A new era in structured trade receivables finance?
'First published in Structured Credit Investor on 25 March 2014'
Reed Smith partner Nick Stainthorpe discusses new investors, technology and opportunities in supply chain finance
The increased interest from alternative investors in trade receivables is the result of a number of factors. These include: the high asset prices/low yields being experienced in other asset classes; the wariness of corporates to rely on a single source of supply chain/receivables finance in the post-crisis environment; on-going credit shortages in this sector in countries like Italy, Greece and in emerging markets; and improving technological solutions for managing trade debts, which facilitate financing. Supply chain finance is a variation on the theme and could present significant opportunities for alternative investors.
Trade receivables are short-term debts that arise when goods or services are sold. They are generally (but not always) unsecured and can present the financier with some unusual risks, such as the risk of volume rebates and product returns. They can be understood as short-term corporate loans with yields depending on the discounts to face value at which they are purchased, and they are uncorrelated to many other major asset classes.
Defaults have been historically low, even at difficult points in the cycle, but the fast turn-over of the assets means that a well-structured programme should entitle the financier to exit any commitment to continue purchasing on one of a number of early warning signals. Equally, the need to maintain the supply chain in order for a business to survive makes it less likely to default on its trade debts.
Trade receivables financing for larger corporates tends to be done on razor thin margins. However, in peripheral sectors and economies, transactions are possible with unlevered annualised yields over 10%. It is these higher yielding transactions in particular that have attracted interest from alternative investors.
A typical trade receivables securitisation involves one or more originators within a corporate group selling debts owed by a diverse range of debtors on a committed basis to a purchaser SPV (or potentially to a number of SPVs, where local regulatory or tax constraints require the use of local purchaser SPVs for particular originators). Supply chain finance, or reverse factoring, is somewhat different from a standard trade receivables financing, but can also lend itself to securitisation.
In its most simple form, it consists of a company - the head of the supply chain - procuring purchasers for the debts that it owes to its suppliers. The suppliers, once given ready access to finance, may be prepared to supply more goods at lower prices to the company and the company may even invest in the receivables itself.
The company will use its bargaining power with the suppliers to encourage them to use the programme and thereby ensure that it is fully utilised. One way of looking at it is that it offers corporates a means of effectively accessing working capital without borrowing (and entirely off- balance sheet), at the expense of their suppliers.
A key challenge with financing trade receivables is that they have to be purchased frequently to create longer-term investments and the total amount of financing required is likely to fluctuate. For example, the sales of some businesses in the retail sector are highly seasonal.
Within limits, fluctuations in the size of the receivables pool can be catered for by involving a bank to provide senior funding on a revolving basis, while mezzanine investors with higher yield targets make term investments. More generally, investors must ensure that the originator is capable of generating a consistent flow of receivables of suitable quality as part of their due diligence.
Origination is being facilitated by cloud-based platforms like Aztec Exchange, which use a combination of local sales teams and technology to identify and on-board corporate sellers for their finance partners in an increasing number of jurisdictions. The technology to facilitate supply chain finance offered by the likes of PrimeRevenue and Tradeshift is also growing rapidly and could potentially lend itself to structured credit products.
The penetration of alternative investors into this area is set to increase due to the convergence of three factors: capital constraints in the banking sector; corporate demand for working capital; and the hunger for higher risk-adjusted returns. Add to that the enormous opportunities in the SME sector (where financing is being positively encouraged by governments), emerging markets and the growth of cloud-based technology platforms to facilitate this area of finance and it is clear that it is worth close attention.
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