“Hidden Debt Loophole Could be Widespread”: Fitch

Use of this financial instrument has ballooned. No one knows to what extent because there’s no disclosure. But it was a “key contributor” to the sudden collapse of outsourcing giant Carillion.

As regulators and stiffed creditors were poking through the debris of collapsed outsourcing giant Carillion – once employing 43,000 people worldwide – they found that the UK company had hidden much of its debts. And Fitch Ratings warned that this “technique” – a “debt loophole” – may be “widespread” in the US and Europe.

Carillion provided services to governments. It didn’t manufacture anything, didn’t have a lot of assets, and didn’t have a lot of debt – at least not disclosed on its books. Net debt on its balance sheet amounted to £219 million. But Fitch estimates that it had an additional financial debt of £400 million to £500 million.

This debt was hidden by a “technique commonly referred to as reverse factoring,” Fitch says. And it was “a key contributor to Carillion’s liquidation.”

This “reverse factoring” – part of supply chain financing – allowed Carillion to hide a debt of £400 million to £500 million in “other payables,” such as money owed suppliers. There were indications that something was off: Over a four-year period, “other payables” had nearly tripled, from £263 million to £761 million. According to Fitch, “This appears largely to have been the result of a reverse factoring program.”

But this was financial debt owed to banks – not trade accounts payable.

Any disclosure?

Almost none. Fitch explained in the report (press release here):

There was one passing reference to the company’s early payment program in the non-financial section of the accounts, but nothing in the audited financial statements and no numbers.

The only clue to the scale of the supply chain financing was the growth in “other payables,” the implications of which do not appear to have been appreciated by many in Carillion’s broader stakeholder group.

Carillion was no exception. Disclosure rules are “complex” and “highly dependent on specific circumstances, auditor, and jurisdiction,” Fitch says:

Promotional literature in the field regularly cites as a benefit the fact that supply chain financing – and reverse factoring in particular – can be shown as accounts payable rather than debt. Companies borrow cash while avoiding its inclusion in financial covenants or debt reported on the balance sheet.

A review of a number of companies with supply chain financing program shows precious little by way of disclosure.

Reverse factoring programs are aggressively marketed by banks and specialized financial institutions in the supply chain finance industry. And this lack of disclosure requirements is one of the key selling points.

How much reverse factoring is going on?

“We believe the magnitude of this unreported debt-like financing could be considerable in individual cases and may have negative credit implications,” Fitch says. But due to lacking disclosures, no one knows the magnitude.

Greensil, which provides supply-chain financing and claims to have financed $30 billion to date, estimates in its promotional literature that about $3.5 trillion globally is tied up in working capital. But not all of it can be leveraged in supply-chain finance.

Fitch tried to estimate if “reverse factoring” is increasing. It looked at a sample of 337 companies and found that the metric “payable days” – the average number of days companies were stringing out their suppliers – had grown by 17% since 2014, to 96 days in 2017.  Fitch believes that in 2017 alone, payables days rose 6%.

“Assuming all of this increase was reverse factoring, then this could be as much as $327 billion additional reverse factoring since 2014” among the 337 companies, Fitch said. That’s an average increase of about $1 billion per company in the sample.

But not all of this growth is reverse factoring. Other dynamics play a role too, including the “ongoing cash management efforts by the companies in the sample, with supplier terms being squeezed.”  But due to lacking disclosures, it’s “impossible for a third party to tell one way or another.”

How does reverse factoring work?

Supply chain finance in general describes working capital management techniques with which a company extracts financial benefits from its supply chain. The “most publicized” of these techniques is reverse factoring. Fitch explains how it works and the reasons for doing it:

Company A, the buyer, purchases goods in the normal course of business from company B [often not rated or junk rated]. Company A, typically a large well-rated corporate, will arrange a reverse factoring program with a financial institution.

Once it has been on-boarded into the program and negotiated terms with the bank, B will be able to submit the invoices it has issued to A, once A has validated (or confirmed) them, to the bank for accelerated payment. It could get paid after 15 days rather than its usual 60 days.

The supplier benefits because it gets quicker access to cash but at the lower borrowing cost associated with the stronger credit rating of its customer.

The buyer benefits because reverse factoring allows it to borrow without disclosing it as debt:

As part of this process, the bank will also often allow company A longer to pay the invoice than B would have accepted without the supply chain finance arrangement. So rather than paying in 60 days it may pay only after 120 days. This is effectively using a bank to extend payment terms….

Thus, the buyer is borrowing 120 days of its accounts payable from the bank, while the bank pays the supplier. None of this debt that the buyer owes the bank shows up as “debt” on the buyer’s balance sheet but remains in “accounts payable” or “other payables.” The money borrowed from the bank becomes cash inflow on the cash-flow statement. And the highly touted figure “cash” increases. Hallelujah.

How does Fitch treat reverse factoring — if it’s disclosed?

If a company provides “sufficient and reliably consistent disclosure,” Fitch adds the dollar amount resulting from an extension in “payable days” – for example from 60 days to 180 days – to the amount of the debt.

If the buyer has $100 million in unpaid invoices after an extension of payables days from 60 days to 180 days, Fitch assumes that 120 days of that outstanding invoice amount, or 66.7%, is due to a reverse factoring program. It would therefore treat $66.7 million of that $100 million as financial debt, rather than trade payables, and adjust its credit metrics accordingly.

