IFG Asset Based Lending & Supply Chain Finance Conference An Overview of Asset Based Lending

1. mruszczy: NEED LOGOS!! IFG Asset Based Lending & Supply Chain Finance ConferenceAn Overview of Asset Based Lending Richard P. Palmieri 23 October 2013 Istanbul, Turkey

2. What is asset-based-lending? • Asset-Based-Lending (“ABL”) is a form of secured and monitored lending • ABL utilizes assets that can be valued and monitored as collateral (principally receivables and inventory) • ABL uses a formula-based lending approach against eligible trade receivables and inventory with strict monitoring criteria to ensure the loan remains “in formula” • Control over cash collections to pay down outstandings is a key building block of ABL • ABL matches loans to borrower’s cash conversion cycle, allowing borrowers to borrow only what they need and pay interest only on funds borrowed

3. History and development of ABL • ABL started in the USA during the 1920’s • At that time, the USA was experiencing strong economic growth, with a lot of small and medium-size companies needing financing to support their growth • These companies did not have a strong capital base and needed a form of financing to fund their working capital growth • Lenders developed ABL as a way to lend to these companies on a well-secured and monitored basis

4. History and development of ABL • As with any new financing product, ABL had to fit within the existing legal framework • This meant that much of the early lending resembled factoring and receivable discounting instead of the ABL that we know today • Early forms of ABL allowed lenders to provide critical working capital financing to growing SMEs on a monitored and secured basis

5. The evolution of ABL • From its beginnings, ABL adapted to a changing legal and regulatory environment • Changes in laws made it easier to take security in present and future receivables and inventory, thus converting ABL into a secured loan product • New laws and regulations have: • Reduced the number of unregistered priority claimants • Converted retention-of-title claims to security interests requiring public notice • Made possible non-judicial enforcement of liens • Insolvency laws have recognized the priority of secured loans and their collateral rights • Thus ABL, with its secured, monitored and valuation approach to lending has become a primary form of lending to under-capitalized companies

6. The evolution of ABL • With improved laws and regulations and acceptance of ABL, the product offering of ABL has expanded to include: • Receivable and inventory financing • Commodity borrowing base lending • Securitization • Supply chain financing • Purchase order financing • ABL’s growth has resulted in the expansion of service providers needed by ABL lenders in the review, valuation and monitoring of the collateral supporting ABL facilities • These service providers include legal, field examination, inventory valuation, and collateral realization firms and training services available for new lenders entering the field

7. ABL today • ABL is a widely accepted and used form of financing in the U.S. • Many ABL sub-products have migrated to countries in Europe, South America and Asia • ABL use has expanded from only working capital financing to acquisition and restructuring financings • It is estimated that one of every three companies in the U.S. utilize some form of ABL

8. ABL today • Due to secured and monitored aspects of ABL, this form of lending has had lower Loss Given Default (LGD) rates during the recent U.S. recession than other unsecured and secured forms of lending • This lower LGD is allows lenders to risk rate ABL facilities higher than other forms of loans for comparable borrowers and thus allocate lower capital against this form of lending • This lower LGD is a result of the pre-closing collateral analysis and valuation and post-closing collateral monitoring and collateral re-evaluation that are the hallmarks of ABL

9. ABL industry size • Thousands of U.S. commercial banks are engaged in commercial and industrial lending, and the aggregate value of their Commercial & Industrial loans is well in excess of $1 trillion. Many of these loans are asset-based transactions • At least 50 hedge funds and private equity funds with assets under management exceeding $1 billion are active in direct lending, often of an asset-based nature. Also, an estimated 20% of all private equity funds are involved with some form of asset-based lending • Over 1500 credit unions now provide commercial loans, including asset-based loans • Captive finance companies often provide asset-based loans in the form of accounts receivable financing and floor planning to their distributors and dealers • A number of equipment leasing companies also have broadened their involvement in asset-based lending because of intensified competition and shrinking margins in their traditional business

