Repurchase Agreements – alternative short term funding

| 16-04-2018 | treasuryXL |

 

There are times when a corporate needs to borrow funds – this can be accomplished in a manner of ways. If the corporate actually held securities (Government paper, bonds etc.), it could consider entering into a repurchase agreement – better known as a Repo. This transaction entails a trade where the corporate sells securities at an agreed price and date to a counterparty and purchases them back at a future date for an agreed price. In return, the corporate receives cash – in essence, a Repo is a collateralised loan. Let us look at the working and reasons behind this money market product.

As a funding instrument, repos have been around for 100 years – originally used by the Federal Reserve to facilitate open market operations. As a repo is a collateralised loan, the interest rate is, normally, lower than for unsecured lending. The major factor is the type of collateral that is offered. This can normally be Government paper, but can also include other forms of bonds and securitised paper. The interest amount is not paid separately, but included in the final price upon redemption. The classic term for a repo is a “sell and buyback” – the paper is sold in exchange for a principal amount and bought back on the agreed future date. The counterparty that buys the paper is entering into a reverse repo.

By offering the paper as collateral, the lender is entering into a secured transaction – if the borrower defaults, the lender still holds the paper. The preference in the market is for high quality liquid securities, though markets can be found for more opaque paper. After the financial crisis, the demand for repo trading rose sharply as the interbank market was reluctant to extend unsecured funding to counterparties.

The paper falls into 2 distinct categories – specials and general collateral. A special refers to a specific security (recognised by its unique ISIN number) that is in demand. These are bonds that are normally being very heavily traded in the market and market makers need to cover their short positions by borrowing the paper. As such the rates on specials can be appreciably lower than on normal repos – and far below the rates on the interbank money market. In particular times of shortage, rates can even be negative.

General collateral is any paper that is accepted as collateral at that moment – it could be any German Government paper as this is deemed by market participants as being of equal value and standing. Most collateral is subject to a haircut – due to the additional work involved and the potential credit risk. This means that a bond with a face value of EUR 1 million can only be used as collateral to borrow EUR 950,000. Whilst these loans are collateralised, and often cover Government paper, the is always a specific credit risk.

For the buyer of a repo, they are lending funds and receiving collateral. One of the main players on the buy side are Money Market Funds. For the seller there is an opportunity to receive short date finance whilst pledging assets that they are holding in their portfolio.

Repos normally have a short tenor – from overnight to 3 months. They facilitate the short dated market and provide funding at attractive rates, and assist bond traders in covering their positions.

If you have any questions, please feel free to contact us.

 

 

Peer to peer lending – just a fad or a change in the market?

| 27-03-2018 | treasuryXL |

 

Almost 2 years ago we reported that KNAB Bank had started a crowdfunding initiative to allow, mainly companies, to access an alternative area to fund their businesses, whilst at the same time allowing investors to directly participate in these loans and lend directly – via KNAB – to the borrowers. An extra incentive was that KNAB would directly participate in all loans – their role was not only as an intermediary and facilitator. Now is a good time to look back on their progress and refresh ourselves with the concept of peer to peer lending (P2P).

What is it?

It is an online service that matches the needs of the borrowers with that of the lenders. As the service is only related to lending and does not encompass traditional banking roles, the service providers are able to provide these services cheaper and more quickly than a traditional bank loan. The P2P service provider takes a fee – a margin on the interest rate and/or an annual service charge. In recompense, they enable the matching service to take place, administer the loan and ensure that the investors receive their money back – in the form of capital repayments and interest.

What are the features of the system?

  • It is an online facility
  • Intermediation is provided by the site owner
  • Borrowers can post their proposals online
  • Lenders can choose which borrowers and loans meet their criteria
  • Repayment schedule is included
  • Loans can be secured on unsecured
  • Credit ratings are applied to the borrower
  • Loans can be tracked and monitored for compliance

What role does the intermediary play?