But that increase in financial debt might put the buyer in violation of its debt covenants or impact negatively other credit metrics that would increase its costs of borrowing. Hence, this “sufficient and reliably consistent disclosure” is precisely what few companies do. And this financial debt remains hidden in trade accounts payable.

Creditors and shareholders are at risk without knowing it – see Carillion

The fact that this financial debt is not disclosed, “combined with the potentially serious consequences where companies’ use of factoring programs goes unnoticed, is cause for concern,” Fitch says tersely.

“As seen in the case of Carillion, reverse factoring could have a potentially large impact on vulnerability to default for specific issuers, making awareness critical.”

Cash obtained via reverse factoring is particularly fragile because when this company gets into financial distress, the bank simple cancels the reverse factoring program, and the company will have to come up with funding to pay down its accounts payable to the terms agreed to with suppliers.

To use our example above, the buyer would have to come up with $66.7 million to pay down its payables from 180 days to 60 days – and this would happen as the buyer is already under financial stress, just when it can no longer borrow money at survivable rates. This is how reverse factoring increases the likelihood of a sudden default and Carillion-style collapse.

“Sectors that are large users of reverse factoring include consumer packaged goods, telecommunications, chemicals, retail, and aerospace,” Fitch says.

GM, Fiat Chrysler, and Ford all got ugly in unison, in one day, something we haven’t seen since the Financial Crisis. Read…  Carmageddon in Detroit  
 

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  87 comments for ““Hidden Debt Loophole Could be Widespread”: Fitch

  1. Ppp
    Jul 30, 2018 at 9:00 pm

    The next question is: how much are these reverse factoring assets leveraged?

    As I have said previously, when the financial system collapses, which will be very soon, the supply chain will collapse. At that point, not even an autocracy will make the trains run on time. Now what?

    • Mick
      Jul 31, 2018 at 9:43 am

      State of Illinois is doing this is a big way. Maybe not factoring it, but it’s off the books debt none the less.

  2. Chris
    Jul 30, 2018 at 9:11 pm

    Really fantastic article, thanks! Any idea who some major guilty parties might be? I immediately thought of Netflix and pulled their balance sheet, and they’ve got 6 billion in current liabilities. That’s up from 4 billion two years ago. And, they’re 1.5 billion in the hole on working capital. Good god.

  3. Bill from Australia
    Jul 30, 2018 at 9:23 pm

    QUOTE (But due to lacking disclosures ,its impossible for a third party to tell one way or another) Then what the hell do these ratting companies do to justify there existence. They failed 2007/2008 and we rely on them now !!!!! God help us in the forthcoming global meltdown. They are merely confirming that they are incompetent.Millions were lost by there rating scams ,seems like its on again.

    • Jul 30, 2018 at 11:43 pm

      Rating agencies are NOT auditors or regulators.

      • Wisdom Seeker
        Aug 1, 2018 at 1:13 am

        But they ought to be smart enough to count payables as a liability just like debt, when assigning ratings…

        P.S. Worth a mention that Fitch, at least as of 2008, was one of the Good Guys. S&P and Moodys are swamp creatures who will sell ratings as needed.

    • phathalo
      Jul 31, 2018 at 10:41 am

      Yes, this is definitely not something you can put on rating agencies.

      • Javert Chip
        Jul 31, 2018 at 3:27 pm

        Don’t know I agree with that.

        If your trade payables is blowing up to months instead of a few weeks, something’s wrong. Rating companies might not know WHAT is wrong, but they know SOMETHING is wrong, especially so if cashflow is materially increased by increased time-to-pay.

        Administratively I understand how this works but as a retired CFO, I don’t understand how a bank loan to company A (for whatever reason, including paying company B) is not booked as short-term debt for company A.

        Factoring in a time of 1% (or less) interest rates just reeks of desperation. Somebody paid some good bribes (er, campaign contributions) for this loophole.

        • Hirsute
          Aug 1, 2018 at 9:55 am

          Agreed. After all, ratings agencies should not be vigilant to balance sheet deterioration? When your quick ratio is declining, that’s not healthy.

    • Maximus Minimus
      Jul 31, 2018 at 12:55 pm

      You wanted to say auditing firms, and the correct term is willfully incompetent.

      • Javert Chip
        Jul 31, 2018 at 3:33 pm

        However, if this is what the current law (or accounting standard is), politicians, not auditors are at fault.

        Auditors aren’t responsible for pointing out silly stuff, just illegal and/or non-compliant stuff.

        • Wisdom Seeker
          Aug 1, 2018 at 1:16 am

          No, auditors, as a profession, are at least morally responsible for keeping the politicians honest, and they ought to be lobbying against loopholes like this and publicizing the corruption when they fail.

          They should also be waving red flags anytime they see these sorts of shenanigans on a balance sheet.

          Unfortunately, to actually live up to their ethical responsibilities, auditors would have to work for shareholders rather than management.

        • Javert Chip
          Aug 2, 2018 at 3:03 pm

          Wisdom Seeker

          Morally responsible auditors, indeed; dream on.

