Supply-Chain Finance Is New Risk in Crisis
Experts say the economic slowdown could expose weak spots in the arrangements
A “sleeping risk” on the books of U.S. businesses could be awakened by the pandemic, as the sudden cash crunch exposes a hidden type of financing that makes balance sheets look better, credit-rating firms are warning.
The three biggest ratings firms each issued reports last month highlighting the dangers of supply-chain financing, a fast-growing, opaque technique for delaying payments to suppliers to improve cash flow.
S&P Global Inc. called supply-chain finance a “sleeping risk” that can “mask episodes of financial stress.” A prime concern is that the banks or other lenders may yank the financing from struggling companies, cutting off a source of cash at a time when it is desperately needed.
“If banks stop these facilities, it’s like cutting credit lines and we might see some companies run into heightened liquidity problems as a result,” said Frédéric Gits, a group credit officer at ratings firm Fitch Ratings.
Supply-chain financing has been around for decades but really took off after the financial crisis.
Using this financing, companies effectively borrow money to pay their bills, extending, say, 60-day payment terms to six months or more. It would be like taking a personal loan to pay a credit-card bill.
The arrangement gives companies flexibility with their cash for a low cost, but it can paint a rosy picture of the businesses’ liquidity because the deals effectively boost working capital but typically don’t count as borrowing. Instead the loans are treated as trade debt or accounts payable, and don’t need to be disclosed. “They remain under the radar until the company runs into problems,” said Mr. Gits of Fitch Ratings.
Supply-chain financing is the mirror image of factoring of receivables, where companies sell their accounts receivable at a discount to get cash faster.
“Buyers benefit from…extended payment terms and no additional bank debt,” according to a video by Bank of America Corp. promoting its supply-chain finance business. “Think of what could be done with this extra cash.”
A spokesman for Bank of America said it has “received consistent positive feedback from both suppliers and buyers on the benefits of our supply chain financing offering.”
Coffee and soda giant Keurig Dr Pepper Inc. used several banks to defer payment to suppliers worth $2.1 billion as of the end of last year, up from $1.4 billion a year earlier, according to a securities filing. The company’s payment terms range up to 360 days, which it said in a filing was “customary within the coffee industry.”
Ozan Dokmecioglu, Keurig’s chief financial officer, said on an investor call this week the company has “ample unused credit capacity and no liquidity issues or concerns whatsoever.”
The lack of reporting makes it impossible to know the exact scale of the lending, but estimates put it at hundreds of billions of dollars globally. Sectors where it is widely used include consumer packaged goods, telecommunications, chemicals, retail and aerospace, according to Fitch.
Swiss bank Credit Suisse Group AG , which has four funds that invest in supply-chain finance, said it is a “rapidly developing industry, with [a potential market of] $2 trillion in financeable payables world-wide.”
These financing arrangements have grown in importance during the current cash crunch. The risk is that if banks stop providing the cash to companies, it would force them to pay their bills much more quickly at the worst possible time.
While the money keeps flowing, companies can get cash to their suppliers quickly while waiting for their own cash flow to rebound. Citigroup Inc. said some clients may use supply-chain financing to pay even more suppliers.
“In the last couple of weeks, we are seeing companies looking at supply-chain finance to see how they can help their small suppliers and asking if this can be a tool to inject some liquidity,” said John Monaghan, global head of supply-chain finance at Citigroup.
But the lack of transparency is a risk. Supply-chain finance was a “key contributor” to the collapse in 2018 of U.K. firm Carillion PLC, according to Fitch. Carillion was a big U.K. government contractor that imploded after its losses soared. Few investors realized Carillion had £400 million to £500 Million ($491 million to $613 million) of supply-chain finance obligations that it reported as “other payables,” dwarfing its reported net debt of £219 million, Fitch said.
The $2 trillion stimulus package Congress passed last week is designed to help stave off similar collapses. The unprecedented measure includes hundreds of billions of dollars in loans for companies, throwing a potential lifeline to firms facing cash-flow crisis.
That could ease the financial pressure on pandemic-affected companies that use supply-chain finance. For example, the package will make billions available for Boeing Co. and its suppliers.
A spokesman for Boeing, which doesn’t disclose any supply-chain finance arrangement in its securities filings, said in a statement the company gives suppliers the option of using its supply-chain financing arrangements to manage their operating cash flow.
David Gonzales, a senior accounting analyst at ratings firm Moody’s Corp. said these lending programs typically run for up to a year, so it will take some time before it is clear whether they will be renewed. “There’s a bit of a runway until things start to really turn sour," he said.
S&P points out that while most borrowers have solid credit, supply-chain finance has spread to more speculative companies, which could be quickly cut off from the facilities. The risk is that these borrowers either can’t pay their suppliers or won’t pay back their loans.
One of the highest-profile suppliers of supply-chain finance is Greensill Capital, which is backed by almost $1.5 billion from SoftBank Group Corp. ’s Vision Fund, and last year did a total of $150 billion in financing, according to its website.
Lex Greensill, the company’s founder and chief executive, said in an interview that he believes the problem facing the industry is “demand has escalated so much that providers are not going to be able to keep up,” rather than existing financing being withdrawn. His company has seen demand triple in the past few weeks, he said, adding it was “working flat out to get more support to more corporates.”
The Credit Suisse funds, which the bank said aren’t sold to individual investors, source their assets totaling around $9 billion mostly from Greensill. Greensill sells the debts owed to suppliers to the funds in the form of short-term notes.
Credit Suisse in a 2017 magazine described the funds as “similar to the money market.” A spokeswoman said that despite the adverse markets, the funds have “delivered a solid performance so far,” and all redemptions had been met.
The notes held by the Credit Suisse funds include debts owed by big U.S. corporations, such as General Mills Inc. and Kellogg Co. Some of the notes are from companies whose bonds have junk status, such as Newell Brands Inc. Others are from companies affected directly by the pandemic, such as car manufacturer Nissan North America Inc. which has shuttered its plants due to the virus. A Newell Brands spokeswoman said the company no longer works with Greensill.
A spokeswoman for the Financial Accounting Standards Board said the accounting-rules maker is researching a request made in October by the Big Four audit firms for clearer guidelines on how supply-chain finance obligations should be reported.