Demand for supply chain finance (SCF) is soaring, as the Covid-19 slowdown continues to place a squeeze on firms’ liquidity. Though a boost for the industry, ratings agencies are warning that the trend could prove dangerous.

SCF programmes vary widely, but typically involve a third-party financier sitting between a buyer and its supplier. The SCF provider pays a supplier’s invoices earlier than agreed – generally at a discount – while allowing the buyer to hold their working capital for longer.

San Francisco-headquartered SCF provider Taulia says early payment volumes across its platform increased by more than 200% month-on-month in March this year, suggesting that the outbreak of coronavirus has led to “a critical need for liquidity to empower small businesses during this challenging period”.

Similarly, Atlanta-based SCF provider PrimeRevenue says the proportion of invoices traded for early payment rose from 77% in January to 93% in March. It also attributes the steep rise to the impacts of Covid-19, as suppliers’ demand for cash surges due to “a global need for liquidity”.

For many, the ability of suppliers to receive prompt payment without pressuring the buyer’s working capital is win-win. Taulia’s announcement quotes Rocky Schmidt of Karet Trading, a supplier using its platform, who says: “Having the ability to request early payment has given us certainty as we don’t know what the future may hold.”

“Access to extra liquidity enables us to optimise our cash flow to keep the business running smoothly,” Schmidt adds.


Ratings agencies sound alarm

Ratings agencies – which have long argued that SCF can be misused by companies to obscure payment obligations and artificially boost their balance sheets – warn that existing risks are likely to be exacerbated by the pandemic.

Chief among those risks is that lines of finance could suddenly be withdrawn.

David Gonzales, a vice-president and senior accounting analyst at Moody’s, says that stress now brought on by macroeconomic factors means those issues are “coming to life”.

“The short-term nature of these facilities makes the risk that banks pull facilities a primary risk for entities involved in these programmes,” Gonzalez tells GTR. “We [also] expect companies to fully utilise these facilities as they look for liquidity. This exacerbates a risk by maxing out facilities that are short-term and that do not have certainty for renewal.”

Similarly, Frédéric Gits, managing director for corporates at Fitch, says added demand for working capital from suppliers may prove to be beyond banks’ risk appetites.

“It’s just a credit line,” he tells GTR. “From our perspective we see it as no different to an overdraft or any other credit line, so the question is whether the bank will grant a new line or renew an existing line.

“We would expect banks to be cautious, and if you have lines which are not committed the banks might say no, as it’s a credit risk.”

The warnings also echo suggestions by US securities regulators in late 2019 that reverse factoring “is not cycle-tested, which means that it is unclear what might happen in an economic downturn”.


Industry calls for nuance

Providers of SCF have consistently disputed claims the practice is inherently high-risk, arguing that examples of harmful conduct are a misuse of the product and, in reality, few and far between.

There is so far little evidence that banks are deciding to exit or withdraw funding for large numbers of programmes due to Covid-19.

Dominic Capolongo, executive vice-president and global head of funding at PrimeRevenue, says he has seen “a few banks selectively reduce lines to better reflect the actual usage, both historical and anticipated”.

“We have seen only two instances where a bank has exited a programme and in both, we have been able to source replacement liquidity through our network,” he tells GTR.

Capolongo explains that a multi-funder SCF model – where financing is drawn from different banks, rather than a single institution – is inherently built to mitigate risk. “If a bank decides to reduce funding, a multi-funder structure makes it easy to simply replace or add funders without any disruption to suppliers,” he says.

Bob Glotfelty, Taulia’s vice-president of growth, says the company “hasn’t seen any of the often-discussed risks materialise. Every payment that’s been requested through our platform has been funded.”

For Glotfelty, it is important to note that early payment programmes are short-term facilities – typically paid within 30 or 60 days – and on the buyer’s side, are only extended to companies with strong credit ratings.

“I don’t think there’s as much risk as it may seem,” he tells GTR. “Typically when there are challenging economic conditions you’ll see a flight to safety and these are pretty safe assets.”

He adds there is a theoretical risk that the amount of funding available will not be able to match a significant increase in demand, although says that has not yet occurred in reality despite the spike in volume so far. “I don’t foresee it being more than a minor risk,” Glotfelty adds.


Extended payment terms

Steven van der Hooft, founder and chief executive of Capital Chains – a Netherlands-based SCF consultancy firm – says the underlying question is why a bank would withdraw a line of finance.

“If the line is being pulled because the industry, the sector or a specific supply chain is doing badly due to coronavirus, then no matter what product you would have had – supply chain finance, regular factoring or whatever – those lines would have been pulled,” he tells GTR.

“There’s not a single bank out there saying they will support a corporate or a supplier in an industry if they know there’s an increased risk they won’t get their money back; they will increase prices or withdraw the limit. It’s the same risk you would have had for any other uncommitted funding.”

However, van der Hooft says there is a risk buyers could decide to take on new supply chain finance programmes “as an easy way out” of the current squeeze on their liquidity.

“That could be a problem,” he says. “Then they would set up programmes just for the purpose of extending payment terms, keeping their working capital in by suspending payment terms to suppliers.

“If done now, that could be a risk – although it all goes back to why a company uses SCF. Is it just to polish up their own balance sheet, or is it because they have an actual underlying interest in supporting that supplier base?”

GTR understands that at least one provider of SCF has observed buyers seeking to extend payment terms in recent weeks, though so far the reported increase in demand has generally been from suppliers.

For van der Hooft, a greater concern for buyers, suppliers and lenders alike will be how to reboot supply chains that have ground to a halt due to Covid-19. He says support will likely be needed for pre-shipment and pre-order financing.

“The biggest risk is that you just don’t know what’s going to happen,” he says. “You could put any product on it, blame any product for it, but ultimately this is a major situation that could turn supply chains upside down.”