          Auditors are caught between corporations (who hire & pay them) and politicians (who require “audits” and define the rules). If auditors, as currently composed, stood up and fought back, they be crushed in an instant.

          Shareholders (not corporations) should be the party directly paying for REAL audits to ensure compliance with REAL rules.

          A simple tax on stocks probably isn’t the best way to go (some industry’s audits are more complex & expensive than others), but it would be a hell of a lot better that the current fiasco.

        • R Davis
          Aug 3, 2018 at 11:42 pm

          Javert chip: you say “if auditors as currently composed, stood up & fought back, they would be crushed in an instant”

          Not necessarily – one needs to give something a try before shutting the door on it.
          In this deviant & deceitful era, aren’t we all desperately yearning for truth & reality & therefore would we not champion such gusto & then who could bring it down.

          It is that the auditors are part of the game of corruption – it’s no fun to be sitting on the sidelines watching the action happen.

    • R Davis
      Aug 3, 2018 at 11:19 pm

      Hi Bill, I’m in the slick city of Melb … where Premier Daniel Andrews is hell bent on our beloved city having more rabbit warrens under Melb St’s than any other state in Aust.
      TRANSURBAN is laughing all the way to the bank – hey !!

      Okay – the way I read it is that the Ratings Agencies were invented / created / brought into being – by the banks – a bit like you asking your uncle to pretend to be ‘an old boss or the pillar of society’ & vouch for you – even though he knows you are unreliable & lazy.
      Crickey, the things they get way with.

  4. Tom Stone
    Jul 30, 2018 at 9:31 pm

    Wolf loves to criticize those who are “Doing God’s Work”…
    These are JOB CREATORS!
    Their brilliant innovations have led to untold prosperity for the deserving few.

    • Rates
      Jul 30, 2018 at 10:21 pm

      This is why I am not sure what is behind the whole MAGA thing. I mean with these kinds of innovation and Private Equity, the US is already great!!!

      China? China does not have sh** on us.

    • JungleJim
      Jul 30, 2018 at 11:19 pm

      You’re supposed to put “/sarc” at the end so that everyone will know that it is sarcasm. It was sarcasm wasn’t it ?

      • Jul 30, 2018 at 11:51 pm

        It was :-]

        Tom has been around here for a long time.

    • Cashboy
      Jul 31, 2018 at 12:17 am

      ETF’s are a “brilliant innovation” and “job creators” as are CDS’s.
      Debt and methods of creating, hiding debt, protecting debt has created so many jobs and so much misery.

  5. Mean Chicken
    Jul 30, 2018 at 9:34 pm

    Somehow I adore the sound of “Outsourcing giant collapses”.

    • MCH
      Jul 30, 2018 at 9:58 pm

      In certain countries, outsourcing giants will never be allowed to collapse, it would impede good parts of the economy if that happened. Worse yet, it would really hurt the companies that rely on them.

      • Javert Chip
        Jul 31, 2018 at 3:37 pm

        intriguing claim. Got any current examples?

        Indian IT companies?

  6. Mean Chicken
    Jul 30, 2018 at 9:39 pm

    “Cash obtained via reverse factoring is particularly fragile because when this company gets into financial distress, the banks simple cancels the reverse factoring program, and the company will have to come up with funding to pay down its accounts payable to the terms agreed to with suppliers.”

    My guess is you or they (Fitch) really meant to say “lenders” as opposed to “banks”.

    Thus a problem may exist for lenders, as well.

  7. bret
    Jul 30, 2018 at 9:48 pm

    shameful that regulators allow this to happen. Weren’t there major accounting overhauls just a few years ago to catch this stuff? What can be done to stay ahead of these new “innovations” for the public good, or does anyone with knowledge have the will to stop it?

  8. max
    Jul 30, 2018 at 9:49 pm

    John 10:12-13
    “ The hired hand is not the shepherd and does not own the sheep. So when he sees the wolf coming, he abandons the sheep and runs away. Then the wolf attacks the flock and scatters it. The man runs away because he is a hired hand and cares nothing for the sheep.”

    incentives are at the heart of most of the problems

    “Show me the incentive and I will show you the outcome.”

    It’s Not How Much You Pay, But How

    “who will guard the guardians?”

    “Who’ll keep the bastards honest ?”

    The larger the share of company stock controlled by the CEO and senior management, the more substantial the linkage between shareholder wealth and executive wealth.

    • Setarcos
      Jul 31, 2018 at 6:30 am

      Who will guard the guardians? Surely the guardians are not suceptible to the basic human tendencies. /sarc

  9. Mean Chicken
    Jul 30, 2018 at 9:51 pm

    One more though b/c where’s there’s smoke fire always exists…

    If say for instance, Banco Sabadell was a major reverse factor lender then how long could they continue operating if they were to “lose” their accounting records due to a computer database snafu?

    I realise of course many of the bad stories have been manufactured or blown out of proportion by MSM only to discover down the road was at best half true.

  10. William Smith
    Jul 30, 2018 at 9:54 pm

    Have the banksters tranched up these things and onsold the risk to the mums and dads? Seems to me that there is lots of room to play with synthetics in all of this. At least the actual dollars are still on the balance sheet (just “moved” to another GL account), it is when they try to move/hide things off balance sheet (fraud) that is of even greater concern.

