Moving away from traditional means of financing and working in partnership with lenders will lead to more sustainable avenues of funding. This is the view of Natrajan Ramsubramani, director, head of corporate product management, MENA, Standard Chartered Bank
The financial crisis began as the sub-prime crisis in the United States and has now assumed much larger proportions as the European debt crisis. The shift of economic power from West to the East with China and India emerging as economic and political power spots is now more evident than ever with growth rates in Asia much higher than those of Europe and the US.
Economic history has proved that positional advantages are short lived. Now, more than ever, companies need to look into the future and predict potential scenarios and manage their risks and, today, working capital management is on every company’s agenda.
In such volatile conditions, finding long-term and sustainable means of financing at reasonable rates is vital for companies. Such borrowings need to be structured around their working capital requirements.
A company’s working capital requires various modes of financing, which besides being sustainable and reasonable are also self liquidating in nature. Traditionally, Asian and Middle Eastern corporations have built their capabilities around balance sheet lending. Western companies on the other hand have developed financing programmes around their working capital, which even in times of stress continued to be available.
Stock, debtors and creditors are the three main components of working capital that accord to avenues for financing.
Companies in the region have primarily focused on their purchases and usually seek financing means that cater to them. Accordingly, banks are often approached for letters of credit and/or loans for making import payments. This is a long-standing practise and is showing little signs of change. With the new Basel regulations, these means of financing are expected to become costlier.
Financing for purchases is primarily sought for warehousing stock until a buyer has been identified. The stock has an intrinsic market value, which when offered to lenders can bring about a pricing break. Stocks with market value are taken as collateral by lenders, which reduce the capital requirements, thereby reducing lending costs.
The facilities obtained for financing purchases often extend in to the sales period and beyond. Corporate sales or debtors offer yet another lucrative means of obtaining financing at a rate that is cheaper compared to a loan on the purchase side.
Companies relying on the strength of their balance sheets can have limited access to financing. However, if the company’s book has several reputed buyers, this offers them an enhanced means of financing. Whilst financing the sales of a corporate, banks consider diversified buyer portfolios as lower risk, which encourages financiers to provide lower lending rates.
Changing financing habits
Changing a company’s financing habit results in several benefits, including balance sheet credit quality enhancement. For example, lenders offer services that allow receivables of clients to be purchased by the lender on a without-recourse basis thereby converting debt into cash. This cash improves the liquidity ratios of the company or, if used to repay debt, it reduces the debt to equity ratio. Both factors result in enhancement of the credit grading of the company. This eventually reduces costs of borrowings.
Similarly, financing against stock can also be undertaken. The lender may take ownership of the stock releasing it as and when required. This allows for the company to borrow only as and when needed. Such financing methods are more pertinent and its effects are amplified when companies are required to maintain significant stocks due to cyclic availability or when they would like to maintain stocks to take advantage of low prices.
An extended working capital loan – commonly raised on the purchasing side – is usually obtained to finance the sales side and beyond. Such financing has high risk as some companies use it for purposes other than what it was originally intended for.
For instance, during the pre-crisis period, a few corporates ventured into non-core businesses such as equity trading, property development, commodity speculation based on liquidity extended by lenders. When the crisis broke out, they were left with severely depreciated assets, which caused a strain on their repayments to lenders.
A simple logic is usually applied by most lenders – the longer the loan tenure, the higher the margin and vice versa. Ideally speaking, a company should obtain an import loan for as long as it takes for them to procure, manufacture and process the goods. After a sales transaction is completed, the company should convert the purchase loan to a sales loan, which in turn self liquidates via payments made by the various buyers. This in turn leads to a sustainable, long-term and reasonably priced credit.
Greater levels of transparency need to be accorded to financiers and other stakeholders. Financing obtained based on market reputation is vulnerable to shocks as was evinced in the West during the crisis. Such companies also need to be more receptive to unique and innovative means of financing and according financiers the requisite information. Borrowing costs can be substantially lowered by working in partnership with financiers and being receptive to newer means.
In conclusion, companies have to make the most of the current situation to gear themselves up for the future. The current economic climate will change. Moving away from traditional means of financing and working in partnership with lenders will lead to more sustainable avenues of funding.
Sourcing structured working capital facilities can cause some contortions in the short term; however, those measures are bound to pay dividends in the future.
The future of corporates in the MENA region remains promising, but future competition from the West needs to be recognised and strategically countered.