An alternative and even more

Marina Chernysheva

Potential of the so called commercial finance market is enormous. Factoring happens to be a part of the gigantic segment

Assets of the largest Russian bank - Sberbank of Russia - by the end of 2007 reached 200 bln dollars. Assets of American GE Commercial Finance neared 300 bln dollars. The company profile - Commercial financing (CF) or Asset based lending (ABL) - is to finance business, secured by borrower's assets: receivables, equipment, goods at stores, raw material, real estate, non-material assets (see diagram 1). The assets are mostly used as backing when the bank credits corporate clients. CF differs from traditional bank financing by attitude towards backing. When a bank demands a pledge, implication is that the borrower would be motivated to pay due to unwillingness to lose the pledge. The bank undoubtedly has to appraise the borrower's financial status, since necessity to sell the pledge is also a risk. A CF-company actually buys the pledged asset out, counting only on one's own asset management skill. This approach allows to make decisions without taking the borrower's financial assessments of risks for a basis and, correspondingly, to offer him the more profitable conditions. If the borrower fulfills its obligations to the financial company, he continues to freely use and manage the asset. The main purpose of such a financial company is to profit from efficient asset management, whether it is asset-supported loan interests, commissions for client-requested asset-management or profits from its sale.

Scheme 1. Bank crediting and commercial finance use the same assets for backing, but performing different functions

Source: Expert RA

Badly conceived old ways

Certain services traditionally rendered by Commercial financе - factoring, loans backed by material goods, equipment-backed financing (leasing and payment by installments), financing to purchase commercial property - have long been existent in Russia. But the services are provided by leasing and factoring companies, mostly attached to banks, and by banks themselves. That is why Russian enterprises take such services as a part of the banking business. "After a while clients would undoubtedly validate advantages of dealing with commercial finance companies, - says Ilya Volkov, Eurocommerz managing director. - When it will happen depends on the market dynamics. One can say with high degree of probability that non-banking financing would not look exotic in three-five years".

Liudmila Klimanova from MFK Trust explains the difference between current Russian ways and Truth ABL: "In case of Truth ABL financing all assets of a potential client are assessed - from receivables to main assets. Each asset gets its own financing ratio, for instance, 0.9 for receivables, 0.5 for main assets, and 0.7 for material stock. The client may get financing for all of its assets altogether, without referring to different financial institutions: banks, separate leasing and factoring companies. It can deal only with one CF-organization. Promotion slogan to advertise ABL financial product all over the world goes as follows: "More money!"

There are certain types of CF-services, not popular in Russia, like the so called Vendor financing - financing up to 100% funds required by the CF-company client to purchase equipment or any other assets from a specific vendor.

But the main asset, dealt with by CF-companies, is receivables, and the key business is factoring, well-known in Russia. True, so far the Russian factoring looks very modest comparing with large Western markets: its volume in 2006 amounted to 11 bln dollars, or 8.7 bln euro (see table 1). For comparison: the US factoring market in 2006 exceeded 127 bln dollars2 - and it is only a quarter of the whole Commercial finance American market. It would be wrong to say that the existing ABL US market is not big because the banking system is underdeveloped. In 2006 there were 33.2 banking outlets per 100 thousand citizens, and in Russia the indicator equals less than 14.

Factoring in America accelerates slower than the CF market altogether: in 2006 the increment was 12.7 и 16.5% accordingly. "The ABL market in the USA has been progressing for the last 20 years, comparing with four or five in Europe. The European factoring market owes its development mostly to ABL-financing. Still, in some European countries, like Spain and Portugal, "un-friendly" legislation makes the service prohibitive", - says Liudmila Klimanova. One can safely say - considering positive trends in the Russian economy, political stability, relatively weak institutional saturation with bank services and speedy development of the Russian factoring market (annual increase by 80-100% for the last three years) - the potential for Сommercial finance in our country is enormous.

Importing algorithms

The factoring market has been developing everywhere in the world along the similar lines. At the first stage, finding the service to be on demand, a number of players appear on the market, mostly universal banks, providing financing against invoice discounting, see diagram 2. As to risk management, technologies and approaches are comparable to those crediting-related.

