Author: Neil Aiken, global head of asset solutions and structured finance at Commerzbank
There are a broad range of trade receivables financing tools available to clients, including factoring, invoice discounting and asset-backed commercial paper (ABCP) conduit financing, among others. Such forms of finance typically relate to shorter-term receivables, payable in 30 to 365 days and often across a broad pool of underlying customers.
However, many customers will generate large receivables that are payable over a number of years as part of the sale of products and services to their customers.
Alternatively, there are businesses that enter into multi-year service contracts with their customers that may require significant up-front investment on the part of the company, for which they will receive compensation over the term of the contract. Such larger receivables payable over a number of years are often less well suited to traditional forms of receivables financing such as factoring or ABCP conduit funding.
Structured receivables financing provides companies with a tool to monetise larger ticket receivables or payment streams relating to a single or small number of obligors.
A bank acquires the specific receivable from the company on a non-recourse basis, and assumes the credit exposure to the customer. The primary concern of the financing bank in such transactions is the credit worthiness of the underlying debtor, but detailed analysis of the contractual documentation between the seller and its customer, and the agreed payment mechanics, is often also required.
The bank often needs to work closely with its client to develop a structure that is tailored to the specific underlying contract or payment arrangements in place between the company and its customer. For example, it may need to identify and segregate certain payment streams within a broader overall contract that are eligible for financing. The larger size and longer-term nature of these receivables justify the additional time and effort required of both the bank and the client in structuring a funding solution.
This is a powerful financing tool that can be highly beneficial for clients. Up-front monetization of all or part of the receivable provides the company with a significant liquidity benefit and improved returns on capital.
Given the detailed analysis undertaken by the bank on the underlying debtor, the client often obtains financing for 100% of the receivable amount, in contrast with purchase discounts applied in other forms of receivable financing. If the creditworthiness of the debtor is superior to that of the seller, the financing may be cheaper for the company than if it was to seek funding based on its own credit profile.
In many cases, structured receivables financing stays off a company’s balance sheet due to the non-recourse nature of the funding. It also provides companies with a very effective tool for managing their exposure to key clients and potentially releasing capacity to do further business with these customers.
Structured receivables finance can also be a means for certain companies to increase their credit capacity with financing banks. There is a limit to the exposure any bank can take on a single client. Unfortunately, all too often that limit may be less than a client would like to borrow. Structured receivables finance can enable a bank to significantly increase its funding support for a client, as the primary credit exposure in such transactions is on the client’s customers rather than the client itself.
The asset solutions and structured finance team of Commerzbank was recently approached by a global IT services company seeking to monetise certain receivables relating to an IT outsourcing contract with one of its key international customers.
The IT services company was required to make a significant up-front investment at the outset of the contract, and the client undertook to make periodic fixed and usage-related payments over the contract life to reimburse the company for the outlay and to pay for the outsourcing services over the contract period.
By working closely with the company, we were able to isolate and purchase the rights to the fixed element of the receivables due from the client on a true sale basis. Significant structuring work was undertaken to limit our reliance on the performance and other operational undertakings of the IT services company, as well as obtaining sufficient comfort on the overall contractual arrangements and the customer’s obligations thereunder.
Collection risk was also mitigated via payment of the receivables into a blocked third-party bank account pledged to Commerzbank. The resulting release of capital enabled the IT services company to earn greatly improved returns on the contract, with the liquidity benefit from upfront payment available to generate incremental business with other clients.
Structured receivables finance will not be appropriate for all types of companies, or for all situations. The underlying receivables should be ongoing, rather than one-off payments. Critically, the payment stream must be an absolute obligation of the customer on a hell-or-high-water basis.
The transactions must also meet minimum size and/or duration thresholds to ensure the benefits for the client and the bank are sufficient to justify the additional work typically required.
Commerzbank’s minimum term for structured receivables finance is one year – although, in most cases, deals typically have a term of between three and seven years – and the minimum receivables amount is in the range of €8 million to €10 million.
The product is therefore best suited to larger companies – typically multinationals – that are in turn providing goods and services on deferred terms to similar sized customers. The individual deals will mostly relate to receivables from a single or small number of underlying obligors.
However, for companies with the required receivables profile, the negotiation of master sale and purchase agreements mean such funding can be efficiently scaled across a company’s client base.
Many top-tier banks offer structured receivables finance or similar financing products to the world’s largest multinationals for contracts with a value of €100 million or above. Fewer banks offer this financing to clients for receivable amounts in the range of €10 million to €20 million, as these deal sizes are often not regarded as sufficiently large to justify the structuring work required.
While Commerzbank’s asset solutions and structured finance team is active in larger structured receivables finance transactions with values of €100 million or higher, we also have a strong focus on smaller deals that may be of less interest to other banks.
Our client-led approach means we seek to be a strategic partner to our corporate clients serving all of their key financing needs. In particular, the asset solutions and structured finance group is focused on structuring tailored financing solutions to address its clients' specific funding issues.
Commerzbank offers receivables financing through relationship managers in its network of offices across Europe, the US and Asia. The structured receivables finance business is part of the broader asset-based and receivables financing product offering of the asset solutions and structured finance group, and we view it as an important area of future growth.
Although not suitable for all clients, structured receivables finance is a complementary funding tool to more traditional forms of receivables finance, such as factoring and ABCP conduit funding, and serves as a key source of financing for large clients across a broad range of industries.
By unlocking the significant hidden value on a company’s balance sheet of longer-term receivables relating to good credit-quality customers, structured receivables finance is a powerful financing tool for balance sheet optimisation, liquidity management and improved returns on capital.
This communication is issued by Commerzbank AG and approved in the UK by Commerzbank AG London Branch, authorised by the German Federal Financial Supervisory Authority and the European Central Bank. Commerzbank AG London Branch is authorised and subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority.
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