Worldwide revenues from supply chain finance grew in the first quarter of 2020 despite global trade disruption, and some banks are seeking to expand their market share. But credit rating agencies warn that this financing technique could mask episodes of financial stress.

A type of trade finance, supply chain finance has been consistently growing since the global financial crisis of 2008, and revenues derived from it reached between $50 billion and $75 billion in 2019, the International Chamber of Commerce estimated.

While trade finance revenues overall were down 1% year over year in the three months of 2020, income from supply chain finance grew by 3% to 4% globally, driven in particular by growth in Europe and the U.S., according to Coalition, an S&P Global-owned research company that tracks the performance of the world's top 10 transaction banks.

'Reverse factoring'

A supply chain finance program is commonly set up by a corporate buyer with a bank or alternative provider to allow suppliers to get paid early for an invoice, usually at a discount. This method, known also as payables finance or reverse factoring, is particularly valuable for SMEs, who can access more affordable funding because the cost is based on their buyer's credit rating.

As cash-strapped companies seek liquidity during the coronavirus crisis, demand for this type of financing has surged. In March, PrimeRevenue Inc., a platform that pools funding from banks into hundreds of organizations' supply chain finance programs, facilitated $10 billion in early payments, a 5.6% increase year over year. The proportion of invoices traded for early payment on its platform rose to 93%, up from a usual level of 70% to 80%.

HSBC Holdings PLC, one of the world's largest trade finance banks, has seen a 30% to 40% increase in supply chain and receivables finance in the Asia-Pacific region on the back of longer tenors, additional suppliers and new deals coming through, a spokesperson said.

Certain banks see an opportunity to gain market share in what is a very competitive landscape, according to Nathan Feather, CFO of PrimeRevenue, which works with about 100 banks globally.

He said that while a few banks have reduced their risk exposure on the PrimeRevenue platform during the crisis, others are deploying more credit either under existing programs or by joining new schemes.

Higher margins on supply chain finance also contributed to revenue growth in the first quarter, following an erosion of margins in 2019, according to Eric Li, research director at Coalition. This is in part driven by lower funding costs because of lower interest rates, particularly for the U.S. dollar, he said.

Supply chain finance providers have also adjusted their risk premiums on certain industries or companies, Feather said.

'Sleeping risk'

Credit rating agencies, meanwhile, warn that supply chain finance poses certain risks, which could be exacerbated during the pandemic.

In a March 10 report, S&P Global Ratings called this form of finance a "sleeping risk," saying poor disclosures can obscure a company's underlying health and result in mispricing of risk or misallocation of capital.

Fitch Ratings has previously claimed that reverse factoring was a "key contributor" to the liquidation of British construction giant Carillion in 2018 because it veiled some of the firm's financial challenges.

Corporate buyers typically use a supply chain finance program as a bargaining chip to negotiate better payment terms with their suppliers. Past instances have seen companies extend payment terms up to 364 days, creating a working capital benefit equivalent to almost a year's payables "without any recognition of borrowings," said S&P Global Ratings.

Such lengthening of payment terms is in principle no different than a credit line from a bank, yet it is reported as trade payables rather than debt, said Frédéric Gits, group credit officer, corporates at Fitch Ratings.

"The concern is that if there is a lot of that happening, you will potentially have more essentially financial debt being reported as trade payables, and it's therefore going to make it more difficult for investors to understand what is the true amount of financial leverage of a company," he told S&P Global Market Intelligence.

In the case of Carillion, this "accounting loophole" allowed the company to show an estimated £400 million to £500 million of debt to financial institutions as "other payables," compared to reported net debt of £219 million, according to Fitch Ratings.

While it is too early to say whether this is a more widespread trend during the coronavirus crisis, Gits said lengthening terms of payment under a supply chain program is likely one way in which companies are going to look to improve their liquidity.

Idiosyncratic risks

Another risk associated with supply chain finance is that banks can decide to withdraw funding or not renew a program, which could happen in response to a deterioration in a customer's credit quality, loss of market confidence or broader credit market disruption, according to S&P Global Ratings.

A potential retreat from supply chain finance by banks is a real risk during the pandemic. The collapse of large corporate players such as Singapore-based oil trader Hin Leong Trading (Pte.) Ltd. and global car rental company Hertz Global Holdings Inc., which are likely to have supply chain finance programs in place, could impact banks' future appetite, said Li.

Banks including HSBC, Standard Chartered PLC, Deutsche Bank AG and DBS Group Holdings Ltd. have a combined exposure of at least $3 billion to Hin Leong Trading, according to sources speaking to Bloomberg News.

"Overall the market is still reasonably healthy. Having said that, it is not completely rosy either. We do see idiosyncratic risks coming from different markets," Li said, adding that he expects trade finance revenues generally to drop during the year.

Coalition is owned by CRISIL. S&P Global Market Intelligence and CRISIL are owned by S&P Global Inc.