  • Process the loan applications
  • Authenticate the validity of the borrower
  • Perform relevant credit checks
  • Process the cash flows
  • Service the loans
  • Ensuring correct compliance and reporting are carried out

What are the advantages?

As the service is an online matching service, it is fast, simple and cost efficient, This leads to lower interest costs for the borrower and allows investors to directly access the loan market and earn a higher return on their money than traditionally obtained at the bank. Also, the administrative processing time can be a lot quicker than by a bank. The system also can appeal to the ethics of a lender – they have the opportunity to directly help a company that is looking to expand or who require finance for major investment. Furthermore, an investor knows exactly who is borrowing their money – depositing money at a bank does not detail how that money is used by the bank. There has been a political and ethical backlash to banks over the last decade in response to the perceived domination they have within the market. As a lender, it is possible to get yields of between 5% and 9% on your investment. This will be lowered by the costs that the intermediary levy – KNAB take a service charge of 0.85% per annum on the outstanding balance.

What are the disadvantages?

As a lender your money is not guaranteed. You bear all the risks and, in the worst case, could lose your investment. Despite all the due diligence that has taken place before the loan request was placed on the platform, it is still necessary to perform your own checks on the potential borrower – your criteria may be different to that used by the platform. You cannot demand early repayment from the borrower – money that you invest must be money that you can miss for the duration of the loan.

 

How is KNAB doing with their P2P?

  • They have arranged funding for 57 loans totalling EUR 9,125,000
  • The average loan is for EUR 160,087, takes 49 hours to complete and charges an interest rate of 7.83% pa
  • There are 4,533 investors with an average exposure for EUR 905 and a yield of 6.98% pa.
  • All loans are based on linear redemption, have a tenor of between 6 months and 10 years.
  • To date there have been no defaults on principal repayments and there are not payments in arrears.
  • Participation can be from EUR 100 per loan – this allows for diversification.

Conclusion

For investors looking for an alternative investment with a longer duration, P2P can appear interesting. The risks are greater than depositing money at the bank, but the potential rewards far exceed the returns offered by banks. Additionally, for investors looking to approach the market more ethically, it does give the possibility of directly participating in someone else’s ambitions – knowing that your participation is having an effect on society. There are considerable risks, but these must be weighed up against the potential reward. Any investor needs to work out how much they can afford to lose on their principal investment against the higher return being offered.

Contact us

 

Commercial Paper – alternative short term funding

| 03-01-2018 | treasuryXL |

 

There are many different products that a company can use to meet its funding requirements. These products mainly fall into (but are not exclusive to) 2 major categories – equity or debt. Within both categories that are many different bespoke products that can be used. Debt can be either for long term or short term – both in respect to the tenor and the interest rates. Furthermore, interest rates can be fixed or floating. In this series we shall be looking at popular products that are used to help fund a business.

Definition
Commercial Paper is a money market product issued by large companies to receive funding for short term needs. The tenor (maturity) is normally for a short period up to 270 days. The paper is a promissory note that is unsecured – there is no collateral/security offered against the paper. As such Commercial Paper is normally only ever issued by large well-known companies who have credit ratings.

How it works
When a company needs short term funds it can issue paper (promissory note) against receiving the funds. Issuance can take place either via a recognized dealer who can sell the paper into the money markets, or paper is directly issued to an investor who wishes to buy and hold the paper until maturity. Paper is normally issued at a discount to its face amount and redeemed at par.

The programme
Commercial Paper is subject to a company issuing a programme. This provides details as to the maximum amount that can be borrowed; the lifetime of the programme; registered dealers etc.

Why borrow?
Commercial Paper allows a company to be flexible in its short term funding. Yields are, traditionally, lower than bank borrowings and are not subject to additional bank covenants. A company can benefit quickly from changes in interest rates. It is both a quick and inexpensive way to raise short term working capital.

