Is Supply Chain Finance Pricing Mispriced?
Funding has grown more sophisticated with supply chain finance programs to large companies, driving margins down in many cases. There are several interesting issues around pricing:
- Platform providers make money on transactions not explicit charges for their sales, marketing and onboarding efforts. How are platform costs embedded in pricing? What about third party platforms? Managed services?
- If Syndication models are being used to create more capacity for buyers, how does that model impact pricing? For example, the way many large bank originators make money is by distributing most programs to other banks. If they have a $3bn outstanding program – they may keep $400m and sell $2.6 billion with a distribution margin of 25bps between what they originate and what they sell. If they have a leverage ratio of 5 or 6:1, they can make their return models work.
- If new funding players are participating in the market, Hedge Funds, Insurance Companies, and European and Asian Banks, is that money going to be there if credit cycles take a turn for the worse?
Is Expected Loss Priced Appropriately for Supply Chain Finance?
Pricing to suppliers is being priced closer to the buyer risk and the buyer’s short term borrowing. Funding is typically benchmarked off of USD or Euro Prime or Libor and will fluctuate monthly based on increases or decreases of those indexes.
Is risk mispriced? If you really price risk you put a capital loss on expected loss and its a premium to that tied to your cost of funding and operations cost. If a bank buys a AAA government bond, its capital cost is zero. U.S. treasuries are not really risk free but that is what how they are treated from a regulatory standpoint.
For SCF programs, the key question is if the expected loss (“EL”) for the contract for that party is assessed properly. Expected Loss is tied to the covenants of the program as well. You can look at Credit Default Swap data on the counterparties as a proxy to EL, but CDS was not designed for this purpose.
Because of tight pricing, more solutions are being targeted at the Middle Market (AIG-PrimeRevenue as an example). But a middle market company of $500M on 90 day terms with suppliers, and COGS is $400, even if you got every supplier onboarded, its only $100 M program. That’s the challenge there.
So are we pricing Expected Loss properly in these programs? I would be interested in hearing from you.