Financial stream in exchange for transferred money claims gradually gets involved in additional services like managing and taking receivables, insuring risks, - which results in Full factoring. In Russia the border between the two stages is a bit washed out: many banks announce Full factoring, but in practice offer Invoice discounting. At the second stage the amount of services grows larger, but all of them are rendered against one and the same asset - money claims.

Today majority of the Russian factoring market players moved to the second stage, offering some other factoring services - next to financing. Some bank-factors singled out factoring into a separate company or plan to do it in a near future. This helps to avoid competing with other bank products and use the same approach to credit risk analysis in the bank, and the same approach to risk assessment in case of assets-based financing - in the company.

If a financial structure plans to offer factoring together with financing and services against other assets but receivables, at the third stage you need a specialized distribution net. The point is that assets used by Asset based lenders, cross with those pledged in case of bank crediting (real estate, equipment, goods in production).

As a result we get two types of financial institutions, universal in relation to type of assets used for financing, but similar in risk-management approaches, namely, banks and CF-companies.

The above modes of financing clients differ in complexity, but it would be wrong to say that one is better or more perfect than the other: the modes are simply called to resolve different tasks. A borrower chooses between bank services and CF services, rendered against the same assets, on the basis of the client's financial status, quality of his assets, and, most important, volumes of required financing and business strategies. Sometimes the best choice for an average active company to get required financing is to approach a CF-company. "It is worth remembering: monitoring of company's assets is a very costly procedure, since next to initial asset assessment you have to trace the client's assets on monthly basis. Therefore the service may hardly be offered to small clients. CF-companies would find it unprofitable", - says Liudmila Klimanova. A big conservative client may prefer to take credit in a bank. But one and the same company may diversify sources of its funding and use both banking and CF financing instruments, using CF mostly to finance working capital. In this respect banks and CF-companies do not compete with each other, but rather complement each other at the financial market. Besides, regardless of the source of financing (a bank or a CF-company), all financial operations pass through bank accounts and do not "run away" from the banking system.

Scheme 2. Modes of financing corporate clients: from simple to more complicated

Source: Expert RA

Passing by off-road

In 2007 Eurocommerz - the Russian factoring leader - announced its intention to develop the Commercial finance market and offer its clients to be financed not only through transfer of receivables, but against other existing assets, including trade stock and equipment. "We are assured in progressive development of non-banking financing, which will be joined by other factoring market players, - says Ilya Volkov. - It is hard to predict the number of the market players, but active presence of companies at the market segment will not happen overnight".

Current factoring market players would not want or be able to present the whole complex of services based on ABL, and limit themselves to factoring or invoice discounting. CF business development would demand significant investments into special technologies, risk management systems and development of distribution channels, which would not always agree with plans of shareholders in a universal factoring-engaged bank, and may be out of reach financially.

The ABL-focused market players would invest into dynamic growth and in purchasing other factors' portfolios, increasing their share in the market. Those promoting themselves as full factoring companies would grow smaller. Further technological development would bring to surface companies, providing Commercial finance services against transferring receivables and other types of assets.

Foreign Commercial finance markets are interested in Russia, but they would hardly appear at the domestic market any time soon. The Western interest to Russia has two important limitations. First, foreign ambitions are visibly limited by poor efficiency of our court system and inability to conduct business in line with traditional Western standards. Second, the Russian financial market is quite young - institutions to secure credit risk assessment infrastructures (credit bureaus) are only emerging. Russian factors have good legal experience and their own debtors' database and have more chances to succeed at the local Commercial finance market, than large and seasoned Western players. "Despite great interest of Russian leading factoring companies in the product, they will have to encounter tax and legal challenges, like complicated long-term and ambiguous legislative procedure of realization of collateral security", - forewarns Liudmila Klimanova. But the game must be worth the candles: Commercial finance is a financial market segment, with Russian domination over Western players. Besides, CF-companies operate in B2B sector and do not credit individuals. It enables the companies to be protected from negative trends at the outside markets. That is why even in time of the world credit crunch ABL-companies may expect to be financed by large investors wishing to make money at the Russian market.

Irina Velieva and Pavel Samiev contributed to the article

²COMMERCIAL FINANCE ASSOCIATION: Annual Asset-Based Lending and Factoring Surveys, 2006
http://www.cfa.com/Documents/Annual_ABL_Factoring_Survey_2006.pdf