GTR has brought together some of the leading players in the supply chain finance market in the Americas to gauge their views on the impact of recession on areas such as open account transactions, letters of credit and on managing the financial supply chain. It is generally recognised that what starts in the US ripples out to the rest of the world six to 12 months later.

Paul Johnson, senior vice-president, global product and strategy, Bank of America
Mike Quinn, managing director, product development, JP Morgan
Mike McDonough, global trade product management, The Bank of New York Mellon
Jane Guttridge, managing director, global supply chain finance & Ae Kyong Chung, director, Americas export and agency finance, Citi
William Nowicki, head of trade & supply chain for North America, HSBC
Robert Kramer, vice-president, working capital solutions, PrimeRevenue

Justin Pugsley, Supply chain & technology editor, GTR

GTR: How is the recession affecting the roll-out and use of supply chain finance programmes in North America? Are there any particular industries that stand out in terms of adoption?

Johnson: Trade is a somewhat counter-cyclical business, therefore, we’re not surprised to see a tremendous up-tick in client interest as the North American recession has deepened. Notwithstanding a dramatic increase in spreads, volume processed through both our invoice and draft discounting supply chain finance (SCF) programmes continues to accelerate.

We believe this is a reflection of the continued dislocation in the credit markets, the reluctance of banks to offer/renew medium-term lines of credit and a strong desire of clients to reduce the amount of working capital deployed along their global supply chains.

Kramer: We’re seeing a significant increase in usage by non-investment grade suppliers as the spread between their cost of funds and their investment grade customers has increased over 500% since the onset of the credit crisis.

The credit markets are virtually closed to non-investment grade companies so SCF is one of their only financing options. What’s really interesting is the even greater increase in usage among suppliers with investment grade credit ratings. We’re hearing that the value of liquidity availability has skyrocketed and even though these highly rated suppliers can access financing at or below the rates offered by SCF, they want to improve their cashflow and diversify sources of liquidity. The industries that stand out in terms of adoption are those that value their supply chains the most, manufacturing and retail.

Nowicki: We see buyers who have existing SCF programmes continuing to on-board strategic suppliers to improve their processes as appropriate for enhanced efficiency.

Quinn: From the investment grade buyer perspective, they are concerned that their supplier base does not have access to liquidity or, if available, it is not reasonably priced. As a result, supply chain disruptions are increasingly probable as suppliers may not be able to fill orders in a timely or effective manner. Secondly, if suppliers do have access to capital, they are paying a premium for it. Such premiums will result in higher prices if not in this order cycle then the next.

McDonough: We believe there has been a noticeable shift of trade activity back towards letters of credit and other more “traditional” instruments by many in the trade business. But I don’t believe we have seen a noticeable impact (yet) on roll-out of supply chain finance programmes in the market.

The change is seen more in the way trading counterparties are managing the risks associated with their activity and should, we believe, reverse itself as we emerge from the current crisis

GTR: In terms of supporting supply chain finance programmes, how are banks dealing with the fact that many buyers running SCF programmes have actually suffered a significant deterioration in their credit quality, sometimes to below that of their suppliers?

Guttridge: Programmes are functioning well even where the buyer’s credit is of a lesser standing than their suppliers and this speaks to the fact that there are many benefits to the programmes beyond the simple arbitrage of credit ratings.

The efficiency and productivity of the whole invoicing process, the implicit credit risk management of monetising receivables, the value of such a flexible revolving short-term working capital facility with no set up fees and the access across many global markets have made this a favoured tool in any company’s tool kit.

Quinn: We continue to monitor the credit quality of our buyers in the programme and modify their programmes based upon their credit standing and our credit appetite. Pricing may be raised, programmes may be reduced in size and scope or, in extreme circumstances, programmes will be terminated.

Kramer: The value of having an additional source of readily available liquidity has risen in comparison to pricing considerations. In addition, if the buyer becomes a credit risk themselves, suppliers use SCF to manage that credit risk and reduce receivables balances instead of as a source of low cost liquidity. That said, if the buyer’s credit rating falls below investment grade, most banks will not fund their SCF programme.

