While it may be the case that remortgaging the assetss runs counter to the entrepreneurs quest for ownership, releasing dormant value is the wise and obvious step for ensuring strong cash flow and facilitating growth. Zenifer Khaleel reviews this important fiancnial strategy
To put it in a nutshell, investment in assets offers dead value to the company in the sense that the cash flow is generated only from the usage of the assets. Asset Refinance is the act of remortgaging or re pledging the asset in order to release the equity or the underlying value at the current market rates. This enables the business to inject cash when capital is tied up in assets. It essentially involves refinancing equipment, vehicles, financial investments, real estate, etc. which are either owned by the company outright or are subject to an existing finance arrangement.
Refinancing provides a convenient form of cash supply as they are used to free up the capital a company already owns, which is then repaid over several years. Companies benefit from knowing exactly what payments are to be made, assisting with budgets and forecasts, as well as retaining the use of the asset throughout. The asset can continue generating profits even before the first payment is due. Unlike an overdraft, a refinancing package will run for the whole term agreed and cannot be called in. This enables the company to plan and manage the cash flow with confidence.
Generally, the following categories of assets qualify for refinance:
- Property / Real Estate
- Plant & Machinery, Equipment
- Shares (listed on stock exchange)
In case of the refinance, the asset is pledged to the lender and the facility can be repaid over an agreed time period with regular payments at an agreed interest cost. The asset is valued by an independent valuation professional and the loan granted ranges from 70% to 90% of the asset value. In such cases, the repayment capacity of the borrower is ascertained and the facility will be subject to necessary approvals from the credit department of the lender.
Benefits of asset refinance
- Boost cash flow of the business
- Reduce the cost of existing borrowing
- Reduce existing monthly repayment liability by increasing tenure of the facility
- Raise capital in order to purchase other assets required in business
For the lender, this is a secured term loan. It boosts a business cash flow by releasing cash against the value of a company’s existing assets. You therefore sell an asset to the leasing company for the current value, which then leases it back to you. Additionally, asset refinance also protects the business from asset depreciation.
It can be considered as a quick method of accessing cash in cases of emergency or as a method to fund expansion. Companies which are planning major strategic changes like expansion into overseas markets, product R&D and innovation, up scaling payrolls or structured M & A activity; can resort to the quick money influx method of refinancing . With refinancing, the business can continue to use the asset without any interruption in operation.
Asset refinance payments are treated as business expense rather than a business debt, so the profit/loss equation is not affected. Financial directors often favour asset refinance to avoid hefty depreciation allowances.
Methods prevalent in the UAE
“Asset refinance is a popular method of obtaining Bank finance in the Middle East, specially the UAE. It is being offered by most local banks and is very popular in the real estate market. With increasing market prices and reduced interest rates, this has become a favoured source for obtaining finance by property owners. All major types of asset can be refinanced by the UAE banks.” says Rajiv Shah, Chief Executive officer of Gulf Investment Consultants.
“UAE banks are keen on the cash flows emanating from the asset which are assigned to the banks to ensure repayment of principal and interest. The amount to be lent by the banks depends on the cash flows from the asset and not so much from the market value of the asset.”
“For instance, for a real estate property, the cost of property up to AED 1 million will be ignored by banks. Market value of property up to AED 2 million will not be very relevant, but loan amount will be restricted to 70%-80%. If the property is self-occupied, and used for business, it will be difficult to get a loan against the property. If the property if given on lease, the loan amount will depend on the rent being generated by the owner from the lease. The rent amount should be enough to cover the principal repayment and interest for a year.” he further adds
A few guidelines
The pitfalls of asset refinancing are
- The borrower will pay back more than the original price of the asset.
- Asset refinance contracts tend to be rigid, set over a fixed term.
- Interest rates are generally fixed
- Personal guarantees are often required from the businesses owners or directors to secure the asset refinance.
In order to employ the best refinancing strategies, the following steps are to be considered
Credit control – Companies should ensure that their credit balance is minimal before beginning the refinancing process. In order to create the best impression in the valuation process and get the optimum deal for their assets, all previous backlog should be cleared.
Contact different lenders. The difference between interest rates for the best and worst deals can be as much as a full percentage point, but in the long term, it can prove to be detrimental to the costs. Loan costs also can vary substantially. Getting estimates from multiple lenders can give you ammunition to negotiate a better deal.
Relationships can make the difference. Banks remain cautious about lending, but some show more flexibility to their better customers. Eventually all relationships are built on trust and you can extract the best deals from long standing and stable relationships.
The cash that asset refinance generates can be reinvested into further asset growth. Having the cash to move fast and decisively is often the determining factor between success and failure.
Asset refinance boosts business cash flow by releasing cash against the value of a company’s existing assets. A structured refinance plan can help the company grow, take advantage of a situation or simply help survival without getting banks involved. More importantly it can keep your existing credit lines free and the day-to-day business running smoothly.