Can government save the supply chain finance market?

If you were to ask people which is more important for businesses, the commercial paper market or supply chain finance market, most would err and say supply chain finance if for no other reason than it gets so much press.

Supply chain finance (SCF) is a relatively small market compared to its more short-term liquidity cousin, commercial paper (CP). Yet, the SCF market is going through turbulent times and may need to be rescued with some form of guarantees. The CP market is extremely important to company liquidity and was frozen before the Fed put together a $1 trillion backstop. Essentially, CP broker-dealers would not buy paper because they were unsure companies would be able to pay it off at maturity within 90 days or less. The Fed announced a special credit facility to purchase corporate paper from issuers that have been having a difficult time finding buyers on the open market.

As such, that leaves us the supply chain finance market, where arguably there are anywhere from $50 billion to $75 billion in outstandings at any one time compared to $1 trillion or more for commercial paper.

There are a few concerning events with this scenario:

First, investment grade companies are rushing to draw down on revolvers and incremental loans at a pace not seen before. In recent weeks, investment-grade companies drew down over $143 billion, compared to $56 billion for non-investment grade. Companies continue efforts to shore up liquidity amid the coronavirus crisis, with many of these debt issuers citing in their SEC filings the coronavirus as the reason for tapping these lines.

Access to drawdown credit facilities by Credit Quality

(Click image to enlarge)

Second, in a report in March by Fitch, cumulative two-year U.S. default rates for leveraged term loans and high yield bonds are forecast to each be near 15% in 2020 and 2021. The Fitch Ratings team led by Michael Paladino commented, “A lot of companies are going to default, especially those with lots of debt relative to their income. Leveraged loans are going to get particularly hard-hit, the report predicts, with loan defaults reaching $80 billion in 2020 and $120 billion in 2021, versus the 2009 high of $78 billion.”

Third, yields on U.S. T-bills became negative for the first time in late March, with the cost to park money in U.S. debt for 3 months becoming negative for the first time. I thought it would take 2 years; it took 6 months.

March 25, 2020

What can the government do?

Back in 2010, EXIM Bank developed an SCF guarantee program, which combines a traditional SCF program with EXIM’s guarantee. The original program was restrictive in that 50% of the suppliers had to be small businesses as defined by Small Business Administration guidelines. Additionally, there had to be a 50% U.S. export content requirement to the accounts receivable. Also, the guarantee covered 90% of the buyer’s liability to the bank. It was truly an export-focused program.

Unfortunately, credit quality is in serious decline, and banks are shying away or withdrawing from pre-existing programs, given that SCF is an uncommitted bank credit facility. As credit quality declines and more companies are downgraded, a bank’s willingness to bear this risk is curtailed immensely given costly capital charges for these credits. One must wonder what can be done now.

The good news is that EXIM has temporarily modified their 2010 program to make it more widely available for suppliers as follows:

  • Temporarily” eliminate the target of 50% small business as defined by Small Business Administration guidelines as suppliers in the supply chain. This will allow EXIM to help U.S. exporters that have supply chains composed of suppliers that are not mostly small businesses.
  • EXIM will “temporarily” allow for the U.S. exporters to make sales directly to foreign affiliates rather than directly to unaffiliated foreign buyers (i.e., intercompany transactions were before excluded but are now allowed).

In addition to the points above, lenders have strongly recommend increasing the EXIM guarantee from 90% to 100%.

Is this enough?

It’s hard to tell if this is enough, but the Fed has developed an alphabet soup of new programs to backstop the economy:

  • CPFF (Commercial Paper Funding Facility) — buying commercial paper from the issuer.
  • PMCCF (Primary Market Corporate Credit Facility) — buying corporate bonds from the issuer.
  • TALF (Term Asset-Backed Securities Loan Facility) — funding backstop for asset-backed securities.
  • SMCCF (Secondary Market Corporate Credit Facility) — buying corporate bonds and bond ETFs in the secondary market.
  • MSBLP (Main Street Business Lending Program) — Details are to come, but it will lend to eligible small and medium-size businesses, complementing efforts by the Small Business Administration.

Source: Bianco Research

Should the above backstop be extended to supply chain finance, or is the EXIM Bank’s temporary program all we are going to see? It’s difficult to argue how the above arrangement of Treasury-Federal Reserve-Blackrock is a healthy long-term scenario. However, if any of the loans are risky and go bad, that ultimately comes out of the funds the Fed delivers to Congress, and taxpayers will bear the brunt. This should be done under congressional approval, as Congress decides how taxpayers’ money gets spent.

Perhaps it’s time for industry associations to address government support for SCF. One of the problems with SCF is there is just a limited amount of data on the market. While there is more transparency than in the past, it pales to markets that the Fed is currently backstopping. This lack of data and transparency may be preventing a coordinated and coherent response from industry associations.

There’s one thing for certain: Credit quality downgrades will continue, and that is not good for SCF.

David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital. He can be reached at dgustin (at)

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