Monday, February 29, 2016

SUPPLY CHAIN FINANCE / REVERSE FACTORING

Why Factors Do Not Offer Supply Chain Finance

Factoring guys go out and work with companies to establish Asset Based lending and factoring lines based on receivables and inventory, a few are involved in purchase order finance, and some have even gone the technology route to do Merchant Cash Advances.  Most are happy to develop $1M to $5M facilities for clients.
But when it comes to offering Supply Chain Finance (reverse factoring, Approved Trade Payable Finance or whatever you call it) to buyers to fund their suppliers – it’s not a space specialty finance companies operate in.
Banks are not developing Supply Chain finance programs for this segment.  We know Basel III capital rules make the cost of capital onerous for banks to commit their scarce capital.  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.
As one Global Trade banker described to me, the reality is when you work with the middle market, you first have to compete on credit internally with other product groups so you can carve out enough to offer supply chain finance. Next, a middle market company may only have two or three suppliers which you can offer the finance, so the scale is not there.  In addition, you have the onboarding costs for a program that for the non investment grade company is not going to generate huge volumes.
Despite those challenges, what makes these deals at least somewhat attractive is the spreads are much greater given the risks involved and you don’t need fancy platforms to do these deals.
So back to the question, why don’t specialty finance companies fill this space?  On the surface it makes sense.
According to one commercial finance company, liquidity is the big issue.  Most commercial finance companies borrow from banks and to a lesser extent private equity.  Interesting enough, this financier said those lenders won’t give us liquidity because they don’t understand this space.  The fact their FI Group will not give factors lines is perplexing as many global banks run these programs on their Capital finance or Trade side of the house.
One factor told me the banks response is “you want to take an unsecured position in accounts payable, how does that work.” 
It makes sense in some ways. Banks lend to specialty finance companies based on buying receivables on a non recourse basis and managing the dilution and obligor risk.  This is a total switcheroo as they say.
Another problem is how factors will sell it.  Most factors aren’t backed by Private Equity, most are single shingle guys with $10M books.  They don’t have the relationships at a $500M or billion dollar company to navigate the complexity to set these programs up.  Factors and ABL have sales and credit teams that speak a very specific language.   They don’t know how to sell to 1bn companies with Reverse Factoring programs – and engaging procurement is a major pivot to use today’s terminology.  In order to go to market to get $20M flow from suppliers using buyers approved invoice,  they would need a new sales force, a new process, a new system and probably new capital, perhaps too much of a shift.  This really is teaching a dog a new trick.
But it seems to me going to one seller for 1m line versus going to $1bn company and creating $20M or $50M flow, the pain could be well worth it.  Sub investment grade companies don’t have the same accounting restrictions as the Investment grade companies do, particularly since this is unsecured lending that is not corralled by loan covenants.
Perhaps it really comes down to most factors are in first tier factoring business , financing small apparel, footwear, and other domestic companies and financing importers, and inventory financing.   Maybe that’s enough and it’s too much to make an investment in people to even attempt this.