  11. nick kelly
    Jul 30, 2018 at 10:06 pm

    A couple of weeks ago I was reading the biz section of Canada’s Globe and Mail. In the legals was a large ad announcing the CCRA (Our equivalent of Chap 13) of at least half a dozen companies.

    They were all subsidiaries of Carillion.
    And here I thought it was a UK outfit.

    • Prairies
      Jul 31, 2018 at 10:58 am

      It was mentioned when Carillion first hit the news that they had a lot of contracts in Ontario. It was either mentioned or I got curious and dug up the information myself, which happens sometimes. I lose track. Just remember the corporate world is globalized, they hide their banking in a haven, hire cheap labor in a desperate region, all to supply the over indulged.

  12. Gibbon1
    Jul 31, 2018 at 12:54 am

    This like the mirror image of borrowing against payables. Something semi legitimate that can easily result in a sudden crash and burn. Classically used to pay for time and materials during the execution of a contract. But I’ve seen it result in a ponzi type ramp up and crash as loans against payables go to cover losses on previous jobs. Companies can go for years as long as ‘revenue’ is growing. When that stops it’s painful.

    • Cynic
      Jul 31, 2018 at 2:24 am

      Writ large,that applies to our whole industrial civilization: hence the outrageous GDP manipulations ,etc, so well set out by Wolf, but eventually Reality will reassert itself, and it will be more than painful…..

  13. Eastwind
    Jul 31, 2018 at 2:13 am

    Wolf, do you know how auto manufacturers financially engineer their supply chain / accounts payable? They must have had some scheme equivalent to this in place for years, right?

    I was laughing imagining Elon Musk reading this article at 2 am and phoning up his finance guy to yell at him “Why aren’t we doing this? We’re only 90 days past due! I need all our accounts payable at 240 days by next month!”

    • Trey
      Jul 31, 2018 at 4:21 am

      From March 2016 to March 2018, Tesla’s accounts payable has risen from $1.013 billion to $2.603 billion (source: Ycharts). It looks like Elon already beat you to it.

      If Tesla is doing what Wolf describes, the question becomes: how much of that $2.603 billion is held by banks?

      This also puts the WSJ report about Tesla shaking down suppliers for “rebates” in a new light. If correct, Tesla is not just renegotiating terms with suppliers. They are asking firms they owe money to (i.e. creditors) to forgive debt. And based on Wolf’s story, some of that debt may be held by banks. Uh oh.

      • Eastwind
        Jul 31, 2018 at 7:34 am

        Needs deeper data analysis than ycharts to know for sure. Accounts payable for Tesla might be increasing because they’ve been ramping up production, not due to use of reverse factoring or even plain old fashion late paying.

        Apart from index funds, I don’t have a Tesla position, I just mentioned them for the laugh. I am long Ford. So I am interested in whether the auto industry uses reverse factoring, or if perhaps it has its own substitute scheme that does the same thing but was worked out before reverse factoring was invented.

      • Javert Chip
        Jul 31, 2018 at 4:29 pm

        Raw Tesla data “A/P days Outstanding” to chew upon:

        2014 = 155 days
        2015 = 156 days
        2016 = 207 days
        2017 = 157 days

        ps: in a health business, I’d expect 15-45 days outstanding

        My methodology:

        Divide Account Payable (at end of year) by Total Cost of Sales (annual) = %age of unpaid supplier expense

        Multiply 365 (days in year) by %age unpaid supplier expense = days of outstanding supplier expense

        • Javert Chip
          Jul 31, 2018 at 4:31 pm

          ps: in a healthy business, I’d expect 15-45 days outstanding

        • Javert Chip
          Jul 31, 2018 at 4:31 pm

          ps: in a healthy business, I’d expect 15-45 days outstanding

    • Jul 31, 2018 at 8:29 am

      You have to have access to a company’s inner sanctum to find out if they’re doing this. Fitch cannot find out from looking at the disclosed data. So unless a company discloses it, the public won’t know until the company collapses, like Carillion, and then everyone can sort through the debris.

      So for now we can only guess by looking at the payables amount, but there could be other reasons for significant rises.

      • Gibbon1
        Aug 1, 2018 at 1:34 am

        > payables amount

        Thing I know because I actually gab with the accountants. People think big companies pay their bills on time. They do not. They will string you out as much as they think they can get away with.

        That isn’t a new thing either.

        It’s why 2 net 30 exists.

        • Aug 1, 2018 at 8:40 am

          I’m on the receiving end of two of the largest outfits out there, Google and Amazon – I know whereof you speak :-]

          “Net 30” sounds like the silliest thing today.

  14. raxadian
    Jul 31, 2018 at 4:24 am

    So now ranting agencies should start to use asterisks next to a company grade if any company has a lot of “other payables”, right?

    Or they are just warning about this but they don’t plan to change their ranting methods at all?

  15. Jul 31, 2018 at 4:42 am

    I wonder what the Tesla, other payables, contain?

  16. Scott
    Jul 31, 2018 at 5:27 am

    Wasn’t there a time when companies’ standard Payment Terms were Net 30? This seems that the widespread use of reverse factoring (and maybe even factoring) is at least partially the result of this trend towards longer payment terms. Based upon my experience, these extended payment terms (sometimes even Net 120) are especially common in aerospace and pharmaceuticals.