Why lend?
It allows lenders to get a better yield than available if they placed their funds on deposit with a bank. The paper is negotiable – this means that the paper can be sold on in a secondary market. If a lender suddenly had a funding issue, they could sell the paper to a third party, rather than approaching their bank for funding. As the issuers have credit ratings, it is possible to apply your own criteria with regards to who you will accept as a counterparty.

Lionel Pavey

 

Lionel Pavey

Cash Management and Treasury Specialist

 

 

Alternatives to banks – Is Fintech the answer?

| 14-12-2017 | treasuryXL |

With the steady rise of Fintech within the finance industry some people are already calling for the demise of banks as the historical financial partner of choice for corporates. Certainly, Fintech is showing itself to be very dynamic, offering many new products and solutions, and being a lot swifter than the banks. Banks seem to have grown too big and complacent, are being weighed down by new rules and regulations, are less prominent in the field of funding for corporates, and possibly have lost their focus on what used to be core businesses. But let us examine the relationship between bank and client.

The roles of a bank

Banks are, first and foremost, used so that clients can obtain and use financial services. Opening and maintaining accounts enable money to be received and paid – in this way the day-to-day financial operations of the client can be performed. Furthermore, banks offer additional services that compliment the needs of a client – business credit cards for key staff, sales services such as processing of credit card payments for goods, payroll services, online banking, loans and lines of credit.

What does a client want from a bank?

One of the main priorities is that there is an established history and a good working relationship – that the bank understands the client’s needs. A key indicator of a good relationship would be the ability and the willingness of the bank to provide funding to the client. If the bank wished the client to bank and deposit their money with them, then they should be prepared to extend credit where possible – if it meets the criteria of the bank. Running any business means there will be times when liquidity is scarce and a bank that refuses to extend credit runs the risk of losing the client. Other criteria can include the cost of banking services, support given, quality of delivery, credit rating and the overall efficiency of the services.

Fintech solutions

Fintech can provide genuine alternatives to existing banking services as they can compete with modern products – like giant ocean-going tankers, banks are large and very slow to turn around. Most bank services are still paper intensive and require many authorized signatures. By digitizing services, Fintech can reduce the transaction costs and the time taken to authorize a service. Fintech orientated lending services (like B2B) are entirely online and can be quickly approved. Through lending platforms, the risk can be spread out among many lenders.

Can the banks respond?

Banks have at their disposal very large existing customer bases and a wealth of proprietary data relating to the behaviour and patterns of their clients. This is a large untapped potential that does not need to be found or bought. If banks can utilize this data whilst offering a Fintech type of online service that is quicker and more efficient there is a possibility to fight back. The main option for banks would be to examine the Fintech companies and buy the ones that have the best products to compliment the requirements of the bank’s customers. As Fintech works in a different manner to traditional banking, this would require banks to develop internal incubators to discover new products and services that could be offered to customers. Alternatively, banks could look to design and implement their own solutions, but they appear to be behind the speed and knowledge of Fintech and might never be able to catch up.

One last word of advice

Realistically, Fintech offers attractive alternative solutions to banks. However, the power of the personal relationship should never be underestimated. We build relations slowly and by results – the cheapest offering does not get all the business. Having an account manager at a bank can be highly beneficial for a client – one point of contact, good understanding, a history. When things go wrong, you pick up the phone and call the account manager and he/she sorts out your problems. With Fintech, this could mean phoning numerous different companies to achieve the same result that can be obtained with just one account manager at a bank.

Choice is personal, but preference is normally determined by experience.

What’s FinTech and how does it change the financial world?

| 22-2-2017 | Arnoud Doornbos |

FinTech is a term that is becoming popular in the financial world. Only one third of the financial experts know what this means  and understands  what consequences it has for their business. How this innovation is currently changing the ecosystem of money, is still relatively unknown.

