THE TIDE IS HIGH
by Bill Zadrozny, President and CEO, Siemens Financial Services In

In times of increased liquidity, low interest rates and economic and political uncertainty, Bill Zadrozny, president and CEO, Siemens Financial Services Inc, advises business leaders to take stock rather than go for headline moves.

In The Rime of the Ancient Mariner, Coleridge intoned ‘Water, water, every where, nor any drop to drink.’ Had he been writing about today’s financial and capital markets, he would probably be writing, ‘Money, money, everywhere, alas, how to deploy it.’ That would aptly summarize the quandary faced by senior executives in most of Europe, the US and many other parts of the industrialized world today.

This article will focus on the US, where the liquidity situation is especially attenuated and some of the attendant issues affecting its disposition and effect of the economy. Banks, financial intermediaries, manufactures and many other major corporations are experiencing record cash flows driven by high productivity, restructuring and retrenchment at the beginning of the millennium, and the Darwinian shake out of weak companies that occurred after the bursting of the ‘internet bubble’ of the 1990s. In the US alone, non-bank corporations are holding $1.3 trillion, roughly 10 per cent of GDP.

Corporations are now barraged with alternatives such as increasing capital expenditures, increasing dividends, stock repurchases, acquisitions, debt retirement or seeking alternative investments. Banks and other financial intermediaries are more limited in their alternatives. Money is their raw materials which they convert into profits. They must deploy it in their mainstream businesses if they are to execute an acceptable long-term strategy.

Liquidity means low confidence
Why are all these companies sitting on so much cash, especially in the US where the GDP is growing at a robust 3.5 to 4 per cent rate? The reasons are both complex and simple. Complex in that senior executives, while acknowledging that business is good (not great), are deeply concerned about the price of oil and its impact upon consumer, the potential for a stultifying terrorist attack, the current account deficit, the decline of the dollar which may cause inflation and in turn drive interest rates higher at a faster pace, and the yawning budget deficit and attendant issues that must be addressed by the Bush administration, such as social security and Medicare. Simple in that it all boils down to their confidence that end user demand for products will continue at the current pace or better still, increase.

The simple reason for retaining this liquidity should be the focus of all, including policy makers. Why? Because any policy decision on the deficit, interest rates, currency, taxes, and solutions to pending issues that has a positive or negative effect on the consumer will affect whether corporations invest this hoard of money in expansion of their enterprises. This will drive an increasing level of capital equipment expenditures, which will create more jobs, and in turn more consumer demand. Alternatively, companies could use the money for non-job creating activities such as stock repurchases, acquisitions or more debt retirement.

Frequently asked questions are: What is the effect of the interest rate increase on companies? Has the bonus depreciation spurred an appreciable increase in companies been extended or enhanced? While there are normal issues that would have an impact on corporate behavior, these are not normal times as evidenced by the massive corporate liquidity hoard. Due to this liquidity and the dramatic improvement in corporations’ asset management over the past four years, the demand for corporate borrowing, while growing, has not kept pace with the expanded liquidity of lending institutions.

There is so much money to loan that lending institutions are unable to raise pricing on new loans even while their cost of funds is increasing. On the contrary, they are being forced to lower rates on existing loans or risk losing the business altogether. As for the bonus depreciation spurring capital expenditures, it is debatable whether it has had more than a marginal impact on those decisions. The same goes for the other tax benefits. Consumer demand has to be there or spending money on capital equipment does not make much sense, tax benefits or no tax benefits. Which leads to where the rise in interest rates and expiration of tax benefits are sure to have an effect at some point, on the consumer.

Looking at property markets
The most glaring problem could be the property market. Fuelled by record low interest rates, liquidity and financing options, property has appreciated at arguably unsustainable rates over the past four years and that appreciation has been monetized by consumers through home equity loans and refinancings. These have enable the consumer to keep increasing consumption, while other investments have performed sub par and jobs and wage growth have stagnated. With interest rates starting to rise and tax cuts expiring, consumer demand could be in jeopardy if job and wage growth do not pick up the slack.

Furthermore, any need by the Federal Reserves to increase the pace of interest rate increases, for example, rapid decline of the dollar or wider expansion of the current account deficit, could greatly exacerbate the impact of property and the consumer. Once a correction starts, it would be difficult to counteract in a short period of time. Property depends on momentum, if people believe prices are rising, they will rush to buy. If they believe they are declining, they will sit out, if possible, until there is a turn in the offering.

