Bite the Bullet - Ad-hoc Finance

In a recessionary environment one of the most difficult problems faced by the companies (specially the SME and Mid Corporates) is liquidity crunch. The recessionary environment leads to stretched receivables period, loss of receivables, reduced/costly credit period offered by raw material suppliers, increased financing cost, shortage of Working Capital lines, decline in sales and profits, pressure on profit  margins, good customers bargaining for increased credit period, ……. and hell of lot terrible things for a CFO to manage.

The situation becomes so worst that at one side, the sales fall, the good debtors start defaulting (which the Finance Team could never imagine), the lenders increase the interest rates, the easy clean finance available in the market disappears, and on the other side the dream orders start flowing in but Company finds itself short of cash/financing lines to execute the orders, rating agency downgrades the rating(mostly due to defaults or stretched receivables), and the lenders becomes averse to increase the finance … and so on that finding a route to escape is not easy.  

The increase in debtors period/decline in the quality of the same, results in requirement for infusion of additional capital requirement by promoters or by the lenders. Generally, in case of SME and Mid Corporates, it is observed that promoters find it difficult to bring in additional capital since the deteriorated market conditions does not support them in raising funds through equity (mostly due to lower valuation offered), and the unsecured funds are also not easily available. This situation also leads to instances of devolvement of Letters of Credit (LC) and Bank Guarantees (BG). LCs devolve due to cash shortage, and BGs get invoked due to delay in completing the orders on account of cash shortages.

Mostly, in this situation, Corporate looks at its Working Capital (WC) lenders to rescue. As I have mentioned in my earlier articles (Yes, Abhimanyu can successfully exit from Chakravyuh : in the disguise of Working Capital Lender), Working Capital financing is a Chakravyuh, exit from which is not so easy. The situation is not painless for the WC lender also since the deteriorating receivables, low order book position, low profits, defaults etc. do not support the argument of increasing the exposure on a long term basis until the situation of the Corporate improves. Typically, the solution to such situation is found by way of ad-hoc finance on temporary basis for a short term (generally 3 days to 6 months) period or for completing the specific sales contract in order to support the cash inflows/profitability. Although, the Ad-hoc finance helps the borrower, but difficulty faced by WC lenders (specially in case of restructured accounts/borrowers with track record of regular delays in payment/devolvement of LC/BGs) is in facilitating the same since in the absence of additional collateral, increasing exposure to a stressed account is big challenge. The situation requires generating confidence by past long term experience with the borrower/promoters, but more important role is performed by the clear visibility of the proposed transaction cash inflows (if ad-hoc for execution of specific order) to be channelled through the lender. In these types of difficult situations, the long term relationship between the lender and borrower shows its magic. In case of export based companies, where the international customers of the Corporate also bank with the MNC lender of the Corporate, the WC lender can greatly help in devising the ad-hoc finance transaction. Generally, the ad-hoc fund based WC limit is granted in the form of Short Term Overdraft and Working Capital Demand Loans (WCDL). However, the Sales Bills Discounting (SBD) with good credentials of the buyers is a better option for the lender in facilitating the ad-hoc finance since SBD provides the clear visibility to the transaction, its cash flows and duration.