FinTech is a contraction of the words financial and technology. In other words: it covers all innovative financial products and services that simplify and accelerates the way we handle money. For traditional banks FinTech is still an uncomfortable concept. Why? Because a large portion of the revolutionary financial concepts are derived from technology driven start-ups. These start-ups change the traditional ecosystem. This is enormously important in a country like the Netherlands where the majority of firms is financed by banks and personal finances of the people are predominantly held by financial institutions  which find it often difficult to modernize.

The emergence of ICT in the financial sector may also have different consequences. Those FinTech companies that focus on a single product or service can erode the business model of banks. At the same time the same technology also offers opportunities for traditional players to improve their service and reduce costs. Also, traditional players have a competitive advantage over new entrants based on their knowledge of regulations and access to information from relationship banking (also called soft information).

FinTech companies have greatly changed the rules of the sector. Today we can pay via our mobile phone, quickly apply for online credit and invest online with one click. The list of innovative ideas is endless and an enrichment for everyone.

FinTech VC investments

The explosive growth of the financial technology industry continued in 2016.

  • 2016 has seen 839 deals globally attracting $15.2bn of investment
  • Global investment is up 27% to Q3 2016 vs the same period in  2015 and has surpassed the 2015 total of $14.9bn
  • Global deal size is slightly ahead of 2015 Q3 levels, with the average increasing from $14.3m to $18.1m, partially attributable to large Chinese investments such as Alipay

 


Source: Pitchbook Innovate/Finance

Most money was invested in start-ups. Projections show that the amount of investment will continue to rise.

The power of this technology-driven financial services lies in the fact that it is fast, efficient, transparent and mobile. You can use these services as long as you have Internet access. Of course, this strongly contrasts with the discontent which experienced customers from traditional banks.

Looking ahead — the FinTech industry could experience even greater growth moving into the coming year. The future remains positive from an investment perspective. We may expect an uptick after relative slow growth in the second half of 2016 due to political risks such as the Brexit and the US elections which fueled great uncertainty across all emerging sectors. Along with increased attention, the industry could see a large number of fresh launches and FinTech could make its way into an even stronger growth pattern in 2017 as investors have become more certain about industry prospects.

The possibilities for FinTech in Netherlands

In the Netherlands, there is also a strong rise of FinTech companies. Companies like Paypal are rapidly gaining market share. The biggest and best-known Dutch company FinTech Adyen. This company was recently valued at more than € 2.3 billion.

The FinTech Top 100 announced in 2016 that there are eight Dutch FinTech startups are part of the leading European companies in the financial technology. The financial infrastructure and the international focus play an important role. In addition, capital and expertise is also necessary for innovation, two factors Netherlands as a European Member State meets. The Netherlands also rise in 2016 from the 5th to the 4th place in the ranking of most competitive economies in the world.

The infographic shows that, perhaps inspired by Adyen, payment providers constitute a large share of the pie. Also data startups and alternative financing (crowdfunding example) are well represented in the Netherlands.

Dutch FinTech awards 2017

FinTech startups are disrupting the financial sector. Innovative companies are eager to please millions of frustrated banking customers. Investors are fascinated by the phenomenal profits made by banks struggling with outdated technology. Today, more and more money is being invested in FinTech. The Uber of the banking sector has not yet emerged, but this is only a matter of time. On April 21 the Dutch FinTech Awards 2017 will be held in Utrecht at the Rabobank Headquarter. The panel of judges of this years event consists of seasoned investors, academics, marketeers, entrepreneurs with an extensive track record in finance and/ or technology.  (http://www.fintech.nl).  The author of this article is one of the judges

Future

What we see in practice is that components of banking products and services are being redeveloped by the FinTech Industry.
These FinTech solutions are smarter, faster and better.
As a result we now see that different FinTech companies will work together. The individual Fintech products often turn out to be complementary to each other.
FinTech companies now recognize that collaboration with other FinTech companies leads to high growth and a better product range.

The Uber of the banking sector

 

The Uber of the banking sector has not yet emerged, but this is only a matter of time.

 

 

Arnoud Doornbos

Associate Partner