What action to take?
So with all these concerns yet all this liquidity, what is a business leader to do? First of all, as Shakespeare advised, she or he must remember, ‘The path is smooth that leadeth on to danger’. In this case, the challenges may be the positive resolution of all the issues clouding the horizons which could cause a significant call on all company’s resources so as to meet a rising tide of demand, thereby draining their liquidity at a time when the availability of capital is becoming less plentiful and the cost is much higher today. In other words, they should consider availing themselves of the favorable terms and conditions that abound in the current lending and leasing markets. Instead of paying cash for everything now, especially for longer-lived assets, consider matching the cash flows from their capital equipment investments with the very attractive lease or loan arrangements currently available. Business leaders must take advantage of the financial institutions’ need to deploy their liquidity.

Second, develop sound alternatives for deployment of excess liquidity without urgency to ‘make something happen’. Remember, there are many uncertainties regarding taxes, inflation, the current account deficit, terrorism, employment, and so on. Business leaders must be ready to react to all of these, and continued liquidity combined with a sound game plan will be the key to success.

Third, resist headline moves unless they are dead, solid or great moves. What are headline moves? Consider what gets more publicity – a dividend increase or an acquisition? A stock buy-back or reinvestment in research?

Finally, be aware that this too shall pass. In a dynamic economy with so many uncertainties this tide of liquidity is bound to recede. When it does, some companies, those that did not use the time to shore up their businesses and use this time to bake in more flexibility to their capital structure, will be pulled out into the deep water where, as everyone knows, dangerous creatures lurk. It sounds easy and obvious, but why do many companies forget?

Bankruptcy Code Changes Will Impact Bankrupt Retailers’ Leases, Pose Other New Challenges
By Lee A. Diercks

Recent changes in the U.S. Bankruptcy Code will almost certainly affect real estate decisions of retailers operating under bankruptcy protection, as well as present those merchants with a variety of other new challenges. These modifications stem from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, which was signed into law by President Bush this past April and takes effect in October 2005.

Perhaps most significantly, bankrupt retailers considering whether to assume, assign or reject leases will have a maximum of 210 days in which to formulate and announce their decisions. This will afford landlords more control over, and leverage in, bankruptcy-related leasing matters than they currently possess. Debtors presently have 60 days to assume or reject a lease, but can continue to ask for extensions with no “drop-dead” date. Courts have routinely given debtors as much time as necessary to assume, assign or reject leases, and many retailers capitalized on this by keeping certain locations in operation through the holiday season as a means to raise more cash and further evaluate which of those borderline units are worth keeping.  Such leeway will no longer be afforded under the new Act, affording landlords with strong properties the means to quickly re-lease spaces to more desirable tenants.  However, in situations where there is mutual agreement between the tenant and landlord, the new law does allow for an extension of the lease beyond the 210 days—a caveat which can be helpful to landlords with marginal properties. 

The Act also limits the exclusivity period during which merchants can file a Plan of Reorganization to 18 months from the date of the bankruptcy case filing. The current law gives debtors exclusivity to file a plan in the first 120 days of the case, but they can continue to ask for extensions of the exclusivity period. While courts have historically granted such extensions with no cutoff date, they will no longer be doing so. As a result, the new legislation may limit the number of lenders providing debtor-in-possession (DIP) lines of credit.  Further, some lenders may also impose term limits of less than 18 months on any DIP financing.

Additionally, the legislation re-defines the “normal course” of bankruptcy proceedings, facilitating “defense of preference” actions. This will potentially reduce recoveries of the debtors’ estates and may cause DIP lenders to worry about the ability to use preference monies as adequate assurance.

The bill also grants utility service vendors the right to require debtors to provide adequate assurance. If such assurance is not provided, service to debtors’ facilities may be lawfully terminated within 30 days of case filing. Currently, debtors have rarely had to give utilities additional deposits. But going forward, bankrupt retailers will now be required to remit cash deposits to utility service vendors up front, or to post letters of credit with these entities to ensure continued service.

Finally, a new class of administrative creditors is being added under terms of the bill, with creditors now receiving administrative claims for the value of goods delivered to retail debtors within 20 days prior to bankruptcy case filing. This is more than likely to result in a limit in the critical vendor payments bankrupt merchants can make. As well, it has strong potential to create reductions in the amount of cash debtors have available for estates in the post-petition stage.

Clearly, the new legislation will significantly impact various facets of bankruptcy proceedings for retailers. Nonetheless, we believe those retailers that anticipate and make allowances for the changes wrought by the bill—as well as work cooperatively with any turnaround partners they may have engaged in helping them to grapple with these new twists—should not encounter irreparable difficulties in the future.