10. ABL industry size – US market • The size of the overall U.S. asset-based lending market in 2012 was estimated to be $620 billion in terms of loans outstanding. This estimate is based on extrapolations of data obtained from CFA members and other sources such as government agencies (e.g., FDIC) and trade publications (e.g., American Banker). The exhibit below shows market growth and how market size has been impacted by economic recessions: Source: Commercial Finance Association

11. ABL and other forms of business finance Cross Border Supply Chain

12. ABL philosophy • The success of ABL lending in the U.S. and in other countries is tied to ABL’s core processes and philosophy: • Detailed pre-closing collateral analysis and valuation • Detailed review of borrower’s ability to report collateral on a timely basis and in a form that the lender can use to easily track and re-value collateral on a regular basis • Frequent reporting and verification of the collateral • Control of cash proceeds to repay outstanding loan balances and thus keep the loan within the collateral limits

13. Key elements of ABL • The “exit strategy” is based on realization of the collateral in the event of default, even in the borrower’s insolvency • Thus, the focus is on making certain that the loan never exceeds the collateral’s realizable value • This requires the lender to: • Value the collateral with precision • Address legal and business issues inherent in the collateral • Monitor the collateral • Exercise control (dominion) over the proceeds of the collateral • Have immediate access to the collateral • Know how to realize on the collateral • The lender must be an “expert” with respect to the collateral

14. The keys to ABL’s success • As with any form of successful lending, limiting losses due to fraud, collateral value deterioration and business failures are key to being a successful lender • Although ABL structures can not prevent exposure to business failures and fraud, ABL’s basic structure and methodology can reduce losses when fraud, insolvency or asset value deterioration occurs • ABL limits losses through the principles of frequent collateral reporting, valuation and verification of collateral eligibility and control of collateral proceeds to pay down the outstanding loan so that the loan balance never exceeds the collateral’s realizable value

15. ABL requires a supportive legal regime • The balance of this presentation will focus on ten key elements of a legal regime that supports ABL • The legal elements are reflected in the UNCITRAL Legislative Guide on Secured Transactions • Party Autonomy • Creating a security interest in receivables and inventory • Third party effectiveness of the security interest • The registry system • Clear priority rules • Access to proceeds of receivables • Access to inventory • Insurance • Enforcement • The insolvency regime

16. 10 key legal elements of ABL loans • Party autonomy • As in any credit facility, ABL requires comprehensive written agreements • Thus, the legal regime must recognize party autonomy • Subject to mandatory rules (such as consumer protection, usury, commercial reasonableness) • In ABL, the focus of documentation is on collateral-related matters: • Defining “Eligible Receivables” and “Eligible Inventory” • Defining the “advance rate” • Specifying the interest rate and fees • Defining the conditions for making loans • Granting a security interest in the collateral • Defining the events of default • Describing the lender’s remedies • Other relevant provisions (covenants, etc.) are also important

17. 10 key legal elements of ABL loans • Creating a security interest in receivables and inventory • The security interest should be easy to create • No excessive formalities (such as notarization or translation) • No required notice to account debtors • The security interest in inventory should be non-possessory • The security interest should extend to both existing and future receivables and inventory without additional documentation or action • The security interest should secure existing and future advances • The security interest should automatically extend to proceeds of collateral • Prohibitions or restrictions on the assignment or pledge of receivables should be unenforceable

18. 10 key legal elements of ABL loans • Third-party effectiveness of the security interest • There should be a simple way to make the security interest effective against third parties (including the borrower’s insolvency administrator) • The security interest should have first priority over competing secured claims • Preferential claims (wages, taxes) should be limited • Carve-outs for unsecured creditors should be avoided

19. 10 key legal elements of ABL loans • The registry system • The registry should be accessible to all prospective creditors • The registry should be easily accessible and fast (Internet-based) • The registry should be searchable to enable the lender to identify competing secured claims • The registry should use a “notice filing” (as opposed to a “document filing”) system • There should be no formalities (such as notarization) • There should be nominal filing and search fees • The should be no requirement to disclose the maximum indebtedness on the public notice • All competing claims should be subject to registration • No “secret liens” (including retention-of-title claims)

