Recent research appears to confirm that the credit crunch is after all driving the adoption of supply chain finance (SCF). Both banks and corporates are keener than ever to make scarce capital stretch as far as possible.
According to a research note released by specialist working capital solutions provider, Demica, over 93% of the top 50 global banks now offer supply chain financing solutions to their corporate clients.
“This is nearly twice as many as last year,” says the report released in June entitled: Supply Chain Finance Gathers Momentum. Meanwhile, the remaining 7% are actively planning SCF offerings. Early last year by contrast, Demica found that only half of the global banks were offering SCF solutions to their corporate customers.
This shows every sign that the big trade banks are striving to meet their clients’ demands. “The research points to surging corporate demand for collaborative financing tools, with a 65% increase in live SCF programmes over the last 12 months and triple the number of firms actively investigating their options in this regard,” explains the Demica report.
Elaborating on those figures, Demica says that in early 2007, only 9% of corporations had SCF programmes up and running, but by April 2008 this had risen 14% with another 24% seriously investigating the process. “This brings to around 38% the proportion of corporates operating or seriously planning SCF programmes,” says the report.
Demica found that industries thought by the overall majority of top banks most able and likely to benefit from the working capital released by SCF programmes were: retailers at 82%, automotive: 75%, manufacturing industry: 74%, electronics: 70%, food & drink: 62%, pharmaceuticals: 61%, distribution: 56%, heavy equipment: 53% and technology: 51%.
Also, Demica has uncovered a major driver for the adoption of SCF. “Moreover, European corporates believe that SCF will grow more strongly over the next two years than lines of credit from their relationship banks,” says Demica. “The inverse ranking to last year”s prediction and no doubt a reflection of the current credit crisis.”
Reflecting on the credit crunch the research report points out that the majority of banks believe SCF provides an efficient deployment of scarcer credit in the current climate for corporate customers. Indeed, this is a view widely picked up by GTR when talking with trade banks. However, there are some bankers who are concerned that worries over creditworthiness of counterparties could trigger a rush back to letters of credit at some point. “Any serious deterioration in credit quality of buyers and other corporates in the supply chain could well run for the security of LCs, even if it works out more expensive for them,” says one banker.
Running up milestones
But for the time being at least this doesn’t seem to stemming the adoption of SCF. Right now the big worry is over the scarcity of capital and the impact that’s having on its cost. Thanks to the effects of the credit crunch many banks are rationing capital in a bid to rebuild their balance sheets by increasing margins and to boost their core capital ratios. SCF platform provider, PrimeRevenue, certainly believes the credit crunch is boosting SCF adoption.
Noting a key milestone in its history the Atlanta-based company said: “The PrimeRevenue SCF Platform processed over US$30bn in payments from 40 buyer organisations. More than half were made in the 12 months ending May 2008. By year-end 2008, existing and new programmes are planned to bring an additional US$25bn in payments and financing for the year.”
Commenting on the credit crunch, PrimeRevenue found that since August 2007, widely marked as the month the crisis was unleashed, that supplier-initiated receivables sold via the PrimeRevenue solution grew approximately 40%. Several thousand supplier accounts are live and trading in 22 countries worldwide and receiving payments in nine currencies. PrimeRevenue’s supplier population doubled in the 12 months ending May 2008.
Backing up PrimeRevenue was Ron Embree, president and chief executive of River Bend Industries. He says PrimeRevenue’s SCF solution delivers greater cash management, flexibility and allows the firm to more easily plan ahead. “Cash is king,” he says, adding: “conditions in terms of securing funding are just going to be tougher, the lenders are going to be more cautious, and this (solution) gives you easy access.” River Bend Industries is an Arkansas-based manufacturer, which makes injection-molded components for major OEMs engaged in consumer and industrial sectors.
Returning to Demica’s research, it observed that at the same time last year tensions were building in the supply chains of many European buyers as they exerted “unsustainable” pressure on those suppliers to extend their payment terms.
Ideal to securitise?
“Since then, the international credit crunch has compounded financial woes, but it seems that banks remain willing to fund SCF programmes,” it says. “Indeed, nearly two-thirds of banks stated that they would continue to fund their programmes through asset-backed commercial paper conduits.”
Demica suggested this could be because of the suitability of a highly rated, diversified pool of receivables as an asset, which should stand out as being attractive during a credit crisis.
Demica found that there is: “discernment in the ABCP (asset-backed commercial paper) market between strong (eg, corporate receivables) and weak (eg, sub-prime mortgage debt) underlying asset classes.” It noted that 64% of top banks said they would continue to fund their SCF programmes through their ABCP conduits and 60% also said that illiquidity in other parts of the credit derivatives market had not altered their plans in this regard.
