not least because they are intended to match the borrower’s cash conversion cycle so a company can leverage valuable assets being stored in a warehouse at a time when its working capital needs are highest. They are often priced lower than other similar types of financing and have fewer covenants than conventional cashflow facilities.

However, it is important to note that an ABL is not right for every business and, like any financial product, has its own disadvantages which should be carefully considered.  One thing to be aware of is that not all goods stockpiled by a company will necessarily be included in the borrowing base.  The pool of eligible assets often excludes stock in transit, work-in-progress and bespoke products that don’t have a general market, though this will vary from lender to lender.  These assets will also need to be properly secured in favour of the lender which may result, for example, in ownership being transferred to the lender if the loan isn’t repaid.

 The key credit consideration from an ABL lender’s perspective in working out which goods may be included (and how much they are willing to lend against those particular assets) is how easily such goods can be converted into cash, especially in a time of distress.  This will vary from product to product and market to market but for most borrowers, ABL lenders will insist on extensive reporting and rigorous monitoring to ensure the value of their loan never exceeds the realisable value of those goods.  Although there may be a clear commercial advantage in obtaining an ABL, this additional diligence may create a practical hurdle for smaller businesses which don’t have available resources to dedicate to the ongoing management of the loan.

In Summary

The UK loan market has transformed since the 2007 financial crisis with the number of funding options available to borrowers expanding.  As part of this transformation, the asset based lending market has also undergone a renaissance with the industry shedding perceptions of being “loans of last resort” and becoming a mainstream financing solution.  For many companies facing the challenges posed by Brexit-related stockpiling activity, ABL can offer an simply (and often cheaper) substitute to more traditional working capital facilities.

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