Lee A. Diercks is a partner and managing director of Clear Thinking Group LLC, a retail/consumer products manufacturing consultancy headquartered in Hillsborough, N.J.  A retail operations veteran, his 26-year management career included positions with companies such as JCPenney, Coast to Coast Hardware/Total Sports, Herman’s Sporting Goods, Woolworth, Champs Sports, and Jumbo Sports. He leads the Clear Thinking Group Crisis Management/Turnaround Management group.

PURCHASE ORDER FINANCING THE COMPLEMENTARY FINANCING SOURCE
By: Sheldon G. Karras

In the life of every business, there is a time when more financing is needed than can be obtained through traditional sources.  Historically, these sources have been unsecured, and secured financing as well as some form of equity contribution.  Today, there is an additional resource, transaction finance, often referred to as purchase order financing, commonly used to obtain up to 100% of inventory financing.  This type of lending is perhaps one of the least understood, and yet, one of the more creative means of acquiring additional funding in today’s financial marketplace. 

While every circumstance is unique, the usual scenario involves a situation where more money is needed than a senior lender will provide.  Typically, the funds are needed by the borrower to buy inventory to satisfy customer purchase orders.  In this instance, transaction capital is made available to purchase the necessary inventory.  Specifically, the transaction lender enters the relationship providing up to 100% of the inventory financing and exits, as the inventory is shipped, or upon collection of the accounts receivable.  If there is a receivable lender, accounts receivable financing is used to repay the transaction financer’s investment.  If there is no receivable lender, repayment comes from the proceeds of collection of the accounts receivable.  In either case, the balance of the proceeds can be used to satisfy additional working capital requirements of the borrower.  Transaction financing allows a company to make sales and achieve a level of earnings that would otherwise not be possible.

Who Is A Candidate For Transaction Financing?

This unique financing is most suitable for the thousands of fast growing importers, wholesalers, assemblers, and manufacturers engaged in the outsourcing of product lines both domestically and overseas, a growing trend.  Users of this type of financing are diverse, and are found in a variety of industries, from consumer goods to high-end technology.  The Internet, advances in technology, instantaneous communication, ease of travel, and trade agreements have produced a world economy, which requires the services of transaction financing sources.

Candidates for transaction capital often fall into two categories.  The first is the too successful company, undercapitalized and overtrading on its equity.  The second is the company whose performance has been adversely affected by seemingly sound operating decisions, which did not properly anticipate changes in market conditions and has suffered losses.  In either case, there are generally two avenues available to accommodate the working capital requirements of these companies and purchase order financing has a place in each.

The equity route may ultimately be the answer for the successful company, but because of shareholder dilution considerations or the prevailing market atmosphere, the timing may not be right.  In this case, alternative lending could be a viable alternative to equity by bridging the gap between primary debt and the public market.  For the start up situation, a smaller company or a business whose performance does not justify entry to the equity markets, the most practical solution is additional debt, provided by the traditional lending facilities of a bank, or asset bank lender.  In the event conventional financing cannot provide all of the required financing, additional funds can be found through the cooperation of a bank and a transaction finance company.

Purchase Order Financing In The Financial Spectrum

Purchase order financing becomes necessary when a bank cannot satisfy a borrower’s total financing requirements.  Typically this occurs when there is a need for more funds than the bank cares to make available because of financial deterioration, or conversely when a company is simply growing too fast.  If a borrower were able to obtain the necessary capital through its bank, transaction capital, or purchase order financing would not be needed.  Because primary lenders generally measure credit worthiness in terms of operating trends, liquidity ratios, and collateral margins, there are limitations on the amount of credit that can be extended. 

Transaction lenders, however, are deal oriented, and focus on other criteria, such as the cooperation of a primary lender, the quality of the purchase orders, as well as company management’s ability to run the business, reflected by its past performance, and future expectations.  It is this difference in emphasis that creates a natural partnership between a bank and a transaction finance company.  Utilizing the services of both permits a borrower to maximize its loan potential.  As a result, banks are increasingly looking to transaction financing experts as a source of supplementary financing for their customers.

The relationship between a bank and a transaction specialist is not the basic participation normally associated with a venture between lenders, which typically involves two or more lenders, each providing a portion of the loan while sharing in the collateral.  The most significant difference is the increased borrowing power that is made available.  Unlike the customary participation, the association between a bank and transaction finance company represent independent efforts of each, working in tandem to maximize the credit facility.  Each lender concentrates on what it does best to serve the ultimate interest of the borrower.

