Category Archives: Finance

Is Dubai in for a Downfall? And will it take the Middle East Economy With It?

A recent article over on Knowledge @ Wharton last month asked if “Dubai World’s Debt Default Could Spark a Crisis in the Middle East and Beyond” after Dubai World announced in late November that it wanted a six month delay on payments on 26 Billion in debt. In other words, it’s asking for a delay on a loan amount that is greater than the annual GDP of over 110 countries! And, according to the article, that’s just the debt it attributed to it’s overly ambitious real estate subsidiary, Nakheel, which, not satisfied with the construction of Islands in the shape of Palm Trees (Jumeirah, Jebel Ali, and Deira) had to go and construct a massive Waterfront, The World (Wikipedia), and, now, The Universe (Wikipedia).

Needless to say, the announcement threw the markets for a loop. As per the article, the Dow Jones Industrial Average quickly fell 1.5% (155 points), European stocks plunged, and oil prices plummeted. Between the end of November 25 (when it hit Bloomberg) and December 9th when the K@W article appeared, a flurry of news articles hit the wire trying to understand what it all meant, which so far has been very little beyond the initial shock. But given that negotiations are still ongoing and nothing has been finalized, a bigger shock could be coming, especially since Dubai World as a whole has debts totalling 59 Billion, which is an amount greater than the annual GDP of over 130 countries! The detailed analysis from the K@W article was that Dubai World’s lenders will work out a restructuring and will supply funds needed to complete the real estate projects that have stalled, because the buildings will be more valuable finished, quoting the burst real estate bubble that Florida suffered in 1926 (and how the excess building eventually drew people to Florida from around the US), but nothing is set in stone. There’s no guarantee that, in this economy, the lenders can even afford to wait six months for their structured payments, yet invest even more money in very expensive (and egotistical) projects that will take quite some time to sell. After all, how many people left can afford to pay 15 Million to 50 Million for their own island? With the major studios shelving scripts left and right, even “A” list actors are having trouble getting steady work at their usual pay rates! (And if the doctor had 15 Million to invest, he’d be launching new companies offering useful software and services [as they’d have revenue potential], not buying an over-priced man-made piece of real estate that really wasn’t needed in the first place.)

Now, while it’s likely that Wharton Finance Professor N. Bulent Gultekin is right in that problems arising from Dubai World will for the most part be contained in Dubai rather than affecting the region, largely because Dubai is the most highly leveraged country in the area, it’s important to note that if Dubai World did fail, it would be the largest government default since the approximately 100 Billion Argentine debt crisis of 2001 and that could spark a chain reaction (like there was during the Russian default crisis of 1998) as there has been a very big jump in government debts around the world as of late. And if a country like Greece, which has a lot of debt mostly held by lenders outside the country, fell, we could be saying goodbye to a quick recovery and hello to a nice, long depression. I just hope the financial decision makers think about this before they raise national debt limits again and risk plunging the world markets into turmoil.

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Invoice and Asset Based Lending Goes Mainstream

Venture Finance, the UK’s premiere independent Invoice Finance and Asset Based Lender with 20 years of helping thousands of businesses under their belt, just released a white paper on “the evolution of invoice and asset based lending” that is definitely worth a read. The white-paper, which resulted from a roundtable discussion among UK industry leaders in London late this summer, addressed the evolution of invoice and asset based lending and how it addresses today’s business needs in times of recession and growth.

Today, the UK Invoice and Asset Based Lending (ABL) Industry stakes a strong claim for a place at the commercial finance executive table, growing from £ 7.3B and 13,669 clients at the end of 1995 to £ 46.7B and over 46,000 clients halfway through 2009. This represents a strong, and consistent, growth in an industry which provides security and flexibility when compared with more traditional funding choices, which have proven to be quite fragile over the past 18 months as many banks called in loans and lines of credit with little, if any, notice as a result of the failure of the traditional banking system that started with the collapse of Lehman Brothers. According to research done by Venture Finance across 1,000 UK accounts, in the last year, 58% have had their clients refused credit from banks. As a result, payment times have increased to horrendous levels. Over a third of accountants are now suffering an average payment delay of 14 extra days, and over a quarter are now having to suffer an average payment delay of 30 extra days, which puts a tremendous strain on cash flow when you’re waiting an average of 60 to 75 days to have an invoice paid.

It’s important to note that ABL is not a new concept, having been around in some form or another for centuries, with a history that can be traced back to the glory days of Rome. A few centuries ago, in colonial times, it was common for British merchants to make use of factors to sell goods in the Americas. The industry has evolved significantly in the last 40 years. Whereas its modern beginnings consisted solely of basic factoring and invoice discounting forty years ago, in the 1990’s, we saw the introduction of true ABL that leveraged against stock and plant.

ABL is important because it provides value above and beyond traditional financing. This value includes:

  • direct link to business performance
    if your invoices are strong, so is your credit availability
  • flexible and responsive
    you can decide how many of your receivables you want to leverage, how much funding you want to ask for, and if your business improves, so does your credit availability
  • superior service levels
    in ABL, it is the norm to ensure face-to-face visits occur at least every six months in order to establish a productive and lasting relationship; this allows a relationship manager to pre-empt any upcoming issues in conjunction with the client and ensure that capital remains available; compare this to the banking industry where visits can be yearly at best from a manager with a large client portfolio

When you consider that ABL has grown during the recession, and that it can take as many as 13 quarters for a full recovery if we use previous recessions as a guide, it quickly becomes clear that, for many firms, ABL is a much better financing option than the local bank. In other words, if you’re not doing it, maybe you should. If you’re in the UK, you can start with Venture Finance and if you’re in the US, you can start with The Receivables Exchange.

