Supply chain finance programmes have long been touted as an affordable and enticing option for suppliers looking to optimise their working capital. But with interest rates soaring across the US and Europe since early 2022, might suppliers have to rethink the benefits of taking early payment at a discount? John Basquill reports.


What happens when cheap credit is no longer cheap?

After the 2008 financial crisis, interest rates in the US and UK remained close to 0% for nearly 15 years. Rates in the Euro area took longer to drop but eventually plummeted to zero in early 2016.

Yet since March last year, rates have been hiked to 4% in Europe, 5.25% in the UK and as of press time are nearing 5.5% in the US, as central banks seek to put a brake on inflation. This now-unfamiliar landscape has created issues in some corners of the financial services sector.

In the US, for example, the value of historically safe assets such as government securities or mortgage bonds has dropped sharply, in some cases spooking investors and deposit-holders. The situation contributed to mass withdrawals from Silicon Valley Bank, First Republic and Signature – all three of which were subject to intervention from federal regulators – as well as downward pressure on share prices at US regional banks.

For suppliers enrolled in supply chain finance (SCF) programmes, the ramifications of a higher interest rate environment are difficult to predict.

On the one hand, when a supplier opts for early payment, the deduction they take is tied to their buyer’s credit rating rather than their own. If the buyer’s credit rating is strong, the supplier can free up working capital more cost-effectively than if it were to use alternative financing sources based on its own rating.

Industry participants report that demand for SCF programmes has remained stable or even grown since rates were raised, with little sign that taking early payment is no longer economically attractive to suppliers.

However, there are indications that some suppliers are changing how they approach programmes, for instance by being more selective about which invoices they select for early payment.

And more ominously, questions are being raised over the potential impact of a funder withdrawing or scaling back programmes, or of a buyer’s credit rating dropping, which could leave suppliers stranded without financing or stuck with options that are not economically viable.


A rising tide

SCF programmes typically use variable rates, indexed through SOFR, Euribor or another prevailing reference rate, says Bob Glotfelty, chief growth officer at working capital solutions provider Taulia.

“When interest rates go up, the cost to the supplier goes up as well,” he tells GTR. “You might immediately think that makes it more prohibitive, but the cost of all alternatives has gone up, too. This is still one of the cheapest forms of financing for businesses.”

Glotfelty notes that it can be difficult for smaller businesses to find capital during periods of economic stress, whereas more creditworthy companies tend to perform strongly, driven by an increase in the spreads between risky and non-risky assets.

“But that’s not really the situation in the current economic environment,” he says. “Instead, the water level has risen, and all boats have gone up with it. The cost banks pay for deposits has gone up and so has what they charge on loans.

“Some of the smaller regional banks in the US had some struggles around this, and it might be different in some geographies, but this isn’t an economic crisis.”

Even if the banking sector does enter a period of stress and opts to concentrate lending at the larger, more creditworthy end of the market, that could still prove beneficial to a supplier enrolled in an SCF programme, adds Maureen Sullivan, head of supply chain finance at MUFG.

“Because the cost to a supplier is ultimately based on the credit profile of the buyer, it is likely to be more attractive and will incentivise them to participate,” she tells GTR.

“In some cases, particularly during challenging economic periods, bank lending tends to tighten and it may be challenging for some suppliers to secure financing at all, so these programmes can offer a source of liquidity that may not be available from traditional lending programmes.”

Rising interest rates can also drive demand for liquidity among buyers, points out Vikas Shah, chief revenue officer at Florida-headquartered working capital and payments platform LSQ.

“After years of virtually free money, working capital becomes an even more important consideration for treasurers and chief finance officers,” he writes in a report published by Global Business Intelligence, titled 2023 State of Supply Chain Finance.

Shah says shifting patterns in demand and supply during 2022 increased stockpiles of inventory, tying up working capital, while also lengthening cash conversion cycles.

SCF funders have already responded by introducing greater flexibility into programmes, such as allowing a supplier to continue to operate on 30-day terms while the buyer has the option to repay the funder at 60 days, he notes.

“A hybrid solution that combines and leverages a secured receivables structure to maximise both receivables and payables is the ultimate solution that most enterprises need today,” he says. “The secret is understanding and utilising multiple levers simultaneously without relying on a single, rigid option.”


Feeling the strain

Even if SCF is still attractive to suppliers in the current interest rate environment, there may be a tipping point at which the benefits of early payment are no longer justified by the size of the discount a supplier is accepting.

“Yes, the cost of other forms of financing has gone up as well, but that doesn’t make the significantly higher cost of SCF any easier to tolerate for suppliers,” says Adam Josephson, a senior vertical expert at market intelligence provider FreightWaves and a former analyst in the paper and packaging sector.