    This article suggests that the suppliers can’t afford lend the companies the money and are forced to borrow from the banks. This suggests that they will do everything they can to avoid paying their bills, this would be very concerning to me if I was selling them anything or lending them money (even if it is backed by strong legal rights). An organization without a moral obligation to pay debts is one that more likely to default on them even if the default is through bankruptcy.

    • MC01
      Jul 31, 2018 at 6:32 am

      Carillion was UK-based and mostly active in the UK, and in the British market the most common payment terms by far are Net 30, Net 60 and Net 90.
      There are other (relatively) common payment terms such EOM (End of Month), 21 MFI (21st of the month following invoice date) and PIA (Payment in Advance), but the three above are the most common by far.

      Carillion overwhelmingly used Net 60 and Net 90 as payment terms, so one may understand why their contractors and vendors had no problem being aboard the reverse factoring problem, as their payment terms could become Net 30 or even Net 7 (Net 15 is uncommon, albeit not unknown, in the UK).

      Reverse factoring is somewhat reminiscent, and possibly inspired by, some practices used by Japan’s sogo shosha between the 70’s and the 90’s to facilitate payments and which ended in some highly scandalous bankruptcies (IE Ataka & Co) and huge losses for the banks which lent the sogo shosha money (IE Sanwa Bank eating billions of yen worth of losses over the “aggressive” practices of sogo shosha such as Nissho Iwai).
      However back in the zaitech days the banks kept aloof of the system: they merely lent the “middlemen”, the sogo shosha, the money. The system had originally been designed to both facilitate payments among keiretsu members and to keep a lid on financial scandals by ensuring timely payments to small vendors only loosely affiliated with the big corporate groups or operating outside their sphere of influence. Only later it degenerated into yet another part of the infamous zaitech system.

      Reverse factoring was built from the ground up, and is pitched to customers, as a way to hide financial debt, not to facilitate payments. It’s most likely legal, but I have no idea in how many jurisdictions, and even there probably only because, as Wolf so wisely wrote, legislators left a loophole. How much this was intentional however we cannot know.

      • Hill
        Aug 2, 2018 at 8:30 am

        “legal” depends on how much they’ve paid their lobbyists to have the laws and regulations written to make it “legal.”

  17. Bob Johnson
    Jul 31, 2018 at 6:11 am

    Never posted a comment before, but this is absolute dynamite due to the fact that the financial collapse of the company can happen almost instantly and without warning.

    Gibbon1 is absolutely correct and the possibilities are frightening. I’m an old guy but years ago I received a lesson in conventional factoring when my partner and I acquired the assets of an electronics manufacturing company that had been put under by the bank that had provided the financing of receivables (factoring). Immediately after our acquisition a bank rep called on us in an attempt to convince us to repeat the same suicidal program – I threw him out of the building. We eventually turned the company around and sold it as a successful business.

    If conventional factoring is like heroin, “reverse factoring” is like Fentanyl. God help our economy if this practice is widespread in large corporations.

    • AV8R
      Jul 31, 2018 at 9:02 am

      So what you experienced was a sales job by the bank?

      Because it seems to me that in a world chasing yield methods like this used to generate some would be the rule not the exception.

      And if its Fentanyl like you say….

    • Jul 31, 2018 at 9:10 am

      Bob Johnson,

      Back in the day when I had to deal with receivables, we had the factoring folks hounding us. As in your case, this was classic “factoring” of receivables, not “reverse factoring” of payables.

      They offered to buy our current receivables (nothing past due) at a discount. When the receivables went past due, we’d have to buy them back, so we’d have to bear all the risks. But this would have been a hugely EXPENSIVE and very RISKY loan for us.

      The risk is this – as you point out: If you rely on this factoring service for part of your operating cash, and the factoring service suddenly says, as of now, we’re not doing this anymore, suddenly you have a liquidity problem that is totally unforeseen.

      Factoring at the time was a high-risk rip-off. So we never did it. We got a credit line at the bank instead, with our receivables as collateral. My feeling was at the time that only really desperate companies with no access to a bank credit line would deal with a factoring service.

      • David in Texas
        Jul 31, 2018 at 1:31 pm

        Wolf,

        A number of years ago, I was peripherally involved in a factoring company, and your point is correct: it is high risk, and is generally used only by companies whose finances don’t allow them access to a bank LOC.

        On the flip side, factoring companies have to be diligent against false invoices and other frauds. I was amazed at some of the things that owners of some of these shaky companies would try. If you didn’t stay on top of things, it was easy to get burned.

      • Bob Johnson
        Jul 31, 2018 at 4:10 pm

        Wolf,
        The bank rep reminded me of someone from organized crime, not a bank, he was about as slimey as they come. When I started to rant to my attorney about “factoring” he told me that it theoretically can work for a business with a very high net margin, but there are very few of those. I can say without question that there is no manufacturing business that has a net margin that can support even conventional factoring for long. And, if the company is an auto “manufacturer” that has a negative margin on every car that rolls of the line, well….

