Will Trade Payable Finance programs move downstream?

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Payable finance programs, mistakenly referred to as supply chain finance (SCF), has been the sole domain of the Fortune 2000 investment grade and near investment grade corporations.  Why?  There are several reasons:

  • Basel III capital rules make the cost of capital expensive for non investment grade corporates
  • SCF is an unsecured loan to the buyer, and banks do not want to build up a portfolio of non secured loans to non investment grade middle market companies.
  • These programs are expensive to establish and onboard, therefore banks want to build scale as quick as possible.  It can take up to 18 months until credit utilization occurs to sign up a Fortune 2000 corporation, to determine funding needs, and to onboard suppliers.  Think about those people costs before one nickel of interest revenue is booked.
  • There is much more risk that middle market companies will go insolvent versus a Fortune 2000.  Plus, it is much harder to insure for that risk.  I can buy credit default swaps on Sears, but try to do so with a $100 million company.
  • Also, middle market companies may not enjoy the arbitrage advantages with their supply base like the Fortune 2000s do, so there is not the scale that large programs can have.

Because of these reasons and others, most of the originators of these programs do not want to build programs to the middle market.   But there is a solution, and one I am surprised more funding providers are not taking advantage.

When you buy receivables from suppliers of a buyer, you want to make sure you get your money back.  When buying receivables, you must manage the risk of the buyer going bankrupt.  You must also make sure the supplier is not double dipping, which is an expensive process to do, as you have to both check to make sure there is not a current lien on the receivable and register your claim.  If the receivable is already pledged, you must go through the process of getting a bank release.

One way around actually buying receivables is to make yourself the paying agent – you pay invoices at a discount and the middle market corporate would pay you when the invoices would mature.  This is unattractive to large corporations, as there is a potential to recharacterize the debt on its books, but the mid market may not be as concerned.

The market is very interested in the non investment grade market because Investment Grade programs are so thinly priced, typically at Libor plus (based on a corporate's credit rating).  For example, Walmart suppliers may pay Libor + 75 basis points, and Lowes suppliers may pay Libor +175 (making the cost of money very cheap for suppliers) but not too attractive for funding providers.

Voices (5)

  1. Wong Kartyono:

    Hi David,

    Its very interesting in the early payment scheme as long as the buyer could be convinced not to categorize the exposure under bank debts and they can also take advantage to negotiate longer term of receivables with supplier. Nevertheless, as consulted to accounting expert, the transaction documents should be accompanied by bill of exchange (addtional to set of invoice) in order to transfer into non-loan assets class in bank, but this also given doubt to large corporation to enter such arrangement as might be recategorized as bank debts in their book.

  2. Gaurav Bhatnagar:

    Hi David,

    When you say that bank becomes the payment agent , is it something similar to sale invoice discounting/financing….in which case bank becomes lender to the supplier .

    Regards,
    Gaurav

  3. David Gustin:

    Hi Tony,

    Thanks for your feedback. I believe the point of being a Paying Agent as opposed to buying receivables is to circumvent the huge costs in getting local counsel to tell you how to buy receivables in accordance with local law. There are some countries that cant offer because local law is now that clear as well. Global banks can afford these law bills, but many can not.

    I agree, I have not heard of insuring risk under this arrangement.

    David

    1. Tony Brown:

      Actually, in the bigger scheme of things, it’s not that costly in my experience. One can be selective in which countries one offers the program — bearing in mind that over 50% of U.S. merchandise imports originate in a handful of Asian countries. There’s no need to get too ambitious to start with.

  4. Tony Brown:

    David,
    I believe interest in payables financing for middle market buyers is likely to increase. And, certainly, early funders of suppliers’ receivables against the buyer’s obligation to pay the full invoice amount at maturity are likely to rely on their own assessment of the buyer’s creditworthiness as well as (in many cases) that of a credit insurer.

    But can the payables funder buy credit insurance when it acts only as paying “agent” of the buyer? What gives the paying agent an insurable interest? Certainly, purchasing the seller’s receivable without recourse for the buyer’s credit risk of insolvency would do so — but it doesn’t seem quite as clear in the case of the paying agent structure.

    Have you researched this? I checked with a leading credit insurer and they agreed with my take (no insurable interest).

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