Companies that specialize in providing transaction capital secured by purchase orders are considered interim lenders.  Funds are made available to accommodate short-term needs until more permanent financial solutions can be found.  They are neither competitive with nor an alternative to traditional lending activities.  Instead, they offer a supplement to conventional debt, the availability of which enables the user to significantly increase its borrowing power.  The introduction of a transaction finance company neither infringes upon the borrower’s relationship with its primary lender, nor does it interfere with the lender’s administration of the loan.  Rather, it provides a service that benefits both borrower and lender.  Specifically, this complementary source of capital permits the borrower to obtain additional funds up to 100 percent of the cost of needed inventory to pursue opportunities that would otherwise be lost. The corresponding benefit to the principal lender is a potentially more profitable customer and an improved association while incurring no increased risk.  In fact, a bank can enhance the relationship with its customer by expanding it to include the services of a transaction finance specialist, to capture an opportunity that would otherwise be lost.

Case Study:  Purchase Order Financing For A Growing Business

Unique sales opportunities or seasonal demands often require the assistance of transaction financing.  A case in point involved a manufacturer of consumer goods, with an exceptional opportunity to do business with a major retailer.  The company received an extremely large order, well beyond its expectations, and production capabilities.  To complete the order, the company needed to find an alternative source of product to supplement its production capacity, which would require additional financing.   An offshore manufacturer, able to provide product at the desired price points, was found, but insisted upon letters of credit, which involved more assistance than the bank would provide.  Additional equity was an option but dilution of ownership at this particular time was neither advisable nor desirable.  The market conditions were not right, and the timing of a public offer was premature.  The bank was, however, interested in finding a solution to its customer’s temporary problem and offered to increase the credit line to finance the higher accounts receivable levels sure to result from the increased business.  In addition, the bank introduced its customer to a transaction lender specializing in purchase order financing.  The supplementary financing that was extended enabled the company to acquire the necessary finished inventory off shore, increase sales and profits, as well as establish itself as a reliable vendor to a major customer.  In addition, the bank’s decision to expand the relationship with its customer to include the activities of a transaction finance specialist enhanced its own profitability and allowed it to retain a client it could have lost.

Once the validity of the purchase order was confirmed and the necessary documentation received, the letters of credit were issued, and the inventory purchased.  Specifically, purchase order financing enabled the borrower to finance100% of the cost of the inventory.

Purchase order financing can play an important role in a variety of situations, from start-ups, to turnaround situations, acquisitions, and the financing of seasonal needs.  Whatever the circumstance, candidates for purchase order financing have a common thread, a need to acquire inventory to satisfy outstanding purchase orders from credit worthy customers.  While purchase order financiers provide capital to facilitate specific transactions, most relationships involve more than one business deal to fund additional inventory needs.

Transaction or purchase order financing is not restricted to the situations above.  In fact, this type of financing can be utilized in cooperation with bank debt whenever needs exceed the amount of money that a traditional lender can provide.  Unlike a primary lender, the relationship with a purchase order specialist is a short one, bridging the gap between short-term needs and long-term financial solutions.  The purchase order financing serves a temporary need, such as when long-term funds may be difficult to obtain, or when a bank feels the need to modify its credit commitments.  When this occurs, it is important to consider the benefits of working with this unique and innovative financing source.  The borrower gains access to a greater availability of funds without disrupting its relationship with the primary lender, who not only maintains the association with its customer, but also enhances it by finding a solution to satisfy a customer’s total funding requirements.

Providers of purchase order financing have developed operating techniques, and a high level of expertise to operate effectively in today’s global economy.  The availability of this resource explains why more and more lenders consider purchase order finance as a valuable supplement to meeting the needs of their customers.  It also serves as a means of expanding its own services without additional cost or risk, by utilizing the facilities and capability of transaction finance specialists.  As globalization continues and foreign manufacturers expand their position to meet the outsourcing needs of their U.S. customers, purchase order financing will become a more frequent and acceptable source of supplementary financing.

Fordham provides financing to manufacturers, distributors, assemblers, jobbers, importers, temporary staffers and service companies. Fordham offers various types of financing including purchase order financing, factoring as well as inventory and equipment financing. For purchase order financing, we fund from $50K up to $10 million. Financing for factoring and asset based lending is offered from $100K to over $100 million. Fordham works with all industries throughout the US.

Sheldon G. Karras is President of Fordham Financial Services, Inc., a member of the Franklin Capital Network, which is dedicated to satisfying the working capital requirements of the small to medium sized business. Candidates for Fordham services are those companies who need additional working capital to support growth, or those companies who have experienced temporary operating reversals. For additional information, please visit our website address: www.fordhamfinancialservices.com.