That finding does seem to mirror some of the conversations GTR has had with bankers over the last 12 months where there is a strong feeling that SCF is ideal for the ABCP market. In particular, there is the greater transparency offered by SCF over even traditional trade receivables. Also, the default rate on trade receivables, which are short-term in tenor anyway, tends to be lower than for typical consumer credit type loans. Indeed, numerous hedge funds have been formed to take advantage of the relatively safe nature of trade receivables, which is not entirely reflected in their margins, in the sense that risk is potentially being over-priced relative to equivalently rated assets.
Indeed, SCF programmes could create a potentially large pool of tradable financial assets as banks will seek to off-load some of their exposure to particular credits.
Not just idle talk
“Supply chain financing has been much talked about over previous years but it seems that demand has finally caught up with supply,” says Phillip Kerle, chief executive officer of Demica. “Although SCF is still in its infancy, banks in our research were emphatic in their view that SCF is a strong and rapidly growing market, and one which will provide an alternative source of funding for those corporates facing difficulties obtaining traditional bank credit.”
He goes on to explain that corporate respondents cited operational issues as hindering the adoption of SCF. “In fact, sophisticated solutions are now available to eliminate the need for major technology integration,” says Kerle. “Banks also agreed that disruption to suppliers’ and buyers’ processes and IT systems may be a perceived obstacle, but it is largely one that, in reality, no longer exists.”
This is indeed true. IT vendors and even banks, which create their own solutions in house, have been going to great lengths to make their solutions scaleable and flexible. And for those who don’t want the hassle and up-front cost of licensing, there’s the hosted route. It enables users to be up and running very quickly.
Recalling some of the discussions GTR has had with the bankers, the main barrier seems to relate to a ‘silo’ mentality that often exists within corporates. For instance: Is SCF the responsibility of the procurement department? Treasury? Accounts? IT? Whose departmental budget is investment in SCF allocated to? Who in the organisation takes charge of implementing and managing the process? These often prove tough questions to address.
Nonetheless, some banks such as HSBC and Standard Chartered have been rolling out portals, which combine both trade and treasury functions. It’s possible that these ‘cross-departmental’ functions can help a ‘fragmented’ organisation adopt SCF. Nonetheless, these human factors can sometimes prove far harder to overcome than technological ones.
Customer differentiation
Another interesting finding by Demica is that 80% of banks view SCF as an important component of service differentiation. “Respondents expressed the view that if SCF is correctly implemented, banks stand to extend significantly their reach to cover customers ‘end-to-end’ supply chain processes, including such ‘upstream’ processes as e-invoicing.”
As HSBC recently noted, SCF is about managing working capital and financial flows, but also managing information across the supply chain and the documents and data that supports these flows.
Certainly in the early stages SCF can offer differentiation, possibly being more advanced than other banks in itself can make a particular bank stand out. But as Demica’s findings show, most of the big banks now have some sort of SCF offering. At some point they’ll all be roughly offering similar things, i.e. when the methodology becomes mainstream.
But SCF as a product is highly reliant on technology, much more so than traditional trade finance offerings. By combining technological and financial innovation banks have the potential to come up with tailored solutions for their clients or unique products for the market place. In a sense that is what SCF providers such Demica, Prime Revenue and EZD Global are doing.
Common capital
At one time banks appeared to show little enthusiasm for SCF as they often associated it with low margin open account type business. In a way this was not surprising. It posed a potential threat to many of their profitable income streams such as creating LCs, they also saw that it could further compact lending margins and shorten funding periods.
SCF seemed very much about multinationals bullying their banks into providing them with more competitive solutions. Banks concerned over losing those clients, often responded reluctantly. But those were in the days when credit flowed freely and easily and was cheap. Today’s environment is completely different. With credit now being so tight and more expensive, concerns over compacted margins and shorter lending periods seem to matter less. If anything SCF is enabling banks to recycle capital more quickly around their customers and enables corporates to be more efficient in the use of funds as well. At the same time the bank can effectively undertake a profitable arbitrage between the credit rating of the buyer – usually higher – and that of the supplier – usually lower. This can actually translate into better margins than would be achievable through more traditional forms of financing. There is also the opportunity to collaborate with other banks and increasingly non-traditional providers of finance such as hedge funds.
And crucially, it enables corporates to extend credit terms with their suppliers without damaging them financially. Deployed properly SCF is in fact a ‘win-win’ situation for the corporate and its suppliers and may even help safeguard the supply chain in times of financial stress. In essence, suppliers can get paid, say, within five days by discounting their 90-day invoice to the bank. The bank then collects the funds directly from the buyer. Also, the transparency offered by SCF gives lenders greater comfort during these uncertain times.
By promoting SCF, a bank not only helps corporates reduce their capital usage and bolster the financial health of corporate supply chains, but stands a better chance of retaining them as clients.
Suddenly, both banks and corporates have a common and compelling reason to adopt SCF – scarcity of capital. What could be a better catalyst for driving SCF?
