Moody’s has warned that the growing use of supply chain finance in the Emea retail sector may distort companies’ financial metrics and leave them vulnerable to liquidity problems.
The ratings agency said in a December report, seen by GTR, that the majority of the region’s food and apparel retailers appear to be using buyer-led supply chain finance (SCF) to manage working capital cycles, following a study of financial disclosures from 57 companies.
The report said seasonal changes in demand and fluctuating inventory levels in these sectors create “significant working capital swings”. SCF can help ensure suppliers are paid on time while buyers can wait until busy sales periods are over to repay invoices, helping smooth liquidity management, it said.
However, following the study – the agency’s first since the International Financial Reporting Standards (IFRS) introduced disclosure requirements around invoice financing facilities – Moody’s said reliance on such programmes “may mask underlying liquidity pressures”.
Using SCF to extend payment terms can inflate days payables outstanding, a measure of how quickly a company pays its suppliers, it said.
“This artificially improves working capital ratios and makes liquidity appear stronger than it is,” the report said.
“The distortion is especially pronounced at year-end, when seasonal cash inflows and peak payables coincide. Many retailers close their fiscal year on December 31, shortly after the holiday season, resulting in elevated cash balances and lower net debt. This timing can give a misleading picture of leverage, which may appear lower than it actually is.”
This risk is amplified because most companies’ programmes are already heavily utilised, often exceeding 80% of available capacity, it said.
One particularly dangerous scenario is when sales during a busy seasonal period underperform expectations, leaving companies facing liquidity shortages when repayments fall due, it suggested.
Silja Calac, a board member at the International Trade and Forfaiting Association (ITFA) and Santander’s head of private debt mobilisation for documentary trade and supply chain finance, acknowledged programmes can carry some risk.
“Like every other instrument, supply chain finance can be abused,” she told GTR.
But Calac cited a guide first published by ITFA in 2018 that shows warning signs for when programmes are used to disguise lending as short-term working capital.
“That includes when payment terms are extended beyond industry norms, when the buyer assumes the financial cost of discounting the receivables, or if a programme is extremely large compared to other liabilities,” she said. “I don’t think much has changed since that was published.”
She emphasised that to minimise risk, bank credit committees generally assess programmes in a similar way to short-term lending.
“The bank still needs to consider whether the buyer is worth the credit being provided, whether it’s correctly priced,” she said. “It’s a serious credit analysis.”
And although there have been a small number of cases where SCF has been abused, Calac added that thousands of other programmes have proven successful in bringing stability to suppliers, including SMEs.
“I think this is an incredibly good testimony for the product,” she said.
Liquidity crunch
According to Moody’s, the liquidity risk arising from SCF is particularly acute if funding is suddenly withdrawn by a financial institution. The agency issued similar warnings in September last year following a comparable analysis of the US market.
Programmes are typically provided by a single bank or platform, and are generally uncommitted, meaning funding can be withdrawn at any time, it pointed out. Although open-ended, they are often subject to annual review.
SCF programmes are often sizeable compared to other liquidity sources, such as cash and undrawn revolving credit facilities, meaning their withdrawal could lead to a sudden increase in working capital requirements, Moody’s added.
However, this risk “needs to be put in perspective”, said Christian Hausherr, a subject matter expert at the Global Supply Chain Finance Forum and Deutsche Bank’s product manager for trade finance.
“First, if a bank grants a regular financing line, that can also be withdrawn immediately,” he told GTR.
“Second, any SCF product is subject to extreme scrutiny by the bank, and there are clear recommendations that each bank uses to formulate its credit appetite. No bank will withdraw their engagement for fun; they may drive down the line if they believe the credit rating of the buyer is going down, but that is no different from any other credit engagement.”
Despite the added transparency brought about by the IFRS reforms, which require companies to disclose the total value of invoices paid by a provider of SCF but unpaid by the buyer, Moody’s said its analysis is still hampered by inconsistencies in the information available.
It said quarterly data would provide a more accurate assessment of a company’s leverage and liquidity, but that many publicly listed retailers in Emea only publish financial statements on a half-yearly basis.
This “limit[s] transparency into seasonal swings in revenue, earnings and cash flows and the true extent of supply chain finance usage”.
In cases where disclosures do allow more precise assessment, Moody’s said it may adjust debt metrics to reflect SCF liabilities, though added that sizeable cash balances could offset any negative effects.
