How ABL Borrowers Can Stabilize Cash Flow and Minimize FX Risk

How ABL Borrowers Can Stabilize Cash Flow and Minimize FX Risk

Thomas Anderson, Managing Director at moneycorp, gives us an in-depth look at why Asset-Based Loan borrowers need to consider an FX hedging strategy. 

An FX Hedging Strategy Tailor-Made for ABL Borrowers

Written by Thomas Anderson

Managing Director

If your company’s plans to globalize have been disrupted by the pandemic, then you’re not alone. Covid-19 has had an immense impact on international trade, foreign direct investment, and international travel, forcing companies to rethink their plans to integrate internationally. However, globalization should not be taken off the table. In fact, according to Harvard Business Review, “while international travel remains significantly down and is not expected to rebound until 2023, cross-border trade, capital, and information flows have largely stabilized, recovered, or even grown over the last year. The bottom line for business is that Covid-19 has not knocked globalization down to anywhere close to what would be required for strategists to narrow their focus to their home countries or regions.” 

Business leaders are now looking for unique ways to expand internationally through this “new normal”, and because of this, we are now seeing an increase in cross-border asset-based lending. Asset-based lending, or ABL, was once stigmatized as a “last resort” for companies who had challenges qualifying for a traditional bank loan, undergoing operational or supply chain issues, experiencing declines in sales, or simply have a seasonal business model. However, due to the pandemic’s uncertainty, ABL is more popular than ever due to its accommodative lending structure that provides increased flexibility. 

ABL can help companies improve their liquidity and flexibility within their capital structures which can be attractive for businesses impacted by Covid-19 such as tourism and manufacturing. 

“But if you’re an ABL borrower doing business overseas, you will need to manage risk, including foreign currency risk”.

Why do ABL borrowers need to consider an FX hedging strategy? 

The answer is simple. Market volatility, asset valuations, and cash flow can quickly exhaust the borrowing base and hinder company growth. Because of this, ABL borrowers typically need more financial flexibility than other borrowers. Managing your FX exposure can provide more stability to your company’s assets, protect the value of your borrowing base, and minimize the potential impact on cash flows. It can also provide material benefits for your firm by reducing earnings volatility. This is especially true if your company has thin margins or volatile earnings before interest, taxes, depreciation, and amortization (EBITDA). Hedging, with a combination of forwards and structured options, can stabilize and potentially improve your business’s cash flow. 

Case Study: Orthopedic medical equipment supplier

At the peak of the pandemic, many elective surgeries were being put on hold, forcing medical vendors to have to quickly shift their business plans. A North American-based supplier of orthopedic equipment faced much uncertainty around the future of his line of business. The dislocation within the supply chain, caused not only by Covid-19 but the winter storms in Texas and the Suez Canal blockage, prevented critical equipment from reaching them. This caused their clients to try and stockpile inventory, which created a significant cash flow issue. Furthermore, once orthopedic elective surgeries resume, the need for equipment was forecasted to surge. 

The medical supplier now faced numerous issues including liquidity, risk of a stronger currency where they imported, uncertain timing of when the currency would be needed, cash flow shortage as the company stocked up on inventory in anticipation of need, restrictive bank and FX lines of credit, and the added complication of when elective surgeries would reopen. 

Developing a flexible hedging strategy coupled with dynamic FX credit lines is a critical component to managing both your cash flow and currency risk. In this example, the medical supplier can create enough flexibility to manage tight cash flow and minimize the risk of a stronger currency. One conservative, yet time-tested approach, to solving this problem is utilizing a combination of structured FX options, coupled with the ability to take delivery of the currency over a 90-day window. In this case, the supplier can eliminate the risk of adverse currency movements, participate in a degree of any favorable currency move, and take delivery of the funds anytime over a pre-determined period, usually 90 days. 

The Benefits:  

  1. Quarterly expiries allow flexibility to take delivery of currency at any time during the quarter, but at a pre-agreed strike or hedge rate. This accommodates timing issues and recognizes the disruption in the global supply chain.  
  2. Complete protection against adverse currency moves. 
  3. Participation in favorable currency moves and unlimited upside on a percentage of the notional amount hedged. In most cases, companies can hedge 100% of their exposure against adverse currency moves, and still participate to a degree in favorable currency moves.
  4. No upfront cost or Zero Premium. 
  5. Reduces potential for margin call on the full notional amount of the contract. By definition, many structured solutions can reduce both the initial FX credit exposure and the potential for future margin calls.

The Risks:

  1. In the event the currency moves in your favor, it would always have been better, with the benefit of hindsight, not to have hedged your exposure. 
  2. If the client wishes to terminate the contract, they will be obligated to settle the percentage of the notional amount of the contract they elected to participate in. For example, if they elected to participate in 50% of favorable currency moves, termination cost would be calculated on 50% of the notional amount of the contract. 
  3. This strategy can be subject to margin calls on the amount they elected to participate in, depending on the valuation of the product.

Utilizing structured options, forwards, and spot contracts will not impact the borrowing base formula for working capital, all while hedging against adverse currency movements, minimizing the potential for a future margin call, and allowing for some gains in the event of favorable currency movements. The benefit of hedging and its costs will be unique to your company as it is based on credit terms, collateral, currency, tenor, and hedge type.

How can a global hedging and payment specialist support ABL borrowers?  

Moneycorp can support foreign exchange payments and hedging in two ways: Unsecured FX lines of credit and collateralized FX lines of credit. Unsecured FX lines of credit, also known as zero deposit FX credit lines, are by far the most commonly chosen option. Upon review of financials, a hedging and payments partner can typically offer zero deposit facilities to support ongoing or additional capacity for a client’s FX hedging needs. Collateralized FX lines of credit work well for clients who do not wish to share their financials or are simply more comfortable utilizing cash deposits to mitigate FX risk. Moneycorp offers a real-time, dynamic solution that does not arbitrarily assign risk factors based on a currency's potential future movements or exposure (PFE). Using real-time market rates to determine commensurate collateral to and from clients can reduce collateral (cash) calls up to 30-50% depending on the currency and tenor of the transaction.

With monyecorp, you can rest assured our team of FX specialists can create a tailor-made FX hedging strategy with your business growth plans in mind. If you’re interested in learning more about how we can stabilize and potentially improve your business’s cash flow, please get in touch. 

 

About Thomas Anderson, Managing Director

Thomas Anderson is the Managing Director at moneycorp where he also runs the structured solutions and dealing teams. Prior to joining moneycorp in 2009, Thomas was a Managing Director in the FX Advisory Group at Bank of America for 12 years. At Bank of America, he held various senior FX advisory roles including FX Manager for the Asset Based Lending & Real Estate Divisions, team leader for the middle market & small business FX groups. 

Before joining Bank of America in 1997, Thomas was a VP in the FX Group at First Union (Wells Fargo now). Thomas holds a BA from the University of Massachusetts Amherst and an MBA from Queens University in Charlotte, North Carolina.

Connect with Thomas on Linkedin!

 

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