That means buyers need to place a greater emphasis on multi-bank programmes to diversify their sources of SCF liquidity should credit appetite diminish within one bank or even a particular group of banks.

GTR: Are there any signs that corporates are finally beginning to break-down silos within their organisations to facilitate SCF?

Nowicki: Increasing visibility is a top priority as working capital has become a focus throughout companies. SCF solutions, including cash management and supply chain services, have the ability to enable greater visibility between the various corporate departments so we see greater interest in how they can foster greater departmental co-operation.

McDonough: Corporates are continually improving the way they manage the information flows, data feedback, and processing mechanisms related to SCF; the major constraint going forward will be the risk appetite of the particular organisation.
But corporates, we believe, will continue to look at all of these services in the context of their working capital. Banks are starting to reconfigure their delivery mechanisms to meet this need.

Johnson: Procurement teams driving commercial contract negotiations with vendors, without considering the impact on the balance sheet was a significant barrier to adoption. This is changing and we are now seeing treasury/finance taking a much more active role in these negotiations, particularly as it relates to payment terms. The appointment of chief supply chain officers by a number of forward-looking corporations is driving enterprise-wide decision making.

Kramer: The current environment is certainly accelerating this alignment because the CFO is focusing on cash while the CPO is hearing from cash-starved suppliers. SCF offers a way to bridge this conflicting gap so these silos have a reason to talk to each other more about a common approach and common challenges, which obviously helps.

Guttridge: I believe that once all the right members in the organisation: purchasing, treasury and payments, have had an equal opportunity to understand the nuances and benefits of such programmes it has not been difficult to gain corporate support for the programmes.

Quinn: Alignment within the customer’s office continues to be a challenge. The priorities of treasury are seldom the same as procurement and typically the technology team necessary to support the programme does not have scheduled resources until some future date. This is especially true now in this time of expense reductions.

GTR: Are SCF programmes being threatened by the return to letters of credit? Is there any evidence of corporates abandoning SCF programmes to return to LCs?

Guttridge: None that we have seen – for two reasons; first for some of the strongest and largest buyers they have not seen this pressure to return to the wholesale use of LCs, second we don’t find that LCs need to be mutually exclusive with a supply chain programme.

SCF has never been a mandatory programme for suppliers, it is another tool for suppliers. Its operational and cost efficiencies make it a compelling choice even where LC financing is a possibility.

Nowicki: Global trade has widely embraced open account trading and we do not envision that the trend will reverse itself. That being said, in the current environment there are some instances where even buyers using an SCF programme may temporarily revert to using more traditional trade services such as LCs for select vendors where vendors request this tool to allow improved access to funding or are looking for greater risk mitigation for counterparty risk.

McDonough: There is anecdotal evidence that some corporates are doing just this as they seek to better manage the risks they are taking. I do not believe we would characterise this as a “threat” but, should the crisis persist for longer than expected, then it’s possible that such a shift could, in the eyes of some, become more of a permanent one. However, we do not believe this is an issue at this point in time.

Quinn: As the crisis developed, JP Morgan had assumed that there would be a wholesale migration back to letters of credit, but to date, this has not happened.

We do see exporters, specifically in the non-investment grade middle market space, asking for letters of credit from their former open account trading partners. We also see these companies demanding that the credits be advised and confirmed only by highly-rated global banks rather than regional banks that were, in the past, considered more “convenient”, but are now viewed as lacking the expertise and risk capacity.

Kramer: We see no evidence of that at all. In fact we’re seeing the opposite, a greater sense of urgency around moving suppliers off LCs. LCs use up credit capacity for buyers and that capacity is of much greater value today than it was before the credit crisis. Anything that negatively impacts available liquidity, like LCs, is being scrutinised. Indeed, many of our buyers see SCF as a way of mitigating the movement away from LCs to open account.