        AV8R – yes it was a high-pressure sales job. The yield environment in those days however was the opposite of what it is now. I compared “reverse factoring” with Fentanyl because both can kill almost instantly and without warning, especially if the company is hiding the fact that they are addicted. Once they get on that program there is no way out except feet first, it would take astronomical net margins to support that kind of debt. Keep in mind that as interest rates rise so does the amount the company has to pay in order to support the debt, unlike a payable that is fixed cost. And from the description it appears as if there is no way an investor or bond holder could ascertain the amount of the debt until it is too late.

    • Unamused
      Jul 31, 2018 at 10:01 am

      ->God help our economy if this practice is widespread in large corporations.

      It appears to be.

      I never give investment advice, but perhaps I can offer some thoughts. While it is true, as Mr. Richter stated above, that “So for now we can only guess by looking at the payables amount, but there could be other reasons for significant rises”, an unexplained rise in payables may still be suspicious. Coincident changes in other balance sheet items enabled by the rise in payables, also unexplained or weakly explained, could also be suspect.

      It may prove useful to go back into the histories of a fairly large sampling of firms, before ‘reverse factoring’ would have become popular, to establish some sort of baseline. From there you need to discount other factors, like changes attributable to the Great Recession, and also discount factors specific to each firm. With sufficient diligence and insight, using Carillion and others as models, the clever analyst might begin to discern identifying patterns in likely industries and particular businesses. You’re dealing with probabilities here and not certainties, but it may be enough to estimate additional risk which could be assigned to elements of a portfolio of equities, and after all it is better to light a single candle than to curse the darkness.

      So such an analysis isn’t easy and you should have started back before 2017 when the cracks were opening. The difficulties are compounded by distortions generated by other bad practices, and of those there are so many. Or you can skip the whole process and instead consider the wise words of Frank Field, as quoted by Don Quijones this past February

      “It’s Not only Carillion that’s Built on Sand, it’s our Whole System of Corporate Accountability”

      https://wolfstreet.com/2018/02/25/its-not-only-carillion-thats-built-on-sand-its-our-whole-system-of-corporate-accountability/

      If I were me, which I am, I might put some thought into a portfolio of short positions, in order to profit from the misery of others, and also shop around for lessons in avoiding financial lava bombs.

  18. manuel
    Jul 31, 2018 at 8:00 am

    Wolf, what amazes me is not the fraud, the lies, the potemkin villages, the wrong doing, running wild among so called free countries.

    I tell everyone the world went bankrupt in 2008,

    What amazes me is, how can ? TPTB manage to get this “circus” going for 10 years !!!!!!!!!!!!

    Even all that “money printing”, how can ? they hold so bankrupt corportations and countries afloat.

    Amazes me.

    Regards

    • Petunia
      Jul 31, 2018 at 9:23 am

      Yeah. I don’t ever want to see anybody shaming people who pay one credit card with another. It’s high finance for the highly financially evolved.

      • Javert Chip
        Jul 31, 2018 at 4:38 pm

        LOL, but point taken.

        How ’bout we settle for “not advisable”…?

  19. dan
    Jul 31, 2018 at 9:39 am

    The HIGH POWERED Forensic Accountants and Litigators must be licking their chops…and the global accounting (auditing) firms must be urinating on themselves.

    “Once more unto the breach, dear friends, once more…”

  20. Kent
    Jul 31, 2018 at 10:25 am

    I am not an accountant. I assume that when I have a payable it is to pay for an asset (inventory) or an expense (advertising). So, as an auditor, if I see “other payables” accelerating over some period of time I should see a corresponding increase in non-cash assets and/or expenses.

    If I don’t see that, and I see a corresponding reduction in cash outflow, it would seem to be pretty obvious that I am doing this “reverse factoring” thingy.

    Am I missing something here?

    • Steve clayton
      Jul 31, 2018 at 11:21 am

      You’re not wrong Kent the auditors should have been all over this, the going concern concept was not adhered to by the auditors.

    • Petunia
      Jul 31, 2018 at 11:22 am

      The interest expense should be increasing out of proportion to debt.

  21. jb
    Jul 31, 2018 at 11:10 am

    Shadow banking keeping “zombie” companies alive.

  22. Ambrose Bierce
    Jul 31, 2018 at 1:00 pm

    None of this seems egregious, the benefit goes to the supplier for using his clients better credit rating, I do wonder if that helps fix costs for the corporate entity. A relative lost his business in 08 when he couldn’t afford supplies to fill his orders, his bank wanted 22%. So he took out a REFI and the global markets took a dive and he lost his house and his business. The downside with this is all with the corporates, who are holding this debt. Probably better in the long run during a down turn if suppliers stay in business.

  23. cdr
    Jul 31, 2018 at 1:44 pm

    I just spent about 1/2 hour looking into reverse factoring. Weird. Lots of smoke but little real information. There appears to be no defined accounting treatment for it. For example, Intermediate Accounting provides gobs of detailed methods to deal with myriad specific situations. Zip with reverse factoring.

    As a counterpoint, AR factoring is common and a certain question on the CPA exam. AP factoring … I doubt it since it falls between the cracks regarding disclosure.

    On one hand, it’s a simple concept and innocuous. You ‘sell’ the payable to the bank. In a perfect world, the vendor possibly accepts a little less because they get paid more quickly. The end user reimburses the bank, probably with interest. The bank makes out from one or both ends.

    Classification wise, there is no classification other that ‘other payables’ or the like. ‘Trade payables’ does not apply, even though it really does.

    While the balance sheet in TOTAL is accurate, the ratio analysis is off because current data looks better than it really is.

    If the company pays it’s bills with no problems, then Who Cares. It’s stock might look better than it really is but there’s an industry that works for that so nothing is really much different. Another day on Wall Street.

    To reverse factor, a bank must accept the payable as an intermediary. The company ‘selling’ it must look good for paying it back otherwise the bank will be out.

    Nobody in their right mind would pay someone else’s bills for them unless they were absolutely sure they would be reimbursed with interest. This is the crux of reverse factoring, unless fraud is involved and then the bank is on the hook there.

    Summary: Yes, fraudsters can do a lot. But this looks like a tempest in a teapot.

    • Ambrose Bierce
      Jul 31, 2018 at 2:56 pm

      and mortgage originating companies are intermediaries as well? and the banks that passed on those loans to the GSEs and sliced and diced them into tranches and sold them as securities? Since you put it that way, now I am worried.

    • Jul 31, 2018 at 4:17 pm

      It seems you don’t — or don’t want to — understand the risks to the company — and therefore to its investors and creditors. Undisclosed financial debt that can be pulled on a moment’s notice. Shareholders and creditors wiped out. See Carillion. That’s what this is all about.

      If you’re not a shareholder, creditor, employee, or client of that company, then sure, as you said, “who cares.” The collapse of Carillion didn’t hurt your CDs (which is all you invest in, if I remember correctly from your previous comments), so from that point of view, “who cares.”

      But there are a lot of companies out there that are engaging in reverse factoring, and their investors and creditors are at risk without knowing about it.

      • cdr
        Jul 31, 2018 at 4:27 pm

        “But there are a lot of companies out there that are engaging in reverse factoring, and their investors and creditors are at risk without knowing about it.”

        How many? Percentages OK. Stratify among large and small companies. Good guess OK if qualified with reasonable stats. No nebulous stuff, please.

        Again – reverse factoring is nothing more than having someone else pay your bills for you. Nobody would do that unless they are going to make money off it. Carillon looks like a bucket of issues with this being only one.

        Agree lots of shenanigans with non-GAAP. Investors embrace them. Call it love if you like.

        This is GAAP and specifically a loophole. The big deal is that current ratios are distorted. Balance sheet unaffected even a little except regarding current ratio accounts.

        Re: Fraud – fraud is fraud and bricks in inventory boxes are no different. Is that a returning ghost in the machine yet to be disclosed?

        • Jul 31, 2018 at 4:51 pm

          You still don’t get it. There is not a single word in this article about FRAUD. Why do you even bring this up? NO ONE said it was fraud. How many companies? NO ONE KNOWS. That’s part of the problem. IT’s NOT DISCLOSED. This isn’t about some horrendous financial crisis. This is about investors in individual companies getting hit out of the left field because financial debt of a very fragile nature has not been disclosed.

      • cdr
        Jul 31, 2018 at 4:30 pm

        No, mutual funds are my thing. Mostly MM funds but busting out a little soon. Doing well with little risk.

      • Prairies
        Jul 31, 2018 at 5:34 pm

        When I read “I just spent about 1/2 hour looking into reverse factoring.” I almost skipped over the comment

        Not sure why Wolf even responded, the cup is obviously running over with knowledge after such a deep dive of knowledge and information.

      • Sadie
        Aug 1, 2018 at 6:19 pm

        Good article Wolf. AP risks will definitely increase as short term interest rates increase. You better believe the banks are making money on this and will be the first in line to get paid. Just curious, maybe correlating COGS to accounts payable? Accounts payable per unit sold?

  24. Paul Morphy
    Jul 31, 2018 at 2:53 pm

    Very interesting article, Wolf

    Risk factoring (RF) is a bank loan. Therefore it should be classified as a debt to be repaid.

    How the auditor to Carillion managed to reclassify “debt” as being “accounts payable/trade creditor”, and not classify “debt” as a bank loan is the question.

    I worked with a company who used to invoice discounting for debtors.

    Everytime the company raised a sales invoice, their bank would provide finance at 67% for each invoice raised eg, company creates a sales invoice for €100.00, their bank provides €67.00 in finance for that invoice. The company had to collect on the sales invoice within 30 days. If the company didn’t get paid for the invoice before day 30, bank interest started to be levied on the €67.00 advanced starting on day 31, and continuing until the invoice was paid by the customer.
    In the company accounts, the interest charged by the bank was disclosed as interest payable, and a bad debt provision was created for all outstanding invoice older than 30 days.

  25. Frank
    Jul 31, 2018 at 3:48 pm

    Could this be going on at Apple?

    • Javert Chip
      Jul 31, 2018 at 4:56 pm

      Raw data for Apple A/P Days Outstanding:

      2014 = 66 days
      2015 = 92 days
      2016 = 104 days
      2017 = 103 days

      Observations:

      1) Surprised me how large Apple’s A/P Days Outstanding are

      2) Given Apple’s convoluted supply chain, who knows what Apple’s supplier terms are

      • Paul Morphy
        Jul 31, 2018 at 5:44 pm

        Apple, because of it’s size and “firepower”, may well be able to negotiate more competitive terms with it’s suppliers (trade creditors)? Apple is forcing suppliers to be paid later rather than earlier.

        90 days plus overdue accounts payable balances could may be an indication of Apple failing to realise debtors quickly enough? In other words, Apple needs to get paid by it’s debtors before it can pay it’s creditors??

        Looking at Apples numbers, it’s payables balances are way out of proportion to it’s receivables balances.
        https://www.nasdaq.com/symbol/aapl/financials?query=balance-sheet

        • Javert Chip
          Jul 31, 2018 at 6:08 pm

          Apple:

          For past 3 years, Apple had revenue of roughly $225B and $30B of A/R. = 48 days of receivables.

          That is moderately higher than I would have guessed, but I have no idea what their sales channels look like. I’d be moderately intrigued, but not concerned (Apple also has $70B of cash & equivalents on the balance sheet).

    • Prairies
      Jul 31, 2018 at 5:42 pm

      I think it is safe to assume the lenders of these loans have offered these loan options to every corporation they have in their customer list.

      Depends if this cancer attacks the heart or not.

  26. richarda
    Jul 31, 2018 at 4:49 pm

    A couple of additional things: Carillion was a PPP – Public Private Partnership, hence the UK Civil Service ought to have been looking over Carillion’s shoulder at their internals, as well as the Auditors.
    Carillion was a management company – the sort that makes nothing besides mistakes – it outsourced all the work, usually to small niche companies as well as larger enterprises. If you looked at Carillion through investor’s eyes you would have seen that their debt ratio was way out of line and growing, compared to similar companies.
    My assumption was that they were using their suppliers to finance their turnover, as a sort of ponzi scheme. Hmmm …. reverse factoring, that hasn’t appeared until now. It doesn’t change the risks, just moves it to the banks.
    I really do not understand how a bank could sensibly finance these debts. They may have assumed that if Carillion went bust the suppliers would survive, but that would be a naive assumption.
    HMG had a Report on Carillion after the bust.

    • Javert Chip
      Jul 31, 2018 at 5:10 pm

      Richard

      “…I really do not understand how a bank could sensibly finance these debts….”

      Easy; it’s based upon trust in credit ratings from rating agencies and/or bank lending officers (loan committee). If there was zero risk, it’d be hard to make loans (who’d need one?).

      • Ambrose Bierce
        Aug 1, 2018 at 1:06 pm

        If banks are making up the difference between say 120 and 60 days between buyer and supplier you bet there is (systemic) risk involved here. The bull market is like a wall which falls apart one brick at a time.

  27. Setarcos
    Jul 31, 2018 at 5:05 pm

    Good friend of mine had 35 years of net worth invested in his employer’s stock which basically went under. Why is this relevant?

    Diversification. Very simple concept. Desperate groups of people AKA companies and govts will do anything to keep control another day. Reverse factoring sounds like concrete water skis.

    • Unamused
      Jul 31, 2018 at 8:22 pm

      Unfortunately, diversification doesn’t help you if every stock in your portfolio is doing acrobatics without a net. You have no way of knowing if they’re all doing reverse factoring, and what you don’t know can hurt you. With investing, ignorance is risk, and these companies are externalizing their risk onto you without your knowledge.

      They do it to hide debt, which hides risk associated with debt, which makes such firms look better than they really are, and therefore higher-priced, and therefore better for company officers whose compensation is related to stock price. It’s not illegal, but it’s not exactly honest, and as we have seen, it can be dangerous, which is to say, risky, and this is a way to deny you any risk premium.

      There may not be much about reverse factoring on Google, but you can be sure it’s caught the attention of risk analysts and graduate-level business students. We will know more in due course, hopefully before the lessons are learned the hard way.

      • Unamused
        Jul 31, 2018 at 10:48 pm

        Oh, what do I know. I’m a begonia.

  28. Bobber
    Jul 31, 2018 at 11:14 pm

    Reverse factoring allows revolving bank debt (in substance) to be reported as an “other payable” rather than debt. A company does reverse factoring for one reason. It allows the company to take on additional leverage without violating debt covenants. Thus, reverse factoring should be viewed as a huge red flag.

  29. Charles
    Aug 1, 2018 at 12:30 am

    If the right 30% of people would stay in bed all day, the rest of us would have a perfect world to live in.

  30. Laughing Eagle
    Aug 2, 2018 at 6:53 pm

    The more I read the more hidden data I see uncovered. This whole financial empire is built on air. Or as Ross Perot said in 1992, “that big sucking sound”.

  31. WSKJ
    Aug 3, 2018 at 9:44 pm

    Very informative; thx Wolf et al..

    I am reminded of one of Peter Lynch’s rules of investing for the common man : look at the nature of the debt. Debt that can be called may be dangerous. But wait, that was before “reverse factoring” existed (?) and therefore such form of debt (before its invention), could not be undisclosed. So this is evidently a new form of callable debt that may not be evident to any but the very sophisticated.

    Corrections welcome if I am getting this wrong.

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