20. 10 key legal elements of ABL loans • Clear priority rules • There should be clear priority rules to resolve conflicts among competing secured claims • Priority among competing consensual security interests should be awarded to “first to file or achieve third-party effectiveness”

21. 10 key legal elements of ABL loans • Access to proceeds of receivables • Dominion over proceeds • Lock box (post office box) • Borrower notifies customers to pay directly into the account • Blocked account agreements (also known as control agreements) • Depository bank agrees to honor lender’s instructions and waive set-off (except for administrative fees) • Two types of dominion over proceeds: • “Full” dominion • “Springing” dominion (dominion only on Event of Default or other triggering event) • No-offset letters with customers • Waivers of restrictions on assignment/pledge

22. 10 key legal elements of ABL loans • Access to inventory • Waivers (for access and waiving liens) • Landlords • To store or sell inventory on premises • To convert raw materials to finished goods • Processors • Warehouses • Mortgagee’s waivers • In-transit goods • Negotiable/non-negotiable bills of lading • Agreements with port processors and other bailees

23. 10 key legal elements of ABL loans • Insurance • Casualty insurance on inventory • Lender as loss payee • Mustbe in place at closing • Credit insurance • Covers risk of customer insolvency • Can also cover political risk • Problems with credit insurance • Reporting requirements • Customer and country limitations • Not a substitute for a security interest

24. 10 key legal elements of ABL loans • Enforcement • There must be efficient and predictable enforcement mechanisms • Receivables • The lender must have the ability to obtain the books and records relating to the accounts • The lender must have the ability to notify account debtors • Inventory • The lender must be able to obtain access to the inventory to safeguard, sell or convert to finished goods • Intellectual property considerations • Insuring the ability to sell trademarked inventory and the “exhaustion” principle • There should be non-judicial enforcement procedures, providing for public or private sale with: • Safeguards for the borrower and third parties (commercial reasonableness standard) • Court supervision if necessary • Courts must be predictable and efficient

25. 10 key legal elements of ABL loans • The Insolvency Regime • A security interest has no value to a lender unless it is recognized and enforceable in the borrower’s insolvency proceeding • The insolvency regime should: • Recognize the existence and priority of validly created security rights • Allow the lender to receive the economic equivalent of its collateral subject to (1) appropriate delays and (2) avoidance proceedings required for the administration of the insolvency proceeding

26. The future of ABL • ABL is expanding globally due to its flexibility and success in providing borrowers with liquidity while reducing the lender’s cost of credit and fraud in lending to under-capitalized entities • ABL has expanded beyond trade receivables and inventory to other assets including equipment and intangible assets where the legal and regulatory regimes permit • ABL is receiving increased recognition as an important lending technique for SME’s: • U.N. Receivable Convention (2001) • UNCITRAL Legislative Guide on Secured Transactions (2007) • Current UNCITRAL Registry Project • Most European countries participated in all three projects • Copies available at www.uncitral.org

27. Richard P. Palmieri Richard P. Palmieri, Managing Director, ANR Partners, LLChas served in a variety of senior rolesand employs a strong analytical approach to business issues. Richard developed his expertise working in a variety of financial service sectors including; factoring, asset based lending, consumer financing, investment banking, supply chain financing and vendor leasing. He currently focuses on enterprise business transformation, mergers & acquisitions, interim executive servicesand business performance improvement. Mr. Palmieri is a past Chairman of the Commercial Finance Association, a member of the Experts Advisory Panel of the United Nations Commission on International Trade Law, a member of the Turnaround Management Association and a member of the Association for Corporate Growth. Richard P. Palmieri, Managing Director ANR Partners, LLC Tel: 917-863-9661 rpalmieri@anrpartnersinc.com www.anrpartnersinc.com http://www.linkedin.com/pub/richard-palmieri/2/72/2bb/

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