Johnson: We are certainly seeing a cyclical trend back to LC payment terms as sellers become nervous about the credit quality of their buyers and require an LC to secure finance. However, we don’t believe this represents a longer-term strategic trend. Bank of America’s SCF programmes continue to grow at a faster pace than our trade and supply chain business as a whole.

GTR: Is there a case for governments to get involved with SCF such as guaranteeing payments by embattled corporates as a means of helping SMEs with their cashflow? (This might envisage government guaranteeing bank loans to corporates operating SCF programmes and possibly lowering margins.)

Kramer: Absolutely. Take the US auto industry. According to the Wall Street Journal, without a new source of liquidity US auto suppliers face mass liquidations with the loss of hundreds of thousands of jobs. Banks aren’t going to provide SCF financing to that industry without some sort of government guarantee.

SCF is the most efficient way to provide the required liquidity because first, SCF provides financing on 100% of the value of receivables versus asset-backed loans which would, at most, finance 80% of the accounts receivables. Second, SCF financing will be provided at a much lower cost since it is bankruptcy remote from the supplier, so pricing is based solely on US government risk vs loan pricing which would include some component of supplier credit risk. Finally SCF can act as a ‘system of record’ for the government, recording each transaction and providing a complete audit trail.

McDonough: If you are referring to ECAs taking a more active role, at least in the short-run, to alleviate some of these credit pressures, then we believe that such a case can be made. The ability of such governmental and quasi-governmental entities to perform this role is well-documented and should be actively explored as a means of restoring market confidence and liquidity flows.

Guttridge: Yes absolutely. But let me say, government agencies have of course long been involved in providing guarantees to all sorts of financing programmes as a means of helping SMEs. They have been at the forefront of finding innovative ways to help SMEs. In this context, SCFs offer government agencies an efficient and flexible tool to put further capital work as they seek to support SMEs in particular regions. For example, Citi has long worked with a number of official agencies globally to structure financing for SMEs. The types of support can take the form of structural subordination such as first or second loss positions to providing guarantees to banks for partial defeasance on a funded or unfunded basis to mitigate credit risk and potentially reduce pricing.

Chung: The agencies now more than ever are focusing on supporting the SME sector and the SCF is a natural corollary to their existing suite of financing products offered to the sector. We are now witnessing this with the multilaterals and the bilateral agencies and have few pilot projects with them already.

GTR: What progress is SCF making in Latin American markets?

McDonough: There are a large number of major Latin corporates who already trade on an open account basis and have been doing so for a long time. I think the question is really one of how are Latin banks adapting to the issue of providing expanded SCF services to these and other corporate clients. The answer to this is, slowly and cautiously. They, we believe, are looking at the trade-off between the revenue benefit of providing additional value-added services and the cost of providing these services, which is often seen in Latin America as being high.

Johnson: While most SCF clients continue to be based in North America and Emea, we are seeing interest from multinational corporates in both Latin America and Asia. Although the credit crunch took longer to have an impact in these regions, it’s now a global phenomenon so we expect activity to grow in all regions of the world in 2009 and beyond.

Kramer: On the supplier side, SCF is making a lot of progress in Latin American markets since financing is even more expensive and harder to obtain there. Many of our manufacturing clients have suppliers in Mexico and Brazil, while our retail clients source quite a bit from Central America. As the credit crisis has unfolded and as their SCF programmes have matured, they’ve driven SCF out to these geographies. We’re seeing more interest in SCF as some of our bank and non-bank partners are increasing their focus there, and, in addition, a number of our buyers are growing their “next-phase” roll-outs to target countries in that market.

Guttridge: SCF has been in Latin America for many years. Indeed for advanced companies in this space, like Walmart, who operate their own programme, such facilities have long been available. The broadest application of such tools offered on a cross-border basis can be slowed by the differential legal environment in each market. Citi finds that using its network and its local knowledge we have been able to grow our programmes in the region and they are growing quite quickly.