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Is Basel II Crippling Trade Finance?

The purpose of Basel II, the second of the Basel Accords (which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision), was to create an international standard that banking regulators can use when creating regulations about how much capital needs to be reserved to guard against financial and operational risks. In essence, the goal was to reduce risk and insure trade even in the event that a series of major banks collapsed.

But did it, in fact, accomplish the exact opposite? In two recent articles in the financial times which addressed the current trade credit shortages that are threatening to throttle the global flow of goods, we see that “Basel II has become (an) obstacle to trade flows”. It seems that the Basel II charter imposes a significant increase in the risk weighting for this activity, relative to its predecessor. (This is scary. Physical goods HAVE a value and invoices to solvent companies result in receivables and trade credit loans make a lot more sense than business development loans to risky start-ups or bail-outs to big corporations that ARE NOT too big to fail in this economy).

More specifically, the focus of Basel II on the “probability of default” of banks’ counterparts — which naturally increases during downturns — substantially exacerbates the negative effect of recessions on banks’ lending. In this context, Basel II has inadvertently become an obstruction to the very lifeblood of international trade. As a result, even though the “World Bank (is) urged to lift trade credit finance” by the primary global players in trade finance, until a review of the impact of Basel II implementation on lending activities is carried out and new recommendations are made, those companies that don’t take a different path to trade finance and start trading against accounts receivable on The Receivables Exchange (in the US) or Venture Finance (in the UK) are going to have a very rough road ahead.

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Could Escrow Accounts Return Us To Long Term Thinking?

Besides the fact that you’re probably as fed up as I am at the ridiculous compensation packages that many Executives are getting these days despite the fact that they are on their way out the door having just tanked the company, there’s also the fact that their focus on short term gain is hurting the company and your ability to do your job.

You want to switch to sustainable sources of supply, because you know that the long term savings (as energy, water, and carbon costs are all poised to go through the roof) will dwarf any short term savings you can negotiate, but because there are up-front investment and switching costs, you’re prevented from making the right choice.

You want to license that new strategic sourcing decision optimization platform because you know the 12%+ additional savings you can expect across the board on every event you run through it will give you an ROI of 10X to 20X within a year, but you can’t because an additional overhead cost will decrease EPS for the quarter, which will temporarily decrease the stock price, and, most importantly, impact your CPO’s and CEO’s Christmas bonus. Thus, even though you could probably double EPS and pump up the stock price within a year, you can’t make the right move.

And so on. And to be frank, it just stinks. We’ve made it too damn easy for fat-cats to get big rewards today for results that may or may not materialize tomorrow, and it just shouldn’t be that way. For instance, in Canada, shareholders are only now getting “say for pay” at most public companies — and all that right gives them is the right to tell the Board what they think should happen. The Board, once elected, can still do what it wants. And at many corporations, the shareholders only have two choices when it comes to electing the Board, vote for the nominees put forward, or abstain from the vote. But if even a single person votes for the Board, they Board is elected and, after allowing the shareholders to provide “input”, can still proceed to do whatever they want. Could you imagine if you were told “you can vote for Mr. X for President, or not, but if even one person in the whole United States of America votes for Mr. X, he’s President”. Scary, eh?

Anyway, a new proposal by Alex Edmans, Xavier Gabaix, Tomasz Sadzik, and Yuliy Sannikov (from Wharton, NYU, and U of C) on Dynamic Incentive Accounts could hold the answer to fixing some of these problems. According to the authors, if executive compensation packages were deposited into escrow accounts that vest over a two-to-five year period, with only a certain percentage allowed to be withdrawn each month, it could push executives to focus on the long-term. After all, if an Executive can’t access his Million-Dollar stock bonus for five years, he’ll be highly incented to make longer term decisions that will insure the stock price rises over the long term. And if the company were to grant more stock during a downturn, he’d be double-incented to turn the company around.

The authors also found that an increase in firm value must be accompanied by an increase in pay to keep the Executive motivated (and suggested a 6% pay increase for every 10% increase in firm value), but that’s perfectly acceptable (especially since it too will go into the escrow account). After all, if you increase profits by 20 Million, you should get a good chunk of change as a reward. It’s when you lead the company to a 20 Million loss that you shouldn’t get your bonus, and that’s what the real problem is. Now, the proposal has a bit of a downside in that they authors also found that an Executive’s base compensation would probably need to be increased 20% because of the longer vesting periods, and some of the packages out there are quite generous already, but this would still be okay if a good portion of the package was stock in the escrow account and the executive actually produced continued growth over a five year time frame.

Thoughts? Or am I the only crazy blogger who thinks this proposal makes sense?

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There’s Something to Be Said for Private Equity

And the ability to tell Wall Street to take a hike. I was absolutely disgusted when I read this piece on the intersection of Wall Street and Private Equity with the Supply Chain and saw the following:

one large retailer had the opportunity recently to save an expected $50 million from a supply chain network redesign project, included shifting from a number of smaller distribution centers to larger ones. The project had a great ROI and the capital was available — but the company delayed the project just because of the potential for Wall Street to view the project as too risky operationally and financially.

There’s wanting a good Return On Assets and then there’s pure stupidity. What do you think this is an example of?

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