Movables Finance: Concepts, Key Elements, and Structuring

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Movables Finance:

Concepts, Key Elements, and Structuring

Jinchang Lai Principal Operations Officer, and Lead for Financial Infrastructure, Finance & Markets, World Bank Group

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Opening Remarks

Strategic Rationale

•  Competition is intensifying in the credit market:

ü  Opening of the sector

ü  Increasing use of technology (e.g., internet-based financial services)

ü  Clients have much more options and are becoming more discerning

•  What can be your credit institution’s strategic response?

ü  Go down/up to the market that you did not do before, with new ideologies

ü  Reach the clients that you did not serve before, using new methodologies

•  Example: What may this dealer

need?

•  Do they have real estate as the

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Movables Financing: Concepts and Approaches

Insights of a Practitioner

-  “Business is more valuable than land and building. Flow

of funds (transaction data) is more reliable than financial statements.”

-  “In movables lending, loans are not repaid from profits;

loans are repaid by the cash generated from operating cycles … … Also, with the availability of financing, an operating cycle can become progressively larger.”

-  Chinese banker, Yang Dayong, from New Finance, October 2013

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Movables Financing: Concepts and Approaches

Basic Credit Principles

•  Among others, business loan structuring usually needs to

ensure that:

ü  A loan finances an “asset” of the borrowing business

ü  A loan can be repaid by the cash flows generated from the normal

course of business, including a proper matching of timing

ü  Security-taking, if any, is consistent with the asset structure of the

borrowing business

•  In emerging markets, what is the typical asset structure of

a SME?

•  Are their financial statements generally reliable?

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Movables Financing: Concepts and Approaches

•  Movables financing: Any debt financing based on movable

assets (credit secured by movable assets--i.e. “movables”)

•  May include credit arrangements using movables

information and monitoring/incentive mechanisms, without an explicit security agreement

•  Key ingredients:

ü  What assets to finance? Where is the financing gap?

ü  A borrowing base, including future and changing assets

ü  An advance rate

ü  A monitoring and re-calibrating (matching) arrangement

•  Security taking is not just about reducing LGD; it is a way

of overcoming the “information” and “incentive” problems inherent in debt transactions

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Movables Financing: Concepts and Approaches

Economics of Secured Credit

•  How lenders control the borrowers?

ü  Various loan and security agreements, and covenants

ü  Security interests

ü  Disbursement methods

ü  Monitoring based on the above

•  Why take security?

ü  Information

ü  Incentive

ü  Controlling Loss Given Default (LGD)

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Movables Financing: Concepts and Approaches

Case I

•  Talk with a construction materials

wholesaler in US:

•  Q: Do you borrow? How do you borrow?

A: Yes. We are a typical small business. My customers normally pay us in one month. I need working capital. It is not difficult to borrow from my local bank. I give them my receivables and inventory as security.”

•  Q: How does the bank monitor you?

•  A: My manager sends them a monthly report

on receivables; and the Loan Officer comes to see our inventory once a month. My

current account is also with the lending bank.

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Movables Financing: Concepts and Approaches

Potential Dimensions of Structuring a Movables Credit •  Legal form of transaction

•  Underwriting basis

•  Control of collateral, and monitoring and recalibration frequency

•  Advance rate

•  Role of third-party services providers (e.g., CMCs, credit

enhancers)

•  Lenders involve in AR & inventory collection/management?

•  Filing of security interests?

•  Transfer of title: With or without recourse?

•  What is the level of MIS support? E-Platform?

•  Notification to account debtor (customer)?

•  Support from supply chain/cluster actors (suppliers, buyers, etc.)

•  Bulk or detail?

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Movables Financing: Concepts and Approaches

Degree of Control High _Low High FS Loan Bulk ABL Low Quality of Borrower D eg re e o f C o n tr o l

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AR Financing

•  The most important movable asset to use

•  Closer to cash … justifying for higher advance rates

•  Examples of AR:

ü  AR of a supplier to a supermarket

ü  AR of an agri inputs dealer from the farmers

ü  AR of a wholesaler

ü  AR of an equipment manufacturer/vendor

ü  AR of a hospital from social security scheme/insurance companies

•  Quality of AR: dilution, concentration, turnover

•  Not all ARs may be “eligible”:

ü  Typical ineligible ARs: accounts beyond X days, cross-default,

cross-aging, contra account, over concentration, accounts due from certain customers, etc.

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AR Financing

Basic Structure Lender Account Debtor (customer) Borrower (client)

Goods & Services

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AR Financing

•  Four types of AR financing in a normal market:

ü  Financial Statement (FS) Lending (Bank Finance)

ü  Asset-Based Lending (ABL, Commercial Finance)

ü  Factoring and Off-Balance-Sheet Finance

ü  Debt Instruments based on AR; and Securitization

•  Two basic legal forms:

ü  Assignment of AR (similar to “pledge of account” in some

countries)

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AR Financing

FS Lending

•  For clients with better credit standing

•  Advance rates typically between 50-95%

•  Often controlled through a “borrowing base certificate”

•  Often in the form of a revolving credit, but not always;

financing amount can grow with sales/current assets

•  Short-term credit: renewed regularly, but may need

30-90 days clean period per year

•  Medium and long-term credit: not unusual, tied to a

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AR Financing

FS Lending

•  Apart from the typical DD requirements on business loans,

need to ensure that:

ü  ARs are from the normal course of business

ü  Account debtor is not related to the borrower (i.e., not from the related

businesses)

ü  Borrower has reasonable commercial credit management capacity

ü  ARs have no burdens (no prior interests)

ü  Some validations may need to be performed

•  Basic regular information requirements: ü  Sales ledger and collection details

ü  ARs Aging

ü  Bad debt list with details

ü  Customer list with contact details

ü  Payables details and aging

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AR Financing

Calibration

Sales 120

Minus: Cash Sales 20

Accounts Receivable 100

Minus: Ineligibles 10

Eligible ARs (Borrowing Base) 90

Advance Rate 80%

Availability 72

Credit Limit 75

Lending Amount = Min (Availability, Credit Limit) 72

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AR Financing

Calibration

Outstanding ARs, beginning of period 5000

New ARs from the period 1000

Minus: Ineligibles 200

Outstanding ARs, end of period 5800

Advance Rate 80%

Availability, end of period 4640

Already Drawn 3900

Available for Drawing 740

Draw-Down Amount Periodic Calculation of

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AR Financing

Asset-Based Lending

•  An intensively monitored form of lending for lower

quality clients

•  Very frequent matching of borrowing base, availability

and outstanding credit amount to maintain the Advance Rate

•  Controls over collaterals: desk analysis; selected

validations; and field audit

•  Controls over borrower cash flows via Lock Box,

Designated Account or Blocked Account

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AR Financing

Asset-Based Lending

•  This type of lending has significant social benefits

•  Potential clients:

ü  Higher risk clients that cannot be taken on by FS Lenders, e.g.

lower-than-top-tier SMEs

ü  Others: new businesses without much history, high-tech firms,

highly-leveraged firms, even financially distressed entities •  Need ability to realize movable asset collaterals

efficiently in case of default

•  Requires a different mentality and philosophy than those

under traditional business lending

•  Often, conducted by a lending team different from the

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AR Financing

Asset-Based Lending

•

Main contents of field audit:

ü  Invoices vs. supporting documents

ü  Sample check on customers and their trading history

ü  Client’s bank account details vs. collection/cash ledgers

ü  Validation of copies of “credit memos”

ü  Examining payables and contra accounts

ü  Regulatory compliance (e.g., tax, special industry requirements)

ü  Follow up with the previous field audit findings

•

The concept may also be applied to large invoice

discounts through three-party agreements

•

Example: How is the different Degree of Control

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AR Financing

Difference between Bulk and Detail – Example of a Leading Player

Bulk Product Detail Product

Pool of ARs Individual ARs Posted

No Customer Credit Guarantee Customer Credit Guarantee

Recourse Non-Recourse or Recourse

Client Submits Aging Agings Generated by Lender

Daily Matching with Advance Rate

Cash Dominion Cash Dominion

Non-Notification, or Notification (the latter is called "factoring with recourse")

Notification

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Inventory Financing

•  Examples of inventory:

ü  Raw materials of a manufacturing SME

ü  Goods for re-sale of a trading company

ü  Commodities in store of an exporter

ü  Merchandise on shelf in a shop

ü  Livestock, crops, and final produce of a farm

ü  Equipment in stock of a dealer

•  Often done together with accounts receivable financing

based on an operating cycle

•  Different “degrees of controls” for different levels of

client risks under various products

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Inventory Financing

•

Quality of inventory: Preservability, inventory mix,

liquidity, turn-over & aging, warehousing/compliance

aspects

•

Similar process of

“eligibility – advance rate –

availability – lending amount -- drawn-down amount”

calculations and matching

•

Valuation risk: Fluctuations of commodity price; need

to hedge, if possible

•

For new lenders, maybe easier to start with Floor

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Inventory Financing

•  Often involve “field warehouse”, particularly for SMEs

•  Use of 3rd party collateral management companies (CMCs):

ü  Lenders need to have acceptance criteria on (and an eligible list of)

CMCs

ü  CMCs better have liability insurance

ü  Reporting, valuation and inspection requirements

ü  Who is responsible for the quality of stored goods?

•  Two main types of contracts: CMA and SMA

•  What standards are your CMCs following?

ü  Do they do serious DDs on borrowers and warehouses?

ü  How many active contracts do they have?

ü  Are they really holding the only key to the warehouse in the case of

CMA?

ü  What is the risk of writing multiple warehouse receipts by a CMC and

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Inventory Financing

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Inventory Financing

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How to Go about It?

Enabling Environment

•  Basic foundations:

ü  A secured transactions law

ü  A modern registry

ü  Lenders’ willingness and capability

•  Further development:

ü  Rules and guidelines from the banking regulator

ü  A collateral management industry

ü  Availability of credit enhancement services

ü  Value chain finance e-platforms

•  There are always some transactions that can be done

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How to Go about It?

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How to Go about It?

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How to Go about It?

How It Looks Like in a Relatively Matured Lending Institution?

•  Movables lending is practiced in practically all client

segments (small business, mid-market, corporate banking)

•  Under the lending function, several business units

(Departments, or sub-lending lines) are engaged in the business

•  Successfully established a product system, not just one

product

•  Have several brands ... often in overt or embedded

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How to Go about It?

How It Looks Like in a Relatively Matured Lending Institution?

•  Have a series of operational guidelines and/or product

manuals

•  Based on value chains (supply chains) or clusters; may

have one or more e-platforms

•  Strive to provide non-credit services leveraging value

chains/clusters

•  Remember: What clients need are practical solutions!

•  NB: “Movables lending” is a conceptual word --- actual

business goes under numerous product and brand names.

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How to Go about It?

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How to Go about It?

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How to Go about It?

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How to Go about It?

Comments of a Borrower

-  “Like me, I do not have land and buildings to be used as

collateral. A CGB banker studied my flows, inventories, inventory ledger, and sales ledger. Then, the bank gave me a loan. This is unthinkable before.”

-  “Now, they give me a loan in three days.” “Since I do not

have adequate financial statements. No bank could lend to me before. I even went to informal lenders; but they asked for 45% interest rate.”

-  A small shoes exporter in Dong Guan and client of CGB, from Economy & Nation Weekly, November 11, 2013

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How to Go about It?

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How to Go about it?

Examples of Two Players

•  A mid-sized national bank:

ü  Under three business lines: Small Business, Transactional

Banking, Corporate Banking

ü  Under one business line alone, 42 products form a “movables

product system” (by April 2013)

•  A very small credit guarantee company (finance company, as of early 2013):

ü  Recently launched a new SME product suite – “An Shang Loans”

ü  It contains five credit products: Real estate equity loan; supply

chain finance (AR & inventory); intellectual property loan; loans based on trade flows (AR & inventory); and unsecured loan for entrepreneurs (natural persons)

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How to Go about It?

Example of a Supply Chain Finance Suite

•  Rolled out by a joint-stock bank around 2009-10

•  Brand name: “Win-Win Chain”

•  It contains seven products (as of 2013):

ü  Future inventory financing: Lender controls borrower access to

inventory; for procurement purpose

ü  Inventory rights pledge loan: Based on WHR, Bill of Lading, etc.

ü  Inventory pledge loan: Secured by a changing pool of inventory

ü  Accounts receivable financing: Based on a pledge of AR or

factoring of AR

ü  Cross-border payments financing: processing and financing in one

package

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How to Go about It?

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How to Go about It?

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How to Go about It?

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What are New in This Space?

•

Developing and formalizing a collateral management

industry

•

The rise of e-platforms:

ü  Digitization of ARs and WRs

ü  The Visibility and transparency of value chains have increased

greatly with technology

ü  Entry of the payment services providers

•

The extraordinary rise of e-commerce players:

ü  What are the Information and Incentive advantages that an

e-commerce player have in comparison to the traditional commercial banks?

ü  What “Controls” and even “Possessions” that an e-commerce

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What are New in This Space?

Case III

Group A is a major e-commerce player with two large online shopping platforms. Not long ago, it started a finance subsidiary to provide loans mainly to the MSME suppliers/sellers on its platforms. The loans are said to be all unsecured. By

August 2014, about half a million MSMEs have been supported.

The payment process for online shopping: buyer places an order à shop accepts order and delivers the goods à the purchase amount moves from the buyer’s online wallet to an escrow account controlled by Group A à money moves from the escrow account to the seller’s online wallet after buyer clicks to indicate satisfactory receipt of goods or automatically 7 days from the date of purchase. Group A also has power to expel or block a shop on its platform.

Questions: What is the nature of the credit provided by Group A? Is it a secured loan? Is this movables lending?

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Thank You !

The views and judgments of this presentation are those of the author. The conclusions and judgments contained herein should not be attributed to and do not necessarily reflect the views of IFC, or its management and Board of Directors, or the countries they represent. The author, by means of this document, is not rendering any professional advice or service, and shall not be responsible for any loss sustained by any person who relies on this presentation as a substitute for professional advice or service.

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Annex: Terminologies (I)

•  In local language •  Secured Transactions, secured

financing, secured credit,

secured loan!

•  Security Interest, security right

•  Security, collateral, guarantee

•  Personal property (movable

asset, or movables), real

property (immovable asset, or immovables)

•  Possessory, non-possessory

•  Movables financing

•  Asset-based finance,

asset-based lending (ABL), commercial finance

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Annex: Terminologies (II)

•  Collateral management company

(CMC)_!

•  Collateral Management Agreement

(CMA); Stock Monitoring Agreement (SMA)

•  Value chain, supply chain, cluster

•  Accounts receivable (AR) financing

platform, supply chain finance

platform, movables finance platform, e-platform

•  Account Debtor (customer, buyer);

Borrower (client, supplier, obligor)

•  Bulk/Detail

•  Security interests registry (collateral

registry)

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Annex: Terminologies (III)

•  In local language •  Invoice!

•  Trade Debtors/Debtors; Trade

Creditors/Creditors

•  Credit Memos/Credit Notes

•  Non-deposit-taking lenders

(NDTLs)

•  Aging, Availability, Cash

Dominion

•  Notification, Recourse

•  Field Audit

•  Field Warehouse, Public

Warehouse

Movables Finance: Concepts, Key Elements, and Structuring