Taulia’s Glotfelty suggests that is not an immediate danger to the SCF sector.

“If rates kept going up and up, theoretically at some point it wouldn’t make sense to take an early payment, but I think we’re a long, long way from that,” he says. “And if supply chain finance didn’t make sense for a business because the rates are so high, that company is unlikely to borrow money since the rates for alternatives will have increased as well.”

But Josephson suggests that rising costs present wider challenges to other participants in programmes, both on the buyer and funder sides, which could indirectly affect suppliers.

For instance, SCF programmes are established on an uncommitted basis, so could be rescinded by a bank if deemed economically beneficial.

“We have no way of knowing how profitable SCF is for banks, and consequently how inclined they are to continue to provide it,” Josephson says.

“Many US banks, particularly regional ones, have been under considerable strain in recent months, and the pressure on them appears likely to intensify as the Federal Reserve continues to tighten monetary policy and as the economy continues to weaken.”

MUFG’s Sullivan notes that programmes “are designed to support financially strong buyers that can typically weather challenging economic cycles, and though banks do have the option to close down a programme, the instances of that happening are pretty rare”.

However, if a buyer’s credit rating does start to drop those dynamics may shift, and that buyer’s SCF programmes could become less desirable for both funders and suppliers.

The scale of programmes already in place is staggering. A FreightWaves analysis of SCF usage among S&P 500 companies estimates that more than US$100bn of financing is currently in use, and suggests overall usage across corporate America could be as high as US$150bn.

Strikingly, its analysis finds that the percentage of total debt represented by SCF programmes is at its highest in the automotive parts sector. Not all companies examined are thriving.

One such business, Advance Auto Parts Inc, had US$3.1bn of SCF outstanding in April 2022, accounting for 84% of its accounts payable – the highest of any firm identified.

In May this year, the company’s share price plummeted after cutting its quarterly dividend from US$1.50 a share to just US$0.25, and its outlook was revised to negative by Moody’s and S&P. There is no suggestion the company has responded by adjusting its usage of SCF, and representatives did not comment when contacted.

Generally, industry advice to suppliers is to avoid being in a situation where the loss of a programme is catastrophic.

As Sullivan says: “Ultimately, our view is that suppliers should not rely on a supply chain finance programme as their only source of liquidity.”

But with alternative financing proving costly or challenging to obtain, that could be easier said than done.


Suppliers adapt

So far, there is little sign of alarm among suppliers.

“In terms of what we have seen day-to-day running programmes, higher interest rates haven’t really changed the level of demand for supply chain finance,” says Taulia’s Glotfelty.

From a banking perspective, there has in fact been an expansion in utilisation of SCF programmes.

“In some cases, we have witnessed suppliers coming back to us that had declined to participate a few years ago,” Sullivan says. “They are now seeing this as a lower-cost financing alternative… and both buyers and suppliers are looking at avenues to contain costs and make sure added expense is not embedded into their supply chains.”

There are, however, indications that suppliers are starting to react to the new interest rate environment and change their approach to SCF.

Speaking at the GTR UK event in London in June this year, Orbian chairman Thomas Dunn said solutions are being developed that let suppliers “lock in and fix the interest rates that they pay on their supply chain finance programmes for one year, two years, five years – whatever might be the term that they have procurement arrangements with their customers”.

Kevin Boynton, head of trade sales, transaction banking at Standard Chartered, adds: “Historically, we’ve seen suppliers will sign up and do what we call auto-turnover: this is where every invoice that comes through will be automatically financed.

“When you were living in a low interest rate environment, it didn’t cost much to finance that receivable; you would be in a position to finance every invoice straight away. Now, we see suppliers looking at this on a more selective basis.

“Once the invoice is accepted by the buyer, they look at whether they need the cash this week or next, and perhaps decide to discount it later, known as selective financing.”

One potential risk associated with SCF programmes is whether a supplier can choose to exit a programme without creating a gap in its cash cycle.

If a supplier has been taking payment 30 days early, but decides it is no longer economically attractive or viable to do so, it would theoretically be facing two 30-day cycles before it receives payment again.

“There will be a substantial short-term hit to that supplier’s cashflow,” says FreightWaves’ Josephson. “The same would obviously happen if the participating bank decided to stop making SCF available.”

But Glotfelty says exiting a programme is not necessarily a binary decision on the part of a supplier.

“Discontinuing use of early payment does not necessarily mean stopping forever,” he says. “Many businesses only want to take an early payment when they need it. For example, if they’re a seasonal business that needs cash quickly at certain times of the year but not others.

“There are some programmes where suppliers might be more locked in, but most have flexibility built in, so suppliers can turn it on or off as needed to manage their cash.”