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No Lack of Clarity ... It All Comes Down to the Credit Quality of the Receivable

Date: Jun 05, 2013 @ 07:00 AM

I have worked in commercial finance for more than a decade and I’m always fascinated how there are always new horizons of opportunity irrespective of marketplace conditions. After all, banks, which have in recent years become more intensely regulated, are now restricted to engage in lending that only fits their narrow parameters. Their capital requirements, overhead, and perspective on exposure pretty much dictate that they can only handle large volume lending transactions. In large measure, it does not make economic sense for them to undertake most small business opportunities.

Even factors and asset-based lenders, although relatively unencumbered by regulation and government oversight, still tend to fall into a comfort zone as determined by certain parameters: the type of industry, the type of business and/or deal size. They will only entertain opportunities which work best for them, which are usually influenced on their past success.

In minimizing risk, banks, factors, and asset-based lenders will not typically finance transactions where payment from the end customer comes from another nation. So import/export trade credit, financing any goods or products traveling from one place to another from anywhere in the world, has become a whole new vista for firms like RMP Trade Credit and RMP Capital. Whether the financing is domestic or international, the overlying issues become the following: (i) Is the end customer expected to make payment creditworthy or not? (ii) Do you know and understand the value of your collateral on products and goods every step of the way?

Some Examples … Generically Speaking

Here is a textbook example of the way in which an import/export trade credit transaction comes together with the participation of different factors. There's an American manufacturer selling tractors to a government-sponsored farming cooperative in Russia. In this example, an American distributor buying the tractors from this manufacturer needs financing. This distributor exports the tractors to Russia and in this case, an American factor would fund the distributor thereby enabling the distributor to properly pay off the manufacturer. The American factor helps to identify a Russian factor who in turn takes out the American factor. The Russian factor who finances this transaction on behalf of the Russian farming cooperative then receives payment over the next sixty days from the farming entity to pay the distributor who is earning a decent, fair margin.

This is a $500,000 procurement order, twenty tractors at $25,000 per unit. The American manufacturer is paid $325,000. The factor charges documentation fees of $1,500 for vetting this distributor and the invoices generated. The trade credit fees in this deal are 3% per month for three months … about $29,250, thus enabling the factor's client, the distributor, to work with a 35% margin. So the distributor has about $145,750 left to use. This distributor had shipping costs of about $30,000, leaving them with a net of $115,000. The American factor is able to identify a Russian factor who takes them out. The Russian factor charges the distributor client 2 1/2%, roughly $5000 per month until payment is made by this farming cooperative.

While this was somewhat of a large deal, based on what I first described, there appears to be a vast need among small businesses and entrepreneurial operations that now depend on overseas business. Financing a $25,000 invoice becomes good business, especially if the client has a smooth experience and then continues to repeat the process frequently.

Another illustration: A small business owner in New York approaches a factor after not being able to obtain credit from any area bank or other factors. The business owner is seeking to fund a deal to move plastics products sourced in China and shipped to Germany. Through "purchase order financing", the factor opens a letter of credit to the Chinese manufacturer. By the time the goods arrive in Germany, a German factor is identified to take out the American factor on this $50,000 order. In turn, the German factor collects from the German retailer who winds up with the plastics products. The American small business owner is now in the midst of another deal, based on this boilerplate, with the understanding that there is money and funding in place throughout the process.

Here, the American factor requires a $1,500 documentation fee from its new client. This enterprise is working on a 50% margin for this $50,000 purchase order and charges $2,250 or 3% in fees for the ninety day turnaround period. The client winds up with $21,000 after being taken out by a German-based factor, who charges the business 2% per month on the remaining $21,000 before it collects from the German retailer.

Import/Export Financing … Overcoming the Barriers

The sectors I find to be the most conducive for import/export financing are generic housewares or clothing items which can easily be bought and sold. In my experience, the electronics sector is the most difficult unless you are dealing with a top, reputable brand. Many times, lesser manufacturers and distributors are plagued by quality control problems. And if retailers demand a money-back guarantee for unsold electronic inventory -- the financier gets stuck.

There are several issues upon which the import/export financier must stay focused. The financier always must maintain control of the merchandise being produced, shipped and used in order fulfillment. Any deviation from this control widens the risk with scenarios such as compromised goods, theft of goods or possession taken in payment of liens at ports.

The quality of the end creditor must be solid. Don’t assume that just because the end creditor is a recognized brand like JC Penney or Sears, that it has the financial capacity to make proper payment on invoices. A related concern is the possibility that the end creditor, a large retailer for example, may cancel its order. In their arrogance, some end creditors want to have their way without paying any damages or penalties.

Getting a first lien in place is not always easy and gaining acceptance of subordination from prior lenders or banks is usually difficult. The resolution of issues concerning monies potentially owed to the Internal Revenue Service or similar government authorities often becomes problematic whenever there is a lack of cooperation as well.

Securing third-party take out is paramount from a factor, a bank, or obtaining a “letter of credit” from an equity capital funding source, or a credit card processor. In the past, the major stumbling block for "purchase order financing" overseas has been the inability to find someone to follow through with the necessary third-party takeout.  So it makes sense to ask your clients to obtain letters of credit from their customers. In turn, their customers can get financing from a factor, who now, could be anywhere!

There is now a basis for U.S. financing firms to look at companies in many nations of the world as debtor candidates so long as these companies and the invoices on which they payout, are creditworthy (emphasis added). Yet many banks, factors, and asset-based lenders will only stay with what works best for them. Since creditworthiness is of supreme concern, more factors are overcoming international barriers and are accepting such deals willingly. This is the opportunity to finance all aspects of the supply process for a client and/or the different parties to that deal, and thus expand a revenue stream.

A note of caution is in order. International transactions undergo political risks and corruption in some nations where their legal system lacks integrity.

Much of the time, the companies that require import/export financing and trade credit do not appreciate that the high rates charged by financiers are a result of having to account for dangerous risk and exposure. Often the businesses and their owners who gravitate to our lending sector lack sufficient capital to back their transactions and cannot obtain it elsewhere. As financiers putting up money, if a deal has a problem, we are the ones in the process who take the loss. Then we have the burden to chase down the money we are owed.

In these financings, innovation and creativity in the deal structure should always work. Because in the end, it all comes down to the credit quality of the receivable being financed. Is there demonstrated confidence that the debtor has the ability to make payment? This continues to be the central question upon which our decisions are based. As a commercial financier, if you are faithful to your principles in determining whether or not to proceed with a deal (through a strong credit department or with credit insurance), finding the answer should not be hard. As with all things, don’t be tempted to compromise on your standards … always stay within your risk assessment parameters.

Richard Eitelberg
Director of Business Development | RMP Trade Credit
Richard Eitelberg is director of business